Situation already so bad that hiding debt becomes a priority?
By Nick Corbishley, for WOLF STREET:
Australian engineering group UGL, which is working on large infrastructure projects such as Brisbane’s Cross River Rail and Melbourne’s Metro Trains, recently sent a letter to suppliers and sub-contractors informing them that as of October 15, they will be paid 65 days after the end of the month in which their invoices are issued. The company’s policy had been, until then, to settle invoices within 30 days.
The letter then mentioned that if the suppliers want to get paid sooner than the new 65-day period, they can get their money from UGL’s new finance partner, Greensill Capital, one of the biggest players in the fast growing supply chain financing industry, in an arrangement known as “reverse factoring”. But it will cost them.
Reverse factoring is a controversial financing technique that played a major role in the collapse of UK construction giant Carillion, enabling it to conceal from investors, auditors and regulators the true magnitude of its debt.
Here’s how it works: a company hires a financial intermediary, such as a bank or a specialist firm such as Greensill, to pay a supplier promptly (e.g. 15 days after invoicing), in return for a discount on their invoices. The company repays the intermediary at a later date. This effectively turns the company’s accounts payable into debt that is owned a financial institution. But this debt is not disclosed as debt and remains hidden.
In its letter to suppliers, UGL trumpeted that the payment changes would “benefit both our businesses,” though many suppliers struggled to see how. One subcontractor interviewed by The Australian Financial Review complained that the changes were “outrageous” and put small suppliers at a huge disadvantage since they did not have the power to challenge UGL. Some subcontractors contacted by AFR refused to be quoted out of fear of reprisal from UGL.
Reverse factoring is that it can be used by companies to create the illusion of cash flow, reduce the appearance of debt, and mask the true state of their leverage ratios. UGL’s massive parent company, CIMIC, has been accused of doing just that by Hong Kong research group GMT. Since the allegation went public, in May, CIMIC’s shares have lost 38% of their value.
CIMIC is one of Australia’s largest construction and infrastructure groups. It is majority owned by the German company Hochtief, which in turn is majority owned by the Spanish consortium ACS. In August ACS, the world’s seventh largest construction company, admitted it is making “extensive use” of both conventional factoring and reverse factoring “across the group,” to “more efficiently manage cash flows and match revenues and costs over the course of the year.”
Conventional factoring is a perfectly legitimate, albeit expensive, way for cash-strapped companies to speed up their cash flow. It involves selling accounts receivable — an asset in the amounts a company has billed to its customers and expects to be paid in due time — at a discount to a third party, which then collects the money from the customers.
Reverse factoring, by contrast, is a much more pernicious form of supply chain financing that is being used by large companies to effectively transform their supply chain into a bank. Put simply, if suppliers want to get paid in a reasonable period of time, they must pay an intermediary for the privilege. But importantly, in most countries there is no explicit accounting requirement to disclose reverse factoring transactions.
The companies can effectively borrow the money from the third party lender — thus incurring a debt — without having to disclose it as debt, meaning it expand its borrowing while maintaining its leverage ratios. This process causes the debt to be understated.
Credit rating agency Fitch warned last year that reverse factoring effectively served as a “debt loophole” and that use of the instrument had ballooned, though no one knows by exactly how much since there is so little disclosure.
In the six months to June, CIMIC used reverse factoring and other supply chain financing techniques to increase its total days payable to 159 days from 135 days in the previous six months, according to New Zealand investment bank, Jarden. By the end of June, its total factoring level was almost $2 billion.
More and more Australian companies are following the same playbook. Rail group Pacific National told suppliers in May that it was using global financial group C2FO‘s services to facilitate what it calls “accelerated payment of approved supplier invoices.”
Telecoms giant Telstra has ramped up its exposure to “reverse factoring” more than 14-fold in the space of just one year, from $42 million to almost $600 million. This $551 million increase, which is also reportedly being provided at least in part by Greensill, represents a staggering 18% of Telstra’s 2019 free cashflow, according to a report by governance firm Ownership Matters. Yet the company’s credit is still rated A- by S&P Global, making it one of Australia’s highest rated industrial corporations.
