Commercial Finance

Cash For Clunkers

2009-08-06T12:02:00.003+08:00

SAW simply can't figure out the rationale for this silly scheme in the US, now the latest recipient of government largesse. Cash is handed out for returning an old non-fuel-efficient car, which is then applied as part payment for the purchase of a newer fuel-efficient car.

Given that vast swathes of the American population are now in debt, all this scheme does is add debt on debt.

© 2009 Sanjeev Aaron Williams All Rights Reserved

Show Me The Money

2009-07-01T01:34:00.003+08:00

A stunning graphic that portrays the huge US bailouts between March 2008 and March 2009 - put in an historical context.

The graphic is taken from www.ritholz.com/blog

As that blog article says,

".....the bailouts managed to spend far in excess of nearly every major one time expenditure of the USA, including WW1&2 (omitted from graphic), the moon shot, the New Deal, total NASA budgets (omitted from graphic), Iraq, Viet Nam and Korean wars — COMBINED".

Total cost: US 15 Trillion and counting.

Lessons From Michael Jackson

2009-06-30T19:11:00.002+08:00

1. OK, you've got tons of talent - but your 2 biggest assets are your health and your time. Let either of those slip, and you've had it.

2. Should those in your organization even be there?

3. How did they get into the organization in the first place?

4. Are you clear on what authority they actually have, as opposed to the authority they think they have?

5. Who's paying them? For what? And Why?

6. What's your cashflow burn rate? Per Week? Per Month?

7. How strong is your ability to draw on new sources of funding?

8. Are your contractual commitments clearly spelt out?

9. Will you be able to keep those commitments?

10. What are your financial, logistical and creative resources to stage a commercial comeback?

11. Do you have the physical, emotional and mental stamina to see it through?

12. What's your corporate succession policy after you've left the scene or the planet?

13. Just how much drama will you tolerate before creativity dies?

14. Your business legacy will be ..........what, exactly?

© 2009 Sanjeev Aaron Williams All Rights Reserved

US Bank Stress Tests

2009-05-13T23:30:00.001+08:00

The 19 - bank stress tests in the US are unconvincing and predictable. While the intent might have been laudable, the heavy back room politicking that triggered the abandonment of mark-to-market accounting weeks beforehand, laid the groundwork for an equally creative outcome of the tests. SAW remains wary – there’s still the weak state of the commercial real estate market, the default rates of prime mortgages, the true extent of the reset of Option ARMs and a potentially major credit card default. The latter if it materializes, would dwarf the combined capitalization of some well known credit card issuers.

So…..what are price earning ratios on banks worth these days? As we wait for the next shoe to drop, the tension in the bank balance sheets is between retained earnings and writedowns.

And guess which one is going to win? Yeah, the writedowns, since retained earnings will drop as current earnings shrivel. It's a little premature to point out "green shoots" or to claim that the financial system is "healing" (per Tim Geithner).

© 2009 Sanjeev Aaron Williams All Rights Reserved

Humility & Humongous Banks

2009-03-03T00:29:00.001+08:00

SAW having kept his mouth shut for a few weeks to see which way the financial winds of change were blowing, has discovered that other than shaking like leaves in a hurricane, the global elite of bankers and the hapless politicians don’t have a clue.

Davos 2009 was a washout, with some CEOs too embarrassed to attend.

The European Union has discovered to its horror that it’s not unified at all, but consists of 3 distinct economic blocs: firstly Germany France and the U; secondly the southern European countries like Portugal, Spain, Italy and Greece whose real estate bubble has burst; thirdly the impoverished Eastern European countries to whose toxic debt the other European countries were exposed in addition to the US garbage. With Germany emerging as a reluctant central banker to the EU, there are pleas to avoid protectionism within the Eurozone which carries with it the spectre of a new Iron Curtain between rich and poor Europe.

Obama grins while throwing trillions at an unquantifiable problem and simultaneously promises new infrastructure projects and increased government stakes in Citigroup and others that still pretend to be banks. How he proposes to spread the wealth back to the middle and working class in the face of the greatest and utterly fraudulent engineered scam, that for 7 years sucked the wealth into the hands of the (unprosecuted) banking elite, remains to be seen.

No doubt as part of his inclusive policies, he’ll have to defer to those bankers complaining that they’re being unfairly bashed. The American Bankers Association bleated to Obama that very few banks were involved in the toxic debts. Numerically, that may be true. But those on Wall Street and elsewhere who were involved, leveraged their exposure to outrageous levels and sabotaged the real economy. Any good that came out of it was the realization that merging fractional reserve banking with the debt addiction of US consumers, for whom repayment was a novel concept, was bound to affect the banks Balance Sheet sooner or later – no matter how exotic the debt instrument or the credit default swap daisy chain that purportedly backed it.

Case in point, AIG that insured those credit default swaps and is now described as a “systemic risk”, is back for a second bite of US30 Billion the government cherry after its first chomp of US150 Billion. It faced a credit downgrade in the face of a US 61.7 Billion loss for the last 3 months of 2008 (apparently the largest quarterly loss in corporate history).

It’s right up there with the talent to be found at RBS.

Or HSBC, whose sub-prime exposure to the US market necessitated a cash call of US 17.7 Billion through a rights issue in the UK (the biggest in UK history), the closure of its consumer lending business in the US, and a cut in dividend.

What really cracked SAW up were HSBC’s statements of contrition, which included this gem that there had to be a reversion to some of the older principles of banking in terms of a simpler sense of providing good customer service, good relationship management and a sensible approach to liquidity.

“Reversion”???!!! why on earth would an apparently prudent bank diverge from those principles?

Oh yeah……….unbridled greed coz everybody else was doing it.

© 2009 Sanjeev Aaron Williams All Rights Reserved

A Whiter Shade Of Pale

2009-01-22T02:44:00.002+08:00

So let’s see..........World Emperor Bush rode into the sunset and hopefully, will be consigned to the trash bin of history. 44 is in, sternly warned the planet that things wouldn’t be easy, partied all night, went to church and started work.

Meanwhile US, UK and Hong Kong markets – and markets pretty much everywhere else, tanked and still are. Bank of America, which swallowed Merrill Lynch is throwing up, divested its “strategic” shareholding in a Chinese bank and screamed for a cash bailout from the Feds. They got it – US138 Billion for them, US118 Billion in guarantees for Merrill’s crap err….assets.

Citibank, the world’s global bank, is a global embarrassment with a share price to match. It’s disembowelling itself and donating part of a vital organ, the brokerage arm, into a joint venture for a capital infusion.

Royal Bank of Scotland proudly announced it had scored another first: a 28 Billion Pound loss, the biggest in British history. One assumes that its overpriced leveraged acquisition of ABN AMRO for 49 Billion Pounds – at the time the largest banking acquisition in UK history –might have contributed to its backhanded stellar performance.

The British government is all set to open the floodgates of liquidity with 350 Billion Pounds of cash. They already have precedent on their side. First it was Northern Rock’s bailout of 55 Billion Pounds in September 2007, then Bradford & Bingley in September 2008, then credit guarantees, a liquidity scheme in October 2008, something about a toxic asset buy up plan etcetera, etcetera…….plus the hint that the Bank of England could be given license to print money, effectively at will to enable “quantitative easing”. That’s assuming that buying up the crap with UK Treasury Bills doesn’t work. And remember, British interest rates are the lowest they've been in 314 years.

Australia is not looking so thrilled. Access Economics reported that the country is heading towards the sharpest recession in its history. Plumetting commodity prices mean a decrease in government royalties, taxes and increasing budget deficits.

With the scale of the toxic debt instrument creation belatedly becoming coherent, both the US and the UK governments have announced plans to set up a special bank to absorb those assets, in exchange for equity in the surrendeing banks.r

Great….so we have creeping trans-Atlantic nationalization, the Fed prints money at will, the Bank of England can print money at will and soon the European Central Bank, given the mess that Eurozone is in, will also be printing money at will. Effectively, every white country is up the creek and the loss of confidence is damaging emerging economies. It’s worth remembering that this scale of money creation, whether individually or jointly, has never been done before. We’re all watching an experiment in which nobody knows what’s going to happen and nobody can predict how much confidence there will be in all this freshly minted cash.

© 2009 Sanjeev Aaron Williams All Rights Reserved

Politicians, Ponzi & Prayer

2008-12-18T00:31:00.001+08:00

So for the moment, the 3 US auto companies were rejected by the Senate in their media circus application for a multi-billion dollar bailout. Accusations and blame are being exchanged as pre-Christmas gifts amongst the management, union and politicians.

Whilst the quality of management and overall competitiveness of the US auto industry is debatable, it’s important to point out that at some level they are also victims of Wall Street’s financial engineering debacle. This is because the 3 US auto companies rely on short term financing via the commercial paper market, which seized up.

The politicians played tough with the auto CEOs – demanding oversight, cutbacks in wages and executive pay, then crashed their bailout in the Senate. It was the same song they sang to the investment bankers but then handed over hundreds of billions with no oversight in sight.

Those politicians screaming for greater financial regulation will no doubt be fortified in their views by the now collapsed, decades long, multi-billion buck Ponzi scheme run by Wall Street grandee, Bernie Madoff under the nose of the SEC (to whom he was an adviser) and NASDAQ (of which he was Chairman). Just how many complaints are necessary before the SEC will act? Ask them. There were complaints about Madoff since 1999.

Call Madoff the aftershock to the main financial earthquake. The best that can be said about him is that he appeared to be an equal-opportunity scammer, targeting the ultra-rich and charities. It’s all great news for the lawyers.