A Telstra spokesman said the company strongly denies that its accounts “are not an accurate reflection of our business,” adding for good measure that “supply chain financing is a practice commonly used worldwide – it provides our suppliers the option of getting paid upfront while at the same time getting the benefit of Telstra’s strong credit rating.” Once again, it’s a win-win for both company and suppliers.
Yet in its last financial report, Telstra disclosed that it had extended payment terms to suppliers from 30 to 45 days to 30 to 90 days. This is part of “a persistent trend” that is hurting the cash flows of small and family businesses across Australia, revealed a review of payment terms released in March by the Australian small business and family enterprise ombudsman. Not only that, it’s also making it more likely that Australia will sooner or later have a Carillion of its own on its hands. By Nick Corbishley, for WOLF STREET.
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– My take on this situation is that the intermediaries UGL is using to are getting more and more reluctant to facilitate this “Reverse Factoring”. I assume that Greensil also has to borrow money to be able to play this kind of game(s).
– It is surprising to see this happen. Infrastructure projects (e.g. in Australia ) have Always the tendency to have cost overruns to the tune of billions of (US) dollars. The australian state governments (Australia is like the US a federation) are feeling the “slow-down” in the australian real estate/property market already in their wallets. Lower sales volumes and lower prices mean that the revenues of the socalled “Stamp Duty” tax are falling (fast) as well. When someone buys a house in Australia then he/she must also pay a tax (a % of the purchase price) to the government. And with those tax revenues the state governments are paying the costs of those infrastructure projects.
– Correction: “It is surprising to see this happen” should be “It is not surprising to see this happen”.
To be a cynic, infrastructure and other large public projects do usually have significant cost overruns due to 2 factors:
1. when the project is presented to the politicians, the cost is understated, to make it easier for the politicos to decide in its favor.
2. the large contractors that run these projects know that once a project is up and running, then the politicos have no other choice than pay up when real costs are becoming visible ….
Fraud innundates the entire system… Enforcement of Laws is eroded… At some point, the endemic fraud either collapses the entire system, or a massive economic “Purge” is required. How can it be otherwise?
there could be a “Third Way?”
Probably got cash from “home offices” – 2% in the bank or 12% factoring and taking some risk, if you got working capital then you can work it, if so inclined.
How nice. Can anyone tell, if American companies are doing this as well? And how new, or old, is this?
Creative financing is just another word for someone who does not have the money.
Seems like a continuous slow motion train wreck in Aussie-land. A lot of stuff is becoming poisonous over there just like all those poisonous snakes and spiders they have (only place in the world that has more species of poisonous snakes than non-poisonous ones….would NOT go looking for my golf ball in the weeds/rough over there !!!).
The Aussies are going to have to deal with their overuse of debt just like everyone else. Amazing all the places debts pops up and the ways of hiding it.
All brought to you courtesy of the financial engineering of the world’s central banks. Gird your loins baby !!!
( their politicians are the most venomous species of snakes known to scientists)! :)
I have said it here before, Australia’s two most populous states NSW and VIC are bankrupt in all but name.
It’s only a matter of time till the three rating agencies get on the business of granting them the honorary “C or c+” rating!
The amount of debt that the dilapidated infrastructure will require is not possible to be sustained by the current population!
That said the lack of planning over the years and the lack of cohesive vision have caused a beautiful country albeit with verity of poisonous snakes to be starring at an economic disaster in the face : very soon.
Cheers
Australians don’t go looking for snakes. They have a horrible habit of turning up uninvited though in gardens if you live near the bush. It’s not that routine though. Thankfully, we have snake catchers who can be called and catch the sods.
As for the economy, I see major signs of strain but our “leaders” appear to be trying denial on as a solution.
It’s pretty common practice in the rag (garment) industry screwing over small operators from NY to LA.
Weyerhaeuser tried this about 15 years ago. It was called “Vendor Managed Inventory”. You sold a truckload to one of Weyco’s Distribution Centers and anything they sold of yours was tallied each month end and they cut you a check monthly. You had no idea what was really in inventory, nor the condition of it.
Kind of like reverse floor-planning that Major Corporations used to do with their dealers. Except for Weyco, their small vendors were financing them.
I told Weyco, if they could not access funds more easily and cheaply than I could, then I would happily discount my prices and sell to one of their competitors.