There are lessons to be learned for SMEs. It’s been widely reported that Madoff was under financial and emotional stress. Even a Ponzi scheme requires cash flow. SME Directors facing cash flow pressures frequently resort to paying off favoured creditors at the expense of others. Cooking the books is another option, but both are a zero sum game.

Cash is king and cash flow is the true measure of business success. Like Madoff, a business may be showing a profit, but is in reality insolvent.

With US interbank lending rates now cut to 0.5%, the hope is this will translate into widespread consumer lending so that the average American can once again, enjoy his drug of choice – debt.

SAW’s suspicion is that the US consumer has been so traumatised, they might actually start doing the unthinkable – save.

© 2008 Sanjeev Aaron Williams All Rights Reserved

The Bigger The Trough

2008-11-24T00:02:00.001+08:00

…..the larger their snouts…..

The US auto companies didn’t quite get the warm political reception they’d hoped for as part of their grubbing for US25 billion. Given that all 3 claim to be on the verge of bankruptcy, it didn’t help their case that the CEOs arrived in private jets. In mitigation, General Motors is returning 3 of its leased jets while promising greater use of video conferencing…..

Oh, and being asked by politicians to spell out exactly why they need capital, what they intend to do with it, over what time frame and what kind of returns to expect, was hardly a surprise. Any SME, whether looking for factoring funds, seed capital, mezzanine financing, venture capital or a bank loan would be asked exactly the same questions. What gave the auto companies’ CEOs the temerity to think they’d be exempt from the basic criteria of accountability?

Probably the fact that to date neither the US Federal Reserve nor the Treasury will disclose exactly what securities they have accepted as part of the now scrapped “cash for trash” deal that was the original TARP. The new plan to directly take equity in the banks (and potentially anyone else) has already been derided as incipient nationalization and crony capitalism. Oversight provisions as to how the government funds will be dealt with once injected, are non-existent, other than a bland assumption that the funds will be deployed for lending.

Meanwhile, according to Calculated Risk, as of 21 November 2008, 22 US banks have failed this year – so far. In fairness, some banks in the US, particularly those that stayed well away from the financially engineered toxic debt instruments, are doing just fine and are happy to continue and extend lines of credit to well managed commercial clients.

And the boys at Citigroup – whose share price is now that of an enhanced penny stock - are working overtime negotiating a government bailout or a sell off (of their lucrative credit card business, the Smith Barney brokerage, or their recently appointed CEO Vikram Pandit who announced jobs cuts totalling 82,000).

The joys of being an international conglomerate like Citigroup, allow for a degree of self-righteousness flatly denied to private companies: Citi is too big too fail and must be “saved” to end the hysteria; as a US company operating all over the world overseas governments should help bail it out; Citi is a victim of short sellers whose stock price has a reached a level that necessitates government intervention by way of cash injection, absorption of bad loans and an assisted merger.

Um… OK… government intervention for whose benefit? The shareholders or the financial system?

© 2008 Sanjeev Aaron Williams All Rights Reserved

Suck My Cash

2008-11-13T23:54:00.005+08:00

It’s either gone surreal or we’ve entered the realms of financial pornography.

So far, at least 23 American banks signed up to fellate the US Treasury-demanded cash injections from the US$250 Billion intended to prop up the banks by buying stock in them and to encourage lending.

Well, that was the theory anyway.

The bottom line is that the onward lending to the floundering consumer and the anxious business owners isn’t happening.

In the last 24 hours, the US Treasury Secretary announced that TARP (the acronym for the program to purchase toxic assets from banks) isn’t working and has been shelved. Instead, the US Treasury will directly purchase shares in banks.

Or, apparently anyone else that needs money......like the big 3 US automakers lining up for US25 billion on the basis that as legacy companies they are too important to fail…..American Express looking at massive credit card defaults and a major purveyor of securitized credit card instruments, now imploding, has become a “bank holding company” in the same way as Morgan Stanley and Goldman Sachs, with greater access to federal funding.

But the real figures are likely to be mind-boggling. Forbes.com in an article entitled, “Washington’s $5 Trillion Tab”, dated 12 November 2008 cites data from CreditSights in an attempt to itemize where the money is going.

But what are we actually witnessing? For starters, a total lack of oversight as to where the money is going and a refusal to fully identify recipients of US Treasury largesse. Bloomberg's report of 10 November 2008 stated that the Federal Reserve was refusing to identify who was receiving US$2 Trillion dollars of loans courtesy of the American taxpayer or what securities the banks were pledging in return. Congressional oversight was allowed as part of the US700 Billion dollar TARP, but far more than this is being lent out in separate rescue programs that did not require congressional approval. Hardly surprising that Bloomberg filed federal legal proceedings in the US under the Freedom Of Information Act. And what else are we looking at? Crony capitalism, the evisceration of retirement savings and ultimately, a global increase in the retirement age.

© 2008 Sanjeev Aaron Williams All Rights Reserved

Global Interest Rate Cuts

2008-10-08T23:43:00.001+08:00

Earlier today, Hong Kong time, there was a coordinated response from the US Federal Reserve, Bank Of Canada, Bank of England, European Central Bank and the Riksbank of Sweden to cut interest rates by 50 basis points. All banks issued public statements in similar form, pointing out the need to take action in a slowing global economy.

Would it be impertinent to point out that interest rates are already low, have been for sometime and still the US economy, the European economies and the Asian economies are slowing or are expected to slow?

Is SAW missing something? How do lowered interest rates deal with the 2 fundamental issues of institutional decapitalization and deleveraging?

And if the problem is one of outrageous consumer debt and shoddy bank lending, are lowered interest rates going to make the banks thrilled to lend again to consumers who turned out to be lousy credit risks?

Not likely.

One of the widely read blogs, Mish’s Global Economic Trend Analysis, asserts in a posting, Global Coordinated Rate Cuts Won’t Solve Economic Crisis dated 8 October 200,8 that the root cause of this crisis is fractional reserve lending. Interesting……SAW is no economist just a simple lawyer, who in his previous post entitled What Crisis dated 1 October 2008 suspected the same thing.

As MIsh put it:

“The world is heading for a global recession and a sure bet is that it will be blamed on a subprime crisis in the US. The reality is the greatest liquidity experiment in history is now crashing to earth.

The root cause of this crisis is fractional reserve lending, and micromanagement of interest rates by the Fed in particular and Central Banks in general. The Fed started the party by slashing interest rates to 1%, but Central Banks everywhere drank the same punch to varying degrees.

The Greenspan Fed lowering interest rates to 1% fueled the initial boom, but like an addict on heroin, the same dose a second time will not have the same effect. The Fed, the ECB, etc. could have slashed rates to 0% today and it would not have mattered one bit.

The reason is simple: There is no reason for banks to go on a lending spree with consumers tossing in the towel, unemployment rising, and rampant overcapacity everywhere one looks with the exception of the energy sector.”

© 2008 Sanjeev Aaron Williams All Rights Reserved

What Crisis ?

2008-10-01T02:10:00.000+08:00

It gets tedious after a while, reading all the political and media spewing espousing the need for an apolitical solution to an economic – and legal- problem. Superlatives are everywhere: “financial Armageddon”, “global meltdown” “catastrophic failure”….ad nauseam.

Yeah, it’s kinda fun watching history being made, and even more fun attempting to make sense of it. All this talk about the need to protect assets, to ensure credit markets don’t freeze and the risk of sharp inflation - even though SAW suspects that the term “inflation” is a misnomer. It’s probably sharp depreciation in purchasing power caused by too much US Dollars aka Funny Money swilling around.

And talking about Funny Money and credit, exactly what is seizing up? Here’s one theory from a simple lawyer. What is seizing up is the grossly over-inflated, exponentially grown, debt- based supply of money that was, literally, created, out of thin air without reference to anything else.

Whilst greed, fraud, conspiracy and tacit governmental approval are all in the mix, SAW suspects that the (presently legal) practice of Fractional Reserve Banking was exploited to the Nth degree with monstrous effect.

If Customer A deposits $1,000 in the bank, the bank has the legal right to lend the majority of that $1,000 to someone else. So the bank might lend say, $900 to Customer B. That is recorded as an electronic transfer of funds into Customer B’s bank account. Therefore, it is technically a deposit of $900.

That allows the bank to then use that “deposit” of $900 to make a loan of the majority of it to Customer C. So, Customer C might get a loan of say, $800. That would also be by way of an electronic transfer of funds into his account and would technically be regarded as a “deposit” of $800.

Again, the bank would lend the majority of that $800 dollars, say, $700 to Customer D….and the process would be repeated ad infinitum.

All this money (technically “currency” not “money” – there is a difference) is created out of thin air without reference to any underlying asset values. It operates solely as a debt-based creation i.e. the more debt that is created, the more money can be created out of thin air for lending. On that view, the creation of sub-prime mortgages made perfect sense. They were the perfect debt-creation vehicle upon which Fractional Reserve Banking could grow exponentially – and did.

And those sub-prime mortgages were subsequently, sliced, diced, repackaged and resold as “Asset Based” or “Mortgage Based Securities” to Investment Banks and Hedge Funds.

The simple point being made is that the money supply, created out of nowhere and based entirely on debt, was so outrageously large that it bore no relationship to the value of goods and services in the real economy. Putting it another way, the actual hard core assets did not exist to support that level of lending.

If that is correct, the widespread practice of shoving the exotic, and now toxic, debt instruments Off-Balance Sheet (and in many cases Offshore), also made perfect sense. Bringing them onto the Balance Sheet would result in an erosion of actual bank capital –which is exactly what is now happening. That explains the reluctance of banks to lend to each other and the recent spike in LIBOR.

Which is why a US Federal Government Bailout is such a lousy idea: the US Dollar is nothing but a debt-based fiat currency. In its crudest terms, the bailout is debt compounding debt.

Perhaps what we are now seeing is not a credit crisis, but a spectacular and necessary implosion of the debt bubble contracting to a level where the debt is backed by capital assets. Will there be severe restrictions on personal and commercial borrowing in the near term? Yes.

Will there be a change in Wall Street’s mentality? Dream on. People got filthy rich on this scam.

What’s a bet they created this situation up to this point plus the frantic requests for a bailout, in order for the next instalment of their grand scheme to kick in? SAW finds it impossible to swallow the notion that Wall Street is spiraling out of control or has been caught by surprise.

© 2008 Sanjeev Aaron Williams All Rights Reserved

US700 Billion Bailout

2008-09-29T02:33:00.001+08:00

The startling thing about the US700 Billion Dollar bailout is the assumption that the Federal Reserve, the US Treasury and the folks on Capitol Hill have the patent on the solution. Despite so much incisive commentary in places like RGE Monitor by Nouriel Roubini, Money Morning and others, the bailout appears to be exactly that – a handout, albeit in tranches with Congressional oversight, whatever that means.

The Calculated Risk blog, in its posting for September 28 2008, sets out a summary of the proposals, via a document that emanated from the Office of the Speaker of the House, Nancy Pelosi. There are 3 critical components:

1. Re-invest in the troubled financial markets to stabilize [the US] economy and insulate Main Street from Wall Street

2. Reimburse the tax payer through ownership of shares and appreciation in the value of purchased assets

3. Reform business-as-usual on Wall Street through strong Congressional oversight and no golden parachutes.

There are repeated uses of the phrase “participating companies”. That’s a warning bell right there. If conditions (2) and (3) are taken at face value, those companies on the receiving end of government largesse, risk increased public interference at Board level, at macro and micro levels, including the scrutiny of executive contracts. Given the propensity in the US to unilaterally assume and extend jurisdiction wherever possible, SAW would not be surprised if, pursuant to the bail out, “participating companies” and not just the US Treasury would find themselves subjected to examination from the General Accounting Office (GAO). In the Pelosi document, the GAO is to have a presence at the Treasury, together with an Inspector-General. (No mention as to how much that would cost).

If anything, conditions (2) and (3) might later deter companies from participating in the bailout and send them down the road of a private re-structuring to maintain their independence, executive compensation and more importantly, the business-as-usual on Wall Street which condition (3) seeks to reform.

The reference to small and mid-sized companies is ominous: the Pelosi plan wants to help save small businesses that need credit by aiding small community banks hurt by poor quality mortgages, by allowing them deduct their losses by investing in Freddie Mac and Fannie Mae.

Why is it ominious? It implies that the smaller banks will be next to implode. That frustrates the intention to insulate Wall Street from Main Street. Secondly, it’s an open question whether the Federal Deposit Insurance Corporation is adequately capitalized to deal with the failure of a host of smaller banks. The irony is that the FDIC might need a bailout.

© 2008 Sanjeev Aaron Williams All Rights Reserved

Thanks For The Memories

2008-09-24T01:09:00.000+08:00

“The reality is that the financial system has been operating as if it were an off-balance-sheet vehicle of the government. Private-sector companies and individual bankers have been making huge profits in the bubble. Their risk appetite has been enhanced by previous bail-outs and, in the case of Fannie and Freddie, by the government’s implicit guarantee. Yet their market pricing does not reflect the potential cost to the system of their own collapse.”

John Plender, “Capitalism in Convulsion: Toxic Assets Head Towards The Public Balance Sheet” published in the Financial Times, 19 September 2008.

OK agreed…something very exciting has been going on in the model of Western capitalism, at least in the US which will probably have to reconsider it’s claim to be the bastion of free market capitalism.

In case anyone forgot, back in 1933 commercial banks (i.e. the ones that take deposits from Joe Public) and investment banks (i.e. the ones that create financial instruments for primarily institutional investors) were required by law in the US, to keep their operations separate. The excesses of the investment banks via over-leveraging and speculation was one of the reasons for the stock market crash in 1929 and the start of the Great Depression.

Back to the present, at last count, 3 of the 5 biggest investment banks in the US have gone: 2 by self-sacrifice, Bear Stearns and Merrill Lynch; and one by insolvency, Lehmann Brothers, whose operational entrails are now being picked by Barclays Bank PLC and Nomura

The remaining 2, Morgan Stanley and Goldman Sachs have been offered the status of “bank holding companies”, allowing them to take deposits from Joe Public. Funny how history repeats itself. Once again, investment banks are morphing into commercial banks……

….and for 2 good reasons (at least for them): First, they will have access to Federal funding should they find themselves in a distressed situation again. Secondly, garden variety retail deposits, boring and predictable as they are, constitute a stable source of capital. It’s now clear that over the last few months, investment banks saw a massive erosion of their capital base when they were forced to bring in Off-Balance Sheet debt instruments over which they had no hope of getting paid.

Or to put it another way, Joe Public stands to fund Morgan Stanley and Goldman Sachs privately, via his retail deposits; and publicly as an over-indebted taxpayer through government largesse.

But the investment banks have to pay a price. First, a reduction on leveraged finance and debt ratios. Second, a submission to greater governmental regulation. Third an obligation to separate retail deposits from capital market activities.

What does all this mean in practice? With their newly re-capitalized status, expect Goldmans and Morgan to go on a predatory spree to acquire small distressed commercial banks – of which there must be lots.

Although the figures for bailouts have been gargantuan, the lesson for SMEs remains easy to digest. If your Balance Sheet is riddled with debt that you have no hope of collecting, your cash flow dries up, your capital base erodes and you go out of business.

And the government couldn’t care less.

© 2008 Sanjeev Aaron Williams All Rights Reserved

Sleight Of Hand - Just For You

2008-09-21T00:45:00.003+08:00

Regulation is inherently prophylactic and cannot be properly created in the crises it seeks to prevent. Today calls for a single coherent and transparent approach to falling house prices (destined to continue), asset write downs (destined to continue) and liquidity crises (destined to continue). We simply cannot have Sunday closed-door meetings deciding the fates of tens of thousands of jobs, life and death for industries and billions in investor losses. Want to see what that creates? Pick up a newspaper.

Max Fraad Wolff
Editor of the Global MacroScope Website
From the article “US At A Turning Point” published in Asia Times Online 20 September 2008

Yes indeed……” a single coherent and transparent approach…..”

It’s not necessary to rehearse the hype or the horror that’s been seen on the streets and the media. More entertaining is how funny money i.e. the US Dollar (removed from the gold standard 37 years ago by Richard Nixon) continues to be printed at record rates to fill financial potholes created by Wall Street and their political cronies.

Having satiated themselves financially, they are now calling for regulation and the creation of a “Bad Bank”. The single coherent and purportedly transparent approach is a super-sized entity, by way of a fund of US800 Billion that will buy all the toxic debt and hold them indefinitely until they can be sold off at some point in the future. Effectively, it nationalizes the mis-managed, corrupt, criminally negligent results of the biggest fraud in modern history……..

…..with apparent legal immunity from prosecution.

There’s a trans-Atlantic threat to go after the short sellers and a temporary ban on short selling in the shares of some listed financial companies. But short sellers did what they do best – responding to rumour and fact by taking an opportunistic position against banks, hedge funds, insurance companies and investment banks who consciously leveraged risk to outrageous amounts then resorted to Sovereign Wealth Funds, private equity and carefully crafted press releases to buy funds and buy time. All this to allow them to dance around the perimeter of their rapidly growing pool of un-saleable, off-Balance Sheet, offshore-held, “asset”-backed and mortgage-backed securities.

If short sellers knew what they were doing, so too did the companies who were shorted.

There’s no denying that short selling abruptly stalls over-valued stocks and might crash their price, but that’s the inevitable flip side of overblown asset valuation, whose prices were allowed to bubble unchecked for……..7 years.

Quoted in the BBC’s online report of 19 September 2008, entitled, “Who’s In The Dock For The Financial Turmoil?” Professor Richard Portes of the Centre For Economic Policy Research said,

“A key issue is the opacity of the banking system. If no-one can truly assess the liabilities of a given financial institution, how can they confidently lend it money? But this has helped people make money.

"You make money when it is opaque, you make money when you have got information that other people don't have.”

The extraordinary dereliction of duty by regulators and central banks fuelled the opacity. The creation of the super-sized “Bad Bank” centralizes the opacity. True transparency requires the full disclosure of actual or suspected toxic debt instruments, the use of criminal sanctions and the refusal to cave in to financial industry demands for lenient accounting standards and waivers.

Granted, the devil is in the details, but just how do you value opaque debt instruments? If banks looking to offload to the “Bad Bank” are forced to declare their toxic mortgage and non-mortgage based assets at a discount, won’t that affect their capital base and drive them into insolvency?

Perhaps SAW is too philistine in his views, but a true meltdown is required to flush this garbage out. We now risk being drowned not in a sea of toxic debt, but in a foam of political blather, half-baked regulations and the cherry picking rescue of those institutions deemed too important to fail. It appears that free market capitalism that made a certain clique rich beyond belief, has now morphed into emergency socialism with the express intent of limiting their losses, while purporting to act for the public good.

© 2008 Sanjeev Aaron Williams All Rights Reserved

Fannie & Freddie

2008-07-15T00:06:00.003+08:00

Yet again, it pays to shut up.

For weeks.

Anyone who read the assertive and incisive comments over the last few months by Nouriel Roubini in the RGE Monitor, would have reacted with déjà vu on hearing about the impending implosion of the US organizations Fannie May and Freddie Mac.