Most box stores, and the likes of Walmart are slow, slow pay.
I supplied small organic molecules to Pharma, Ag, and biotech companies for research in the 1990’s. Eli Lilly one day sent a letter that they were changing from paying in 30 days to paying suppliers in 90 days. That was the end of me selling to them. I doubt they missed me.
Sounds like ‘if you want to get paid at all you’ll have to agree to getting paid less and late’
Suppliers will raise prices to offset the penalty for being paid on time. If they are at set pricing under contract they will do their own creative billing to make it happen.
A company that puts its relationship with its suppliers at risk must be desperate.
Sounds like negative rates! Negative payments!
It may delight Wolf Street readers to learn that Italian banks are not merely waist deep but neck deep in the reverse factoring business. As the saying goes, some folks never learn… especially if they get away with murder without even a slap on the wrist.
I hope some of our Australian friends will shed some light on their peculiar situation, but the beautiful thing about reverse factoring in Italy is the creditor/vendor (henceforth “poor sod”) remains on the hook even after signing away his credits. Confused? Let me explain.
Let’s say your company is owed €50,000 from a customer who pays after 90 days, which is an awfully long time but not unheard of. Most banks engaged in the reverse factoring business will take that credit off your hands (for a fee, more on which later) and give you the cash in 15-20 days. When the receipt comes due the bank will try getting the money from the creditor. If he pays up, all is fine but if he doesn’t or does only in part “poor sod” has to pony up the difference, with the addition of some pretty hefty fees (over 6% is common) and then still try to get his money back.
Do you feel lucky punk?
There’s another kind of reverse factoring which is reserved to “high quality credits”, such as those owed by city governments and large construction groups, which cannot go burst but will handle payments with the worst possible grace. In this case “poor sod” is off the hook after cashing his cheque, but he still has to pay his pretty hefty fees to get at his hard-earned cash.
So let’s speak about these fees. Generally speaking “poor sod” will pay a nice 2% right away and another 4-5% at the end of the fiscal year. On top of this there is a bewildering array of charges for everything, from mailing notifications around to payment through different (yet fully legal) methods than a direct bank transfer. Nick is right in saying “but it will cost them”.
I am not a “Mais où sont les neiges d’antan?” type, but I am convinced reverse factoring would have remained a marginal financial instrument at best had not legislature become so heavily eschewed in the debtor’s favor over the course of the past few decades.
It’s one thing to help people and companies going through a rough patch to stay on their feet, albeit under the watchful eye of an impartial authority figure, and it’s quite another to encourage late payments and all sorts of shenanigans by making it so easy for debtors to get away with it.
I am sorry for the final tirade but sometimes I wish for the return of debtors’ prisons, pillory and true “bank-ruptcy”.
“It may delight Wolf Street readers to learn that Italian banks are not merely waist deep but neck deep in the reverse factoring business.”
Why not.
Its good banking business .
Hint
Providing finance at a cost, thats what banks do, the banks are not the criminals here.
“…a customer who pays after 90 days, which is an awfully long time [to wait] but not unheard of…”
I have a very good friend who contracted with A-B Inbev in St. Louis three years ago, and he felt lucky to be grandfathered in at a “net 120” payment plan instead of the “net 150” they switched to while he worked there (he was there only 9 months).
“Net 120” means you got paid 120 days after your invoice is processed. That last part is significant, because their office only counts invoice submittals once a month. So, if you were really unlucky, you can add up to another 30 days to whatever “net” plan you were under.
By the time my friend left, the rumor was that the goal of A-B was to make all contracts net 180, i.e., half a year until payment was due.
I know this isn’t directly related to reverse factoring, but the fact that a beer juggernaut – or rather THE beer juggernaunt – like A-B would put the screws to its support system like this astounded me. When I saw your comment about 90 days, I had to come out of the woodwork and share. Although, clearly Italians have their Belgian/American friends beaten in other areas.
By the way, MC01, I am huge fan. You’re the most informative commenter here, and a great contributer too. You, Wolf, Nick, and Adam are the Justice League of economics!
Jon, thanks for the compliments.
Reverse factoring was originally born precisely to deal with similar situations: many vendors just could not wait 90, 120 or even more days to be paid as they had a myriad of financial commitments and needed the cash. Others may have just needed the liquidity quickly for whatever reason. It was a way to cope with endemic late payments.
Large customers tend to be the worst payers, for no other reason they can afford to bully their smaller vendors as much as the law allows and sometimes (often) even more. Taking them to court will yield results but it takes a lot of time and money, and let’s not forget you may become persona non grata. Why keep on working with somebody you are having a legal dispute with?
Its beautiful
This story is a beat up. CIMIC has $37 billion work in hand, tendering for $400 billion in projects and is in Net Cash. It is also buying back stock (10% of the company, on like 15% free float, the largest buy back on the ASX), as the share price is way below intrinsic value which is > $50 on a PE that reflects its comparables.
CIMIC shares are down 38%, so CIMIC is buying back shares to prop them up. Classic. With borrowed money. Classic. “Net cash” is inflated by, you guessed it, reverse factoring — which is the purpose of reverse factoring, to inflate the appearance of cash (from borrowed money via reverse factoring) and reduce the appearance of debt. Is CIMIC paying you to post its propaganda around the internet?
You should’ve told Rodney to get out of any investment in the construction industry in Kangaroo land that he might be holding Wolf! :)
The whole industry stinks now, it might appear to be doing major projects totaling $120 billion on the surface of it, but the amount of losses that investors will carry will be staggering .
One more bonus advise:!
The banking sector have inflated the housing market to the tune of $6 trillion dollars! The correction that was supposed to have happened ( in the last 6 months) was stymied by the squealing of these banks!
The Stupid government’s policies of the 4 pillars ( the big four banks that dominate the Australian market) sees those Rouges as a pillar of prosperity to the Australian Financial Economy’s health ( where in fact that these fours will be the undoing of its Economy).
There is Not much left to prop up these Vandals’s value except a bailout which is on the agenda of the Australian governments from both persuasions.
Nothing will hinder the banking sector now , they’re living the dream of the spoilt child, wrecking the health of the Economy without fear .
The largest of these banks ( the commonwealth bank ) which is valued at $ 120 billion is built entirely on the inflated housing bubble, so you could confidently subtract 40-50%?from its value to bring it to reality!
It all brings a picture of cheerful and happy ending indeed!!!
So. Cheers
√
Your lack of tolerance for false propaganda is becoming Legendary.
√
Your lack of tolerance for false Propaganda is becoming Legendary
Excellent correction of R.F.! Ignorance is bliss, as the saying goes ,and RF is blissfully ignorant.
Share buy-backs, together with crooked accounting games?
Looks like a bad investment.
What is Ozzie-talk for “Chapter 11”?
Big discount demands and late payments should instigate a harsh.
Cost benefit analysis, of the customer.
Many times you will find the “Customer” is actually a “COST” to your business, you are better off with out.
Unless you have an LARGE upfront margin that after discount can absorb the “Customer” costs and still return you your required profit margin.
“CIMIC is one of Australia’s largest construction and infrastructure groups. It is majority owned by the German company Hochtief, which in turn is majority owned by the Spanish consortium ACS.”
The above, tells you all you really need to know.
Me I would be putting the whole string of them on cash only. simple, low cost and low stress levels.
\
Chasing/attempting to retain, market share , has put many good supply businesses, into Bankruptcy or the poisonous tentacles of private equity.
When did GAAP become a four letter word? Doesn’t anybody publish the GAAP version of their books?
When did GAAP become a four letter word?
1973.
Doesn’t anybody publish the GAAP version of their books?
That would be unprofitable.
When did GAAP become a four letter word?
1973.
LOL
I have contended for years that 95%+ of the American investing public is financially illiterate (ie: cannot meaningfully read GAAP financial statements).
Couple this with a “fairy-tale ending” renderings of financial reporting (say, We or Uber…), and you get things like EBITDA earnings, or (my personal favorite) “earnings excluding EBITDA and compensation”.
A very few sophisticate investors and financial analysts know when & how to make use of such techniques, but fundamentally illiterate investors are willingly mesmerized by any positive presentation of “income”
roddy6667,
My understanding is that GAAP doesn’t require disclosure of reverse factoring. If a CPA with deep knowledge of how GAAP deals with reverse factoring reads this, please chime in.