In case you didn’t know, Fannie & Freddie are privately owned organizations operating under the mandate of the US Government. They perform a dual function.

Firstly, they provide funding for home loans, not by lending directly to the consumer, but by buying up tranches of mortgages from approved lenders, re-packaging them as investments and selling them off to Wall Street and internationally (sound familiar?).

Secondly, they are the guarantors of last resort of about half of all US home loans. That’s about US6 Trillion out of US12 Trillion at the moment. The figures start getting a bit silly at this level of debt.

The theory is that in their role as middlemen between mortgage lenders and investors, more money would be available at cheaper rates to allow people to buy their homes.

It’s their role as guarantors of an increasing number of crappy and defaulting mortgages that sent their share price plummeting, amidst fears that Fannie & Freddie would run out of cash. Both issued statements that their capital base is strong – although Freddie is scheduled to sell US3 Billion in short term debt right about now.

Predictably, the US Government made patriotic noises about how they must not be allowed to fail. Their line of credit was extended (about time too: Fannie has US800 Billion in debt, Freddie has US740 Billion in debt) and the US Treasury may even buy equity in them. It doesn’t get much sweeter than that. And who would ultimately be paying for all this? The dear taxpayer of course. And what would they get out of it? Nothing, except for continued intransigence and reluctance to lend to individuals and SMEs citing the “global credit crunch” as the excuse.

Problem was, as the New York Times pointed out, for years nobody in the US government would even acknowledge the existence of the line of credit, even though it amounted to an implicit guarantee that a Fed bailout would always be there, while in the meantime the Government didn’t have to show mounting losses on its Balance Sheet for what was in effect, a subsidy.

Again, as the New York Times put it on 13 July 2008:

The dominant role Fannie and Freddie play today is no accident. The companies, Wall Street firms, mortgage bankers, real estate agents and Washington lawmakers have built up an unusual and mutually beneficial co-dependency, helped along by robust lobbying efforts and campaign contributions.

Back in the real world of SMEs, there isn’t the luxury of government insulation that gives the business owner discounted rates on the money markets, covers up lousy management, arguably encourages “moral hazard”, imposed lax capital standards – which went unsupervised for years - and aided and abetted the packaging of toxic debt instruments to private investors. Since you can’t pay for lobbying, the best you can do is network.

Who really benefits from this? It ain't the consumer or the SME. It's those investors in collateralized debt instruments, originated by Fannie and Freddie, seeking to have their returns guaranteed by the state. Or, put it another way, a prime example in the sub-prime saga where profits are privatized and losses are socialized.

What Lehman Did, You Can't

2008-06-07T17:14:00.002+08:00

The Lehman Brothers saga in the US gets more interesting, although it’s unclear whether it’s a story in the making or simply rumour and innuendo attempting to create a story.

An online report by Randall W. Forsyth writing in Barron’s published on 4 June 2008, stated that less than 24 hours after the investment bank was reportedly mulling issuing US$3 – 4 Billion in common equity, it went into the market and bought back its shares.

The obvious question was asked: can a company be under-capitalized one moment, only to be over-capitalized the next? Not likely. Clearly something was going on. In certain situations where the stock price of a company is low and capital cannot be usefully employed for shareholder benefit, it might make sense to buy back the shares. The effect of a share buy-back is to stabilize or lift the share price. While that is what happened in LEH’s case, the stock still sits at its lowest level since August 2003.

SAW agrees with Forsyth’s view that it is arguable whether a share buy-back was the best thing to do, given that LEH’s Balance Sheet is purportedly riddled with (CDO-based?) assets of dubious value and limited liquidity. But, if, as it’s CEO is on record as saying, that LEH’s intention was to hurt those engaging in the short-selling of its shares, then a share buy-back using whatever liquidity a company has, would be a defensive move.

As a publicly listed company, LEH has the option of immediately going into the stock market and buying back its shares. They’re millions of them out there, they have an immediate market value and they’re liquid. Buying them back is a snap. If that’s what it takes to maintain a semblance of solvency and liquidity, so be it.

An SME faced with pressing liquidity and solvency issues as well as a Public Relations problem, does not have those quick options. As a private company, its shares are held by a handful of people, possibly a mix of family members venture capitalists or angel investors. There may be a Shareholder’s Agreement with rights and obligations, a mechanism covering notice of intention to buy back the shares, clauses covering how the shares are to be valued and an arbitration procedure if things get really ugly between a shareholder and the company.

Whilst it is possible for an SME to buy back its shares, it’ll take a while. Lehman still has billions of bucks worth of liquidity on its Balance Sheet and could afford to take an immediate bold move to spend some of that cash on a buy-back. The average SME with a looming cash flow problem, couldn’t do it. Either it has to deal with its Receivables properly, or tighten up on its debtors, or reduce the credit period currently extended to its customers, or get a bank loan (good luck with that, at the moment) or offer equity to outside investors.

Doing nothing will just erode shareholder value. And that opens another can of worms.

Mortgage Defaults & Mortgage Insurance

2008-06-06T16:08:00.002+08:00

2 interesting stories on the Calculated Risk blog caught SAW’s eye today. The first quoted a report from Housing Wire that mortgage delinquencies in the US are quickly spreading beyond sub-prime borrowers into prime borrowers. The second is that mortgage insurers are twitchy in anticipation of one or more of them failing.

Essentially increasing numbers of supposedly solvent or ‘affluent’ middle and upper middle class borrowers are now finding they can’t afford their properties. Ed McMahon, Johnny Carson’s sidekick, is the poster boy for this phenomenon. He’s reportedly fending off foreclosure on his multi-million dollar California home, having tapped himself out on a home equity line of credit.

Remember that “prime borrowers” have been hit on 2 fronts:

Firstly, chalk it up to financial inexperience, ignorance, greed, lousy budgeting, a proclivity to take on more debt that can be serviced and the habit of using the home as an ATM machine – while regarding it as the largest asset on the assumption that its value would continue to rise indefinitely.

Secondly, it’s well documented just how greedy mortgage lenders became when sub-prime Adjustable Rate Mortgages initially proved hugely profitable. They quickly pushed the product onto unsuspecting prime borrowers who found themselves downgraded into the sub-prime category, saddled with a mortgage they couldn’t understand or afford.

So, if mortgage defaults are now spreading up the affluence chain, it must mean that the cash flow from their jobs or from their own businesses are patently insufficient. Expect relocations and more SME failures in the US.

The increasing number of defaults would predictably make mortgage insurers twitchy. They are also exposed on 2 fronts: the insurance of individual mortgages; and more ominously, the insurance of the exotic alphabet soup of Collateralized Debt Obligations.

Heard It Through The Grapevine

2008-06-05T00:16:00.002+08:00

They’re baaa…cckkk…!! Lehman Brothers is back in the news. The Wall Street Journal of 4 June 2008 and one of SAW’s favourites, the Naked Capitalism blog, are reporting that LEH’s appears to be on track to report a quarterly loss larger than the US$300 million predicted by analysts.

And they’re not the only ones making predictions. Investors have bet huge amounts on puts that LEH is gonna sink,sooner rather than later. Their debt rating was downgraded and their stock downgraded to “underperform”.

And what’s LEH said to be doing? Looking for US$3 - 4 Billion worth of new capital to shore up its Balance Sheet.

Effectively, a tsunami of rumour and predictions are driving perception and behaviour. At least the big boys have PR departments, press statements and the luxury of resorting to slick financial euphemisms.

LEH’s denials that it had funding problems and that it did not borrow money from the US Treasury, failed to convince the market and its shares closed down 10%. Let’s not forget that it was in March 2008 that LEH raised US$3 Billion from investors in order to refute reports that it was in the same predicament as Bear Stearns.

For SMEs, any rumour and predictions by outsiders, or insiders, on solvency, are potentially fatal. If cash flow is erratic, intermittent or eroded and debt ratings downgraded in the face of contracting credit, expect to be doing what some SMEs in the US are already doing – taking their goods to the pawnshop in an urgent attempt to raise capital. (Or, to use a Wall Street euphemism, “to shore up their Balance Sheet”).

The problem with rumour is that it takes on a life of its own. For SMEs, even at the best of times, it’s a delicate balance between Accounts Receivables and Accounts Payable. Inevitably, the worst aspect of any rumour reaches the SME’s most intransigent creditors first and encourages the SME’s debtors to delay payments to the last. But the phone calls demanding an explanation keep coming thick and fast.

What a bind. Crippled cash flow in a hurricane of innuendo. What’s an SME to do?

Factor the Receivables immediately if possible – even just a portion of them.

Ironically, shoring up the Balance Sheet through Off-Balance Sheet financing (another term for Factoring) is the quickest way to get cash flow, without giving up equity or sinking further into debt.

One more thing. The reputable Factoring companies are acutely sensitive to outsiders’ perceptions of Factoring and adopt the role of Receivables Managers. It’s all part of the Factoring service. Their ability to make it clear to the SME’s creditors and ultimate debtors that the SME is raising working capital through ongoing cash flow management, often goes a long way in assuaging potentially suspicious parties.

What Due Diligence?

2008-06-03T16:31:00.001+08:00

In Factoring deals, the most important aspect is the due diligence conducted by the factoring company on its prospective client and on the client’s customer to whom the invoice was sent. This is because the client’s customer is the ultimate payor. The willingness of the Factor to purchase the invoice at a discount from its face value and to receive full reimbursement from the ultimate payor, is based on risk assessment.

In other words, is the client and the client’s customer worth the risk?

Frequently, SAW gets clients whining that the Factor is asking too many questions, or the questions are too intrusive about the company’s operations, or why is it necessary for Directors to disclose information about themselves and their finances? (the answer is to determine whether the Directors might be stripping the company to line their pockets).

Yet when a bank asks those questions – and more – just for a loan, the Directors meekly comply. After all it’s a “bank” right? The notion that an institution like a “bank” and all its credit checks, is somehow more “authoritative” and “trustworthy” than a private funding source, runs very deep.

And it is deeply misplaced.

The banks’ role in the residential sub-prime drama is history. What is now unfolding is Stage 2: the banks’ and their co-conspirators compounded greed in the exotic securitization and creation of mortgage-backed, debt-fuelled instruments with purportedly stellar credit ratings. These are now unraveling with billions of dollars of losses in the pipeline.

To say that consumers and SMEs have been hurt by the sudden indefinite contraction in credit, is an understatement. What’s really galling is the utterly feckless credit risk analysis supposedly undertaken by banks, investment banks and credit rating agencies as they fell over themselves to slice and dice these securitized instruments in order to push them onto hedge funds and other “sophisticated investors”.

It’s clear that the credit risk analysis of inherently dodgy instruments was a sham at worst, a formality at best. A nudge and a wink was the order of the day at Wall Street. And they have very thick skins. The effect of shoddy and virtually non-existent risk analysis is now blamed on a computer error. That error apparently led Moody’s to assign Triple-A ratings to billions of dollars worth of complex debt product. The error was discovered in 2007, but the debt instruments’ AAA credit ratings remained until early 2008. And it doesn’t end there. The suspicion is that Moody’s may have tweaked its computer model to arrive at the same result as Standard & Poors, in order to keep business as “a second opinion”.

Of course, Moody’s is now doing “a thorough review” of its derivatives ratings.

To which SAW would add, Really?? A computer error that lasted errr……………….7 years???!! Remember it was after US interest rates were slashed in September 2001 that sub-prime mortgages and their securitized derivatives took off.

So….back to Factoring companies and the questions they take the trouble to ask during due diligence. SAW’s humble advice is to stop complaining, be grateful they’re doing their job (properly) and answer their questions fully.

Your future cash flow depends on it

A Slightly Longer View

2008-05-21T14:48:00.001+08:00

Sometimes, it pays to shut up – for over a month or so, and take in what the pundits are saying in order to make some sense of their pontifications, which could then form a pithy blog posting that would somehow relate to SMEs.

Well that was the theory anyway.

And what did the last few weeks of studied silence reveal?

That Wall Street is trumpeting that everything’s great in the credit and stock markets. That Henry Paulson and Warren Buffet think the worst is over, that Jim Rogers and Nouriel Rubini think the worst is yet to come. That the US is in even more of a financial mess than originally imagined. The credit crunch may (arguably) be over but the recession is yet to properly kick in, and the jury’s still out as to how long that will last and what “shape” the recession will take i.e. will it be “V” shaped with a steep recovery; a “U” shape with a lull and then a steep recovery or an “L” shape with a sharp drop and indefinite flat lining.

As Bill Bonner of the Daily Reckoning for 12 May 2008 put it:

“In America, meanwhile, people are working their way down. We're not kidding. Wages are stagnant. Prices are rising. At the end of the day, they have less spending power; they are poorer. Besides, it said so in the New York Times. People lose their houses…move back in with their parents…and put their stuff in a storage unit. Then, they either can't make the storage payments…or they realize that the move wasn't just temporary and they give up. Pretty soon, the auctioneers are selling the stuff.”

Yeah, that all seems to gel with what I was reading too: Americans hauling stuff to the pawn shops, giving up their SUVs, cutting down on the Starbucks latte (assisted by Starbucks closing some outlets). Foreclosures, especially in California and Nevada, are at record levels.

But here’s the question: if people in the US can’t afford their home payments it means that their incoming cash flow is simply insufficient or they’ve taken on more debt than they can handle. Usually, incoming cash takes the form of wages and salaries. Either they’re not being paid enough or the average American is up to their eyeballs in consumer debt, mortgage debt and worsening credit. The latter appears more likely.

But, what about those compromised homeowners who also own their own businesses? It seems reasonable to assume that amongst the pandemic of foreclosures, there must have been independent business owners too. Their business cash flow was insufficient to maintain their house. If they too are caught up in the scenario that Bill Bonner sets out above, and are forced to move, what happened to their business and their employees?

Could it be that the previously self-employed are now being forced to relocate and turn into employees?

A Prompt Delay

2008-04-10T00:53:00.001+08:00

It’s all getting farcical and paradoxical. Hence the title of this post. An online report in the International Herald Tribune dated 8 April 2008, said that the International Monetary Fund (“IMF”) warned that sub-prime losses could reach US$1 Trillion broken down as follows: US mortgage losses, securities tied to commercial real estate, loans to consumers and companies.

Since the total losses and asset write-downs reported by banks and other flakes are in the region of US$232 Billion, the forecast of US$1 Trillion suggests the worse is still to come.

“There was a collective failure to appreciate the extent of leverage taken on by a wide range of institutions - banks, monoline insurers, government-sponsored entities, hedge funds - and the associated risks of a disorderly unwinding.”

Interesting choice of words. A “collective failure to appreciate……”??? Garbage. It was a conscious act of cumulative greed, going back 7 years.

As one commentator put it, this wasn’t a problem on Main Street, it was manufactured by Wall Street.

Personally, SAW prefers the following quote taken from Byron King’s article, “The Flipping Industry” published online in The Daily Reckoning dated 8 April 2008:

“It is apparent that much of the old way of doing business - particularly in the realm of lending money - was rotten to the core. In my view, it begins with the dollar itself. The dollar has been steadily deteriorating in value for decades, so inflationary expectations are part of the worldwide consciousness. That is, just because of the long-term decline in the value of the dollar, most people expect most things to go up in price most of the time.

So is it any wonder that people developed a "speculation expectation"? This fed into an entitlement mentality, as well, that tainted every rung of the credit ladder. A lot of people wanted to buy and flip, whether it was houses or stocks or commodities. So other people lent to people to enable buying and flipping. Flipping became a dominant, if not defining, element of the financial "industry," of sorts.

But what an industry! For example, in the past five years, many people just plain lied through their teeth on everything from credit card applications to mortgage applications to the lending documents for multibillion-dollar takeovers. It was pure and brazen fraud in many instances, verging on burglary in plain sight. The next level up the food chain - the brokers and loan officers - often just looked the other way and rubber-stamped the papers. "Hey, not my problem."

This kind of bad buck-passing went all the way to the top of some firms, many with familiar names. There in the ethereal reaches of the nice office buildings in Irvine, Calif., and Fort Lauderdale, Fla. - let alone Wall Street - the chief executives knew, or should have known, how risky the portfolios were becoming……”

There’s no lack of wishful thinking in the IMF report either suggesting that banks improve disclosure and take write-downs "as soon as reasonable estimates of their size can be established."

Yeah right. In case nobody noticed, the banks are taking their own sweet time to disclose the size of their losses, apparently operating on the assumption that a periodic drip feeding of their loss disclosures would be easier for their shareholders to stomach – and in the meantime, sugaring the pill by begging from Sovereign Wealth Funds and, if they’re in the US, sucking from the Federal Reserve’s discount window in exchange for tendering worthless securities on a “no-questions-asked” basis.

Oh yeah, the new IMF boss who took office in November 2007 admitted that the organization,

“was not as vocal as it could have been about the risks that a subprime collapse posed for the global financial system.”

Maybe that’s all he should have said.

Double Or Nothing

2008-04-05T01:18:00.003+08:00

So it’s now official. Swiss bank UBS, Europe’s biggest investment bank, felt it needed to become truly famous and announced not only a 2^nd consecutive quarterly loss, but further sub-prime related write-downs of US$19 Billion – basically doubling its losses. It catapulted itself to the top of the loser’s league with total losses of US$37 Billion. See the earlier post, And The Winner is…2, dated 3 April 2008.

In addition, it is raising 15 Billion Swiss Francs by issuing new shares to Sovereign Wealth Funds from Singapore and the Middle East who had earlier thrown money at it.

Now here’s an interesting spin: the SCMP Business News, published in Hong Kong on 2 April 2008 quoted a fund manager at Mizuho Asset Management who said:

“The fact that the latest [news] from UBS is a combination of capital increase and write-down should be welcomed to some extent because it’s a reflection that they are speeding up their write-offs.”

Alternatively, it could be viewed as a sober realization that their mammoth write-offs had truly eroded their capital base and they had to act fast. So fast, that they are setting up a new business to handle their US property assets that are now worthless. That’s a pretty clear indication that a huge level of Receivables cash flow had just plummeted from the Current Assets column of their Balance Sheet to the Bad Debt column.

This blog has repeatedly warned SMEs that poor or inefficient management of Receivables cash flow would have a similar result. Unlike UBS, whose Chairman is not seeking re-appointment (and will leave suitably compensated of course), a CEO of an SME doesn’t always have that luxurious option. A Director’s failure to monitor the risks inherent in the company’s cash flow is a breach of fiduciary duty both to the company and to its shareholders. With shareholders of well known investment banks and Wall Street titans getting burned left, right and centre, it can be expected that shareholders of SMEs (often family members) and venture capitalists, will sit up and take notice of exactly how their business is performing – particularly in this time or rollercoaster uncertainty.

With banks reportedly reluctant to lend to SMEs, Directors of SMEs can expect to be asked hard questions by their shareholders about the company’s positive cash flow and the risk models in place to protect and guarantee that cash flow, the company's working capital and the Returns On Investment.

If the SME's Receivables are badly screwed up through reckless inefficiency and the Directors (to quote the UBS Chairman) promise that the next chapter will be one of "discipline and determination", don't expect them to last very long.

Stating The Obvious

2008-04-03T23:04:00.003+08:00

“If you’re a smaller player, you need more capital to do business in tough times. They now need to show that they can keep churning profits in this environment”

David Hendler, CreditSights analyst, quoted in the Business News, South China Morning Post, 2 April 2008.

He might as well have been talking about SMEs. He was actually talking about Lehman Brothers having raised US$4Billion from a special offering of 4 million shares. The proceeds are slated to increase its capital base and provide greater financial flexibility.

Sounds familiar doesn’t it? Some of the best known names on Wall Street are scrambling to raise working capital and giving up equity to outside shareholders, despite the bravado.

Whilst this blog is not exclusively about Factoring, the pain on Wall Street is a nice contrast to Factoring, the potential benefits of which can be found by going to the Labels column on the Right Hand Side of this blog.

And The Winner Is...Part 2

2008-04-03T00:56:00.004+08:00

It just keeps getting better. Here, courtesy of the BBC’s online report dated 1 April 2008, is the updated list of the sub-prime losers. All figures are in US Dollars. See the up and coming post entitled Double Or Nothing for what SAW has to say about UBS.

UBS: $37.4bn

Merrill Lynch: $22bn

Citigroup: $21.1bn

HSBC: $17.2bn

Morgan Stanley: $9.4bn

Deutsche Bank: $7.1bn

Bank of America: $5.3bn

Bear Stearns: $3.2bn

JP Morgan Chase: $3.2bn

BayernLB $3.2bn

Barclays: $2.6bn

IKB: $2.6bn

Royal Bank of Scotland: $2.6bn

Credit Suisse:$2bn

Directors & Home Equity Loans

2008-04-02T00:13:00.002+08:00

Directors of SMEs, particularly those in start-up mode, are always looking for cash sources. It’s common for them to take a personal home equity loan and siphon the funds into their business. The assumption is that the business will make enough cash to service the home equity loan.

The reality is the home equity loan is usually a second mortgage and the business is saddled with paying that off – plus all the other overheads related to the business. In the US, particularly between 2002 and the end of 2006, rapidly rising home values and lowering interest rates, made home equity loans particularly attractive. Cash appeared to be right there, in the walls of the house.

People borrowed massively. The sillier ones for consumer items, the desperate ones to pay their other bills including their first mortgage, the greedy ones to speculate in property and the occasionally smarter ones, for business investment.

An online report of the New York Times dated 27 March 2008, put the figure of currently outstanding home equity loans in the US at US$1.1 Trillion. Falling interest rates and the Fed’s “nuclear option” of massive injections of “apparent liquidity” (yes, the words are deliberately in quotations because the liquidity is just recently printed money issued in exchange for less-than-stellar mortgage debt) have done nothing to ease the mistrust that exists amongst commercial lenders. Further, falling home prices, rising debt delinquencies and negative equity have only increased the mistrust between commercial lenders and consumer borrowers.

In a financial world awash with US Dollars from emergency measures (recently described as “Dollar Pollution”), there seems to be a huge shortage of US Dollars owed by the consumer borrowers to their lenders in the field of home equity loans.

So worried are lenders who made home equity loans, that they are actively obstructing the borrower from selling the house or refinancing it, unless there is some prospect of them being paid. As the New York Times article pointed out, when the going was good, they really didn’t mind what the borrower did. Using the home as an ATM was widespread.

Should the property have negative equity when sold (i.e. its value is less than the outstanding mortgage(s)), holders of the first mortgage have a priority lien to be paid in full first. That leaves nothing for the home equity lenders – particularly in areas of California, Arizona, Nevada and Florida where home prices are said to have fallen significantly.

If the same lender holds the first mortgage and home equity loan, they might be more willing to allow the borrower to sell or refinance. Where there are different lenders, home equity lenders are obstructing the sale and demanding at least partial recovery from the first mortgage holders.

For a director of an SME whose business cash flow is compromised by a souring US economy, refinancing the home equity loan may be difficult in the face of obstructive tactics by second mortgagees. Further, a delinquent home equity loan is noted on the borrower’s credit record. That will compromise the director’s ability to raise personal financing in future.

If the director files for personal bankruptcy, their ability to manage the company into which they poured equity in the form of cash and sweat is finished. Effectively, the director loses his home and his company. In other words, his cash flow.

It’s a zero-sum game: the worst kind of business equation.

Sticking It To Shareholders

2008-03-18T18:31:00.004+08:00

One of the by-products of the Bear Stearns “rescue” was the destruction of shareholders wealth. Forget the fact that the office building was worth US1 Billion; forget the fact that book value was apparently US80.00 per share; forget the fact that it’s share price fell 47% real quick. At the end of the day, when debt levels are officially “toxic” and cash flow is negative, the company was worth about US2.00 a share.

It’s worth remembering that Bear Stearns had a policy of actively encouraging employee share ownership. 30% of the company was owned by its employees, many of whom were subject to lock-up agreements as to when they could sell their shares. The point is now moot. Their shares are worthless. Ironically, this was the result of the company being deemed too important to fail.

Further, according to a report on Bloomberg TV today aired in Hong Kong, Bear Stearns had US50 - 60 Billion in liquid assets. Really? What took them so long to wake up and turn them into cash? After all, it was in August 2007 that they first reported that 2 of their hedge funds with exposure to mortgage derivatives, were in trouble.

For SMEs the sobering lesson is the fundamental importance of cash flow and liquidity. SMEs are notoriously lax in monitoring cash flow especially from their Receivables. In fact, look at the Accounts Receivables Ageing Report of an SME and it’s often shocking just how many Receivables are outstanding for more than 90 days or worse, more than 120 days.

Whilst they may be presently listed on the Balance Sheet as Current Assets and potentially liquid, the longer they remain outstanding, the greater the risk that they will turn toxic. In time, the Accountants will advise the company to shift those Receivables further down the Balance Sheet to Bad Debt. In other words, those Receivables are written off. The Invoice, which should have generated cash, is now a worthless debt instrument. Effectively, it’s no different to the massive writedowns witnessed on Wall Street from flakey mortgage backed securities. In either case, the cash flow is crippled.

SMEs don’t have the luxury of US Federal Reserve bail outs. The crippling of cash flow results in an erosion of shareholder equity. Yes, you can be profitable, and at the same time you can be insolvent. That’s the lesson Wall Street is now learning to its huge embarrassment.

And if the SME has lousy cash flow, is technically insolvent, is saddled with Bad Debts and has no other liquidity options, the Directors, who are usually the major shareholders, are holding potentially worthless shares.

Manna From Heaven

2008-03-17T02:37:00.004+08:00

“Leveraged risk is a cancer in the market”

So reported the online edition of the British newspaper Telegraph on 7 March 2008, apparently quoting UBS (and they should know, right?)

SAW decided to keep that quote, figuring that something would pan out in the coming days – and it did. First, the default and collapse of Carlyle Capital and then………. Bear Stearns, Wall Street’s fifth largest investment bank, nearly panned out, following a loss of confidence by hedge fund clients who withdrew their cash. All this against an accelerating backdrop of rumour and innuendo from 6 March 2008 that European banks, fixed income and stock traders had stopped trading with Bear because it was having trouble with daily liquidity and that it was not receiving short term financing from banks. You just knew something was very wrong.

By 15 March 2008, despite repeated statements from Bear executives that solvency was not an issue (the real clue that it really was), the US Federal Reserve and J. P Morgan Chase stepped in with an emergency cash lifeline for 28 days. The Wall Street Journal’s online report for 15 March 2008 spells out the sequence of events.

Since Bear is technically an investment bank and not a commercial bank, it could not receive the money directly from the Fed. Instead, the Fed lent the money to J.P.Morgan, a commercial bank, who then re-lent it to Bear. The Fed assumes the risk of default.

So what are the lessons in all this for SMEs?

You don’t have, or at least you shouldn’t be having, the apparent luxury of massive debt to equity ratios. One of the more astounding facts to come out of Wall Street last week was the revelation that companies like Bear were leveraged in mortgage-related derivatives at 32 times equity. That’s a fancy way of saying that you have one dollar in your left pocket, but you owe 32 bucks from your right pocket – and you don’t have any cash flow. How long do you think you could survive?

The more complex the derivatives, the deeper and more pervasive the risk of default. Let’s make one thing very clear. There is a difference between the sub-prime residential and other “asset” backed (read plasma screen TVs) mortgages – which are theoretically quantifiable, and the mountain of structured finance (read paper transactions) which sliced, diced, chopped and pureed these mortgages into ever more sophisticated and ultimately toxic cocktails whose value is unknown – except for the blatant fact that whatever it was, it ain’t now.

By way of contrast to (1) and (2) above, the sale of Invoices through Factoring does not result in debt. First, it improves your debt to equity ratio. Second, it improves your Balance Sheet (because the Invoices, which are listed as Current Assets, are converted into cash). Third, it improves your cash flow. Funny how Wall Street titans forgot that the more dodgy the security, the worse your cash flow, the Balance Sheet and debt to equity ratio. Pretty basic stuff.

For an SME, the unpaid commercial invoice is a quantifiable asset. The due diligence that the funding source does on the client and the ultimate payor ,is the assessment of risk to determine manageability. It's a tried and tested recipe without dubious notions of "mark to model" valuations.

And the rumour and the innuendo? SMEs are sometimes concerned that Factoring will damage their reputation or give the impression that they are financially unstable. It’s well known that Fortune 500 companies factor to improve their cash flow. An SME that is cognizant enough to guarantee its cash flow through factoring, capitalize on the time value of money and ensure that Receivables outperform Payables, will be the subject of one kind of rumour. Smart.

Tightening The Noose

2008-03-10T01:27:00.003+08:00

It’s apparent since the last posting on this blog on 6 February 2008, that financial institutions are in credit-retraction mode across the board – and nowhere more so than in the US. Capital liquidity ratios are being watched – apparently diligently.

What a concept!! For the past 6 years in the US, assumed cash flow from dodgy based credit was considered “prudent” business. It didn’t occur to these stellar bankers that when cash flow stops, capital base erodes, and business confidence with it.

The following quote sums it up. It’s taken from an article by Doug Noland entitled “At The Heart Of Disorder”, Credit Bubble Bulletin, published in Asia Times Online on 12 February 2008:

“[A] survey of senior bank-loan officers provided confirmation both that bankers have become much more cautious in lending and that borrowers have lost enthusiasm for taking on more debt. Moreover, any indication of general tightening of bank credit takes on major significance today due to the seizing up and breakdown of Wall Street finance. Inarguably, what erupted last year in subprime has now evolved into a broad-based and severe credit tightening. Notably, 80% of banks tightened credit for commercial real estate lending and better than a third tightened commercial and industrial (C&I) credit.”

For SMEs the news is ominous. It suggests that credit tightening is so broadly based as to have become indiscriminate. In other words, the company’s track record and creditworthiness are now irrelevant. Financially responsible SMEs may be denied access to funds from banks on account of the inflated and reckless stupidity of Wall Street and their cohorts. These large “sophisticated investors” were leveraged over, above and beyond their equity base in so-called Asset Backed Securities, Mortgage Backed Securities (many of which were sub-prime) and the associated derivatives such as CDOs and SIVs.

All of these products are now the subject of rapidly depreciating asset values, forced sales and margin calls. As mentioned in earlier posts, the issues are one of liquidity and solvency in an inter-connected credit web, where the risks taken were both direct and indirect.

Yeah, interest rates may continue to fall, but what difference does that make if SME’s can’t get the funds at any price?

It’s been one year since this whole sub-prime fiasco broke. For an informative look at how this whole thing unfolded, have a look at the article by Julian Delasantellis entitled, “Subprime Crisis A Year Later – And The Band Played On”, Asia Times Online, 6 March 2008.

Negative Equity & Negative Interest

2008-02-06T21:03:00.000+08:00

Having earlier said in this blog that interest rates are being seen as both the cause and the cure, yet again (and entirely predictably) the US Federal Reserve cut interest rates on 30 January 2008 (Hong Kong time).

Interest rates in both Hong Kong and the US are now officially below the rate of inflation. That’s small comfort to the hordes in the US who defaulted on their mortgages, abandoned their homes and left entire neighbourhoods derelict. Increasing Adjustable Rate Mortgages hit falling home values and home owners fell into Negative Equity.

And with negative interest rates, borrowing theoretically becomes easier for individuals and SMEs.

Not so fast………….if banks and financiers are still coy about their solvency and quietly anxious about their liquidity ratios, particularly in the US, expect them to be stupidly obnoxious and outrageously greedy in the terms of the loan they attempt to extract from SMEs.

Banks have never been thrilled about lending to SMEs and never really trusted them. Given the lies that the banks themselves manufactured about sib-prime and the resulting derivatives, it’s now at a stage where they don’t trust each other.

False Positive

2008-01-26T00:57:00.000+08:00

It’s one of the most ludicrous financial debacles to seep out of Europe – which only 2 days ago, was blaming the US sub-prime fiasco for the Earth’s financial ailments. The French Bank, Societe Generale, admitted that a junior trader responsible for betting on the European market’s future performance, racked up an unauthorized loss of US7.1 Billion on futures contracts.

In SocGen’s jargon, reported in the BBC’s online report for 25 January 2008, the trader had taken “massive fraudulent directional positions in 2007 and 2008 beyond his limited authority”. In other words, he was betting the bank’s capital that the European market would go up even though it was going south, hard.

What makes the whole thing so hilarious is not only SocGen’s abject lack of trader supervision, but just over a month ago, SocGen had to bail out one of its own Structured Investment Vehicles which was exposed to US sub-prime crap, to the tune of US4.3 Billion.

But it goes further than that. The US Fed claims that they had no knowledge of SocGen’s position when they cut interest rates this week (ahead of schedule) even though shortly after the fraud was discovered, SocGen sold massive amounts of futures contracts in a market that was sliding fast, which only amplified its own losses and that of the European markets generally.

The message for SMEs is clear: be careful who you laugh at. And just how good are your back room operations and internal supervision of cash flow? Often the directors of SMEs are so focused on marketing and bagging the next contract, they ignore the mundane administrative and supervisory aspects of Accounts Payable and Accounts Receivables only to take massive evasive emergency action when they least expect it. They blame everyone else, rather than accepting the blame for trusting the wrong people.

Next time a member of your staff says. “Everything’s under control”, be suspicious. Otherwise, like SocGen, your company may be the subject of an emergency cash call on shareholders and / or a rumoured takeover.

Interest Rate Cuts & Cash Flow

2008-01-24T00:34:00.000+08:00

It was common knowledge that a US interest rate cut was in the works. Instead of waiting for their scheduled meeting next week, the Federal Reserve cut the overnight lending rate on 22 January 2008 (US time), 23 January 2008 (Hong Kong time) to 3.5% from 4.25% and cut the discount rate (i.e. the rate at which the Fed lends money to commercial banks) to 4% from 4.75%.

The Fed wants to be seen acting aggressively and proactively. But it’s beginning to sound like wishful thinking. Global stock markets, in Asia and Europe went in 2 different reactions: Asia, re-bounded on 23 January 2008. Hong Kong in particular, soared over 2000 points after slumping over 2000 points the day before. But, at the time of writing this, Europe and the US are sliding.

There’s no shortage of suggested reasons: more US sub-prime leakage, more US housing slumps, more US consumers defaulting on credit card debt, more US manufacturing slowdown, more weakening of the US Dollar, more US and global unease on commercial credit and the authenticity of bond insurers. They’re all related. Putting it another way, it’s just another stack of derivatives.

But 2 points need to be made.

First, interest rates are being seen as both the cause and the cure. The sub-prime mortgage fiasco was due to spiraling Adjustable Rate Mortgages that screwed US mortgagors into a colossal wall of mass defaults, triggering a complex global inter- bank credit panic which is still lingering and might get worse. Sub-prime lending went on in full view and knowledge of the US Federal Reserve which encouraged, and turned a blind eye to, what was unfolding.

Now, the US Federal Reserve is slashing interest rates as the simple solution to stimulate economic growth across the board.

Second, even if a full-blown US recession is avoided, the depth and global scope of the suspicious sub-prime derivatives has yet to be accurately measured – or estimated. Whilst central banks around the world stand ready to pump funds to ensure liquidity, a potentially more serious issue is the solvency of individual finance companies holding worthless bonds derived from sub-prime products. The first shots have already been fired with 2 US monoline insurers singled out – and whose credit rating was promptly dumped.

What does this mean for SMEs? Watch your debt exposure – both long term and short term. Tighten up your incoming cash flow because inflation is kicking in and your Accounts Payable will rise. If SAW is right and corporate solvency is the next major issue, SMEs need to be aware that even if the accounts indicate the business is profitable, it can still be insolvent. Cash flow, not the cost of money, is the name of the game. Don't expect banks to be overly-thrilled to lend to SMEs, even if interest rates have fallen. The control of your Receivables and the credit-worthiness of your debtors will save you or sink you.

Erosion Of Capital

2008-01-18T14:57:00.000+08:00

Let’s face it. The cascading torrent of losses in the billions sustained by the *ahem* financial pillars of society, are no longer riveting. Lately, we’ve come to expect it in the same way as sewage leaks out of a ruptured pipe. For those doing the disclosing, their meltdown in the full glare of publicity might as well be the sequel to Al Gore's "An Inconvenient Truth".

Take Merrill Lynch for example. Not to bash, but reading the BBC’s online report for 17 January 2008 and Financial Times online report for 17 January 2008:

In the last quarter of 2007, it lost US9.8 Billion – the biggest quarterly loss in its history;

It made a net loss of US12.8 Billion in the 12 months ending on 31 December 2007;

There were approx US15 Billion in asset writedowns:

US3.1 Billion in contracts with bond insurers to hedge against losses;

US9.9 Billion in *ahem* “asset-backed” CDOs;

US1.6 Billion in its holdings of individual sub-prime mortgages;

So what’s the lesson for SMEs? The importance of enough working capital.

Merrill’s embarrassment, that eroded its market capitalization and its internal capital base, was attributable to debt and the assumptions made in respect of it. Specifically debt was very poorly assessed initially, then shunted “off balance sheet” via CDOs and SIVs, ceased to produce cash flow, could not be properly identified, could not be properly valued and ultimately had to be brought back on to the balance sheet and very publicly written down.

When one cuts through the artificial fancy corporate structures, the debt was intended to be a receivable that was supposed to generate regular cash flow. The entire sub-prime fiasco was a failure in receivables management that hit a company’s capital base and, in the case of Citigroup, its credit rating as well.

SMEs, focused either on survival or growth, often overlook the importance of receivables management. It’s handled in a haphazard or tardy fashion, only becoming urgent when the Accounts Receivables Ageing Report looks distinctly ugly, or the company faces a cash crunch like inability to meet payroll or rent. There’ll be some frantic activity for a few days to chase up on unpaid bills then it’ll die down again till the next AR Ageing Report or the next crisis.

In the meantime, the Receivables appear on the balance sheet as a Current Asset. That’s the formal way of saying “we’re keeping our fingers crossed and hope we get paid”. If the company doesn’t get paid for a while, their accountants will advise them to write it off as a Bad Debt. That’s a nice way of saying, “we’ve just lost capital we could have used”.

At that point, your SME is no different to Merrill Lynch or Citigroup. Bring on the firings, the tears and the downsizing.

Play your cards right, consistently tighten up on receivables management and the company could have predictable working capital for growth, overheads and a sweeter credit rating.

Lessons Learned

2008-01-17T00:45:00.000+08:00

This blog has dealt extensively with sub-prime. But how does all that relate to private SMEs who are interested in improving their cash flow for the purposes of growth or survival? What lessons can be learned?

1. Surrender of Equity

Factoring does not involve going to foreign investors - Sovereign Wealth Funds in particular - and giving up, or issuing, equity in the company. Just ask Citigroup or Merrill Lynch.

2. Management Changes

The funding source will not demand management changes at Board level as a condition of funding (unless there’s suspected or actual fraud).

3. Debt-Free vs. Debt

Factoring is effectively debt-free growth for the company. It is based on the SALE of the commercial invoice to the factoring company. That invoice, which represents future cash, is a genuine asset. The factor buys it from the company at a discount from its face value and the company gets cash almost immediately. The factor then looks to the company’s ultimate debtor for payment of the full face value of the invoice.

Sub-prime was debt-ridden at all levels with catastrophic results. For the lenders, the “assets” of the individual debtors were either cars or plasma TV sets (which have no residual value) or the assumed ever-increasing value of a home which they knew fully well the debtor could not afford. The basis of sub-prime rested on loading credit challenged individuals with even more debt and then repackaging the “assets” as “safe” corporate investments for Wall Street and beyond.

4. Credit-Worthiness

Factoring is strongly dependent on the credit-worthiness of the company’s ultimate debtor. This is because the ultimate debtor remains liable to the funding source for the face value of the invoice. That is why factoring companies who are buying the invoices, demand to know details of a company’s debtors and run checks on them, including verifying that the invoice issued to the debtor is genuine. If the factor has doubts on the credit-worthiness of the ultimate debtor, funding for those invoices will be refused. Period.

One of the hallmarks of the sub-prime fiasco was that the credit-worthiness of the individual debtor, who often had a lousy credit rating to start with, was fudged or dishonestly recorded to make it appear better than it was. Everybody knew what was going on and simply turned a blind eye. Risk was compounded.

Factoring seeks to minimize uncertainty on 2 fronts: for the company seeking guaranteed predictable cash flow; and for the funding source that assumes the risk of repayment from the ultimate corporate debtor.

Passing The Hat Around

2008-01-16T16:45:00.000+08:00

Whatever brave face that banks were putting on the sub-prime debacle when it first erupted i.e. it was only a small portion of their portfolios, has now all but melted. In the next few days it’s Earnings Reporting Time, specifically for the 4^th Quarter of 2007.

And it will not be a pretty picture. See the previous post, The Mushroom Cloud.

As Bloomberg pointed out in its online report dated 15 January 2008, the writedown on Citigroup’s losses are double what the company forecast in November 2007 and Citi has lost half its market value in the past year. Standard & Poor reduced Citigroup’s credit rating from AA to AA-.

But to put things in perspective, Citigroup’s capital base should not be an immediate issue (even though it did cut its dividend from 54 cents to 32 cents) It acted fast. In November 2007 it raised US7.5 Billion by selling a stake to the Abu Dhabi Investment Authority. It’s now slated to receive a further US12.5 Billion from the Government Of Singapore Investment Corporation, The Kuwait Investment Authority, its former Chairman Sanford Weill, Capital Research And Management (Citigroup’s biggest shareholder) and the New Jersey Division Of Investment – and not forgetting Prince Alaweed BinTalal of Saudi Arabia who’s been investing in Citicorp (as it then was) since the early 1990s and is investing more now.

And who else?

Oh yeah, Merrill Lynch is getting a further US6.6 Billion from the Kuwait Investment Authority, the Korean Investment Corporation and the Mizuho Corporate Bank. In December Merrill raised US5 Billion from Temasek Holdings of Singapore and US1.2 Billion from Davis Selected Advisors.

And these are only 2 banks on the list of The Mushroom Cloud looking for cash.

The Mushroom Cloud

2008-01-16T15:33:00.000+08:00

SAW hates to laugh at another person’s pain, but herewith is the price of greed caused by the crock that was – and still is – sub-prime.

The table of losses is taken from the BBC’s online report dated 15 January 2008

Citigroup: $18bn

UBS: $13.5bn

Morgan Stanley $9.4bn

Merrill Lynch: $8bn

HSBC: $3.4bn

Bear Stearns: $3.2bn

Deutsche Bank: $3.2bn

Bank of America: $3bn

Barclays: $2.6bn

Royal Bank of Scotland: $2.6bn

Freddie Mac: $2bn

Credit Suisse: $1bn

Wachovia: $1.1bn

IKB: $2.6bn

Paribas: $439m

Writings On The Wall

2008-01-03T23:56:00.000+08:00

According to the BBC’s Online Report dated 2 January 2008, the US manufacturing sector contracted in December 2007, seeing its weakest monthly output since April 2003. According to the Institute Of Supply Management, its index of factory activity fell to 47.7. Anything less than 50 indicates a fall in manufacturing output.

World stockmarkets generally, and in the US in particular, swooned.

Oil makes its first trade above US100.00 (not for any fundamental reason, just a lone trader purportedly engaging in a "vanity trade" for personal bragging rights)

The US Dollar continues to weaken.

Interest rates in the US and elsewhere are expected to fall futher.

What’s it all mean? Since it’s the beginning of 2008, here’s SAW crystal gazing:

A weaker US Dollar means cheaper US exports. Theoretically good news for US SMEs. But it also fuels inflation both in the US and elsewhere – and high oil prices don’t help.

Given that the full force of the sub-prime debacle in the US has yet to pan out, housing starts and housing prices are still declining. In other words, the US economy (the world’s biggest driver) is slowing as consumers think twice about spending.

But just how slow is slow? Some say a “near miss” US recession is on the cards, some say a recession is in its early stages and some say no chance of a recession.

Sticking his neck out, SAW’s view is “near miss” recession in the US, with inflation there and in other countries, particularly those whose currency closely follows the US Dollar. Expect the US to cause some (military?) mayhem elsewhere in any event.

Some pundits are already talking ‘stagflation” i.e. inflation continues to rise, even though economic growth slows or reverses.

SAW’s view? Possible if the sub-prime mess turns out to be even worse and international credit markets go into a tail spin again.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

We (Now) Love You

2007-12-07T13:30:00.000+08:00

It wasn’t that long ago that voices in the US Treasury were telling the world that, as far as sub-prime mortgages were concerned, it was up to the borrowers and lenders to privately negotiate a settlement since government intervention would be counterproductive. The government would however, increase funding for debt counseling. Given that roughly 1.8 million happy debt-ridden families in the US with “teaser’ rate Adjustable Rate Mortgages stood to lose their homes pretty soon when rates were due to move up, the attitude was sanguine.

Now, deep into the Advent season when peace, love and compassion suffuse every crisis with a hazy glow, the US government has outlined a plan to freeze interest rates for 5 years for those holding Owner-Occupied sub-prime loans made between 1 January 2005 and 31 July 2007, the adjustable interest rates of which, were due to rise over the coming two and a half years. According to an online Reuters report dated December 6 2007, this covers US367 Billion worth of mortgages.

With foreclosures in the US at their highest levels since 1986, this avowedly “non-bailout” solution is intended to exclude those who have the financial means to pay as well as those real estate speculators who used a sub-prime mortgage as easy leverage into what was then a sizzling real estate market. In practice, it appears only 2 groups of borrowers will qualify:

Borrowers who show themselves to be a decent credit risk but can’t afford the higher payment, will find it easier to qualify for a rate freeze;

Borrowers who can afford the higher rate would be given help in re-financing;

Therefore those who were a lousy credit risk to begin with, who can’t afford their current payments and who definitely won’t be able to afford their future payments, will be excluded from this scheme. Presumably this means foreclosures will proceed and they will lose their homes. Not to sound crass, but aren’t the lousy credit risks the very people against whom sub-primes were aimed at in the first place? Factoring out the good credit risks, the speculators and the 2 groups listed above, SAW’s suspicion is that most sub-primers will be frozen out of this government scheme.

In an earlier post, entitled Town Planning By Default, November 8 2007, SAW suggested that sub-primes could be used as a method of social engineering, population clearance and land development. For the inner city areas of some major US cities, this scenario may be inevitable.

The government scheme has the potential to trigger some interesting displays of human behaviour. It’s widely acknowledged that people who ended up with sub-primes were lied to about the financial risks they were taking or who were downgraded in their credit rating to force them to take a sub-prime. SAW smells revenge here and suspects that many people through sheer anger will now lie about their financial condition to qualify for a rate freeze. And they’ll probably get away with it.

A Stack Of Derivatives

2007-12-05T02:20:00.000+08:00

Now that the media has been awash with the purported astronomical, catastrophic [add the doomsday superlative of your choice] consequences of the sub-prime mess, just finding out in simple terms how this lunacy was “structured” became an expedition in itself.

Perhaps the best explanation is contained in Jon Markman’s column for MSN Money. He correctly made the point that the commercial debt market is far larger than the stock market. It’s in the debt market that companies, governments and pension funds obtain financing, use credit instruments essentially backed by confidence i.e. an expectation that a debt will be repaid on time with requisite interest.

First, the debt forms a chain: banks borrow money from their depositors, pay them low interest rates, then turn around and lend that money at higher rates to companies. The difference between what the banks pay their depositors and what they charge to companies who want to borrow funds