Wolf: I am a retired CPA ( worked for a national firm out of college but then went into in academia but also continued to practice and kept a select few clients – still keep my license active but focus is tax law as it affects our daily lives)….with that said, and totally from memory my thoughts are as follows: since most of these companies have enough horsepower in the form of internal CPA’s who are their CFO’s or controllers are familiar with the provisions of U.S. GAAP and will purposely structure the agreement so that the transaction is treated as a sale rather than a secured borrowing, which again, from memory will “dodge” the disclosure requirements…. I believe , as borrowings need to be disclosed.
If I recall, this also makes the arrangement non-recourse. This treatment is also important if a company has loan covenants and must meet certain ratios such as debt to equity and working capital. Again, from memory, I hope this helps and that my recollection is not out of date. Take care.
Thanks!
A loan is a loan is a loan, right? Maybe not in corporate lala-land.
This demonstrates yet again that there’s no business practice which lawyers can’t screw up for everyone by creating loopholes to create a temporary benefit for a few friends.
From personal experience I can tell you that large foreign companies operating in the U.S. are indeed utilizing Reverse Factoring on a huge scale in U.S. And have been doing so for over at least the last 3 years.
Thank you for a splendid article (and to MC01 for additional details). A small donation made.
Worked well for GE. LOL!
And now suppliers will add in the cost of this nonsense into their bids which will result in the overall cost of these infrastructure projects rising. Guess who ultimately pays?
Or.
These suppliers demand full payment up front before any goods or services will be delivered.
Not every supplier is delivering toilet paper.
Some suppliers are one of a kind and very crucial to these projects. Or are needed in emergencies.
Some may even go back and rip out whatever they had done. I have actually seen that on residential projects for non payment.
I see a pushback and it will only result in additional costs and delays.
Yup. This is exactly what will happen. Liens as well. But your first option is the real truth. No one wants to fight it out. Just charge more for the hassle of dealing with such a deadbeat, deceitful customer. Vendors do this all the time. Also never do too big an order at once because everyone knows one day the checks wont come at all. If you can gouge them now it’ll make up for anything you lose when it goes bust.
Here’s a weird one for you.
My company’s largest customer went from paying 90 days max down to thirty days. Maybe if they get it down to ten days the can get the 1% discount.
The accounts payable department must have hired some ancient throwback from the days before it went to financial engineering and treating suppliers worse than any bank would allow.
Situation already so bad that hiding debt becomes a priority?
If hiding debt has become a priority then the situation is likely to be a lot worse than it appears because even worse aspects of the situation have also been concealed.
Situation already so bad that hiding debt becomes a priority?
If hiding debt has become a priority then one should suppose the situation is a lot worse than it appears because other aspects of the situation have also been concealed.
i couldn’t agree more.
I dimly recall CIT had to file bankruptcy in 2009 when its commercial paper/factoring business blew up so these kind of three card monte schemes can also take down the lenders.
A July Forbes article stated 40% of Australian mortgages are interest only.
Some time ago Australian real estate prices started heading down. GDP growth slowed. In August and September housing prices started to rise again.
A company may have liquidity problems, or is trying to maximize profits. Reverse factoring is like, “I do not want to pay you now, I may be able to pay you later. You may have to borrow money from my recommended finance company to tide you over.”
The July Forbes article about precarious Australian housing market vulnerabilities that may affect engineering and construction companies:
https://www.forbes.com/sites/johnwake/2018/07/23/5-reasons-home-prices-are-falling-in-australia/#688a49962e54
40% of Australian loans being interest only may have been an overstatement by Forbes, but others have written about the hundreds of billions of dollars of interest only loans as well.
Forbes is not exaggerating, to the best of my knowledge. IO investing is favoured by landlords. Mortgages and refinancing are way down this year with government spending keeping the entire economy treading water.
We had a Royal Commission into banking in 2018 which is worth looking up online if you are interested. Bail In legislation was passed in 2018 too.
“CIMIC is one of Australia’s largest construction and infrastructure groups. It is majority owned by the German company Hochtief, which in turn is majority owned by the Spanish consortium ACS. ”
Sounds familiar. Are they selling meth on the side?
That is a shocking allegation!
Spanish companies do not sell meth; they sell crack.
Just a simple question.
It is only logical to assume that those companies using reverse factoring are having some trouble raising cash to pay their vendors.By using reverse factoring ,their vendors may be able to get their money quicker, but at obvious costs.
My question is ,won’t vendors just pass on all of the new fees in future billing cycles, just exacerbating the original company’s cash flow problems?
“confidence games and fraud are a common practice worldwide and thus we at Giant Super Mega Corp have adopted these practices.”
Really Australia? You think coping Chinese corporations way of doing things is a good idea?
Reverse factoring was invented when China was still an exotic and mysterious country esconced behind the Iron Curtain.
It was a bit before my time so I don’t remember the exact details but the system was invented either in then West Germany or Japan during the post-war economic boom and, believe it or not, the original idea was not bad: since late payments were becoming endemic and started affecting operations of smaller vendors, reverse factoring was a quick and easy way for companies to obtain instant credit and/or to be paid quickly.
While one may frown upon having to pay a fee to get paid, the alternatives were not much better and far slower: as the saying goes, it’s the price of doing business.
Reverse factoring lost ground as payments became quicker over the decades but in some countries it always remained an important part of the credit system because, well, local legislature actually encourages late payment in spite of continuous pledges to the contrary. Italy and Japan I am looking your way.
UGL, the construction giant used by Nick as an example, is typical of the “late payers” in that it’s huge, considers itself too big to fail and, most likely, has a shaky financial situation like most large construction groups worldwide. In short they are bullying their smaller vendors around as much as the law allows them.
And it would be really interesting to see the details of their agreement with Greensill, especially if Greensill has an exclusive over reverse factoring deals. An exclusive means less banks and PE firms prodding around to see how financially healthy and solvent UGL really is and not hiring detective firms to see if UGL is up to any financial shenanigans, if you catch my drift…
– The story of UGL simply confirms that more and more australian companies are “struggling” with their cashflow/income. NOT with the amount of debt. The amount of debt becomes a problem only when the debtor can’t afford to pay anymore.
Looks like a good old fashion walkout is in order. If workers want power, they have to take it, they are not getting their money anyway.
This is what Amazon did. They paid every 30 days for years. Fall 2018 they sent a notice that in 30 days they would only pay after 60 days. If you sell it in January, you get paid at the end of March, instead of the end of February. This was with only a 30 day notice. Does this mean they are having financial problems?
No, it probably means they are getting too many returns and it pays for them to wait for the return period to expire before paying out sales. I think this is more likely because anytime we return something, we get an instant refund when we use their return shipping label.
Reading all these ‘shenanigan’ creative accounting stories along with the stress in REPO mkt, real or not, makes me wonder seriously, COUNTER-PARTY is rising among Banks, corporations. This was the exact prelude, months before Lehman collapse! Before Enron, world com collapsed!
Mega credit event either in public or private sector is the the fuse waiting to be lit, for this 3rd largest bubble to burst! hardest part is the timing since, vested parties have kicked this, nicely so long!
Isn’t ‘reverse factoring’ just recourse factoring renamed?
But how does the factored invoice purchased by the finance partner not show up as a liability on UGL’s financials, if it must appear as an asset on the financial partner’s books?
Even if the supplier’s factored invoice is recourse, the supplier is only the counterparty of last resort and UGL is the primary counterparty.
In some states in the US, one of the hidden goals of extended payment periods is to extend it beyond the allowable time in which a creditor can file a lien. Gotcha, you little annoying supplier. God bless those clever little corporate attorneys, just protecting the interests of their corporate clients. Maybe its time to extend that period to file a lien to maybe 2 years.
Having read Corbishley’s post and commentary above, I come away with the conclusion that “reverse factoring” is currently a global practice (re the U.S., Trinacria above seems to confirm that it is commonly done here; MCO1 states that it started in China).
nofreelunch’s comment above is frightening, especially re small businesses, which are probably hurting already by the time they must consider filing liens.
Am I getting this right : reverse factoring is now a global economic practice, with variations in how it appears in the bookkeeping, and the financial statements ??
Thx all.
What about the hidden goals of extended payment periods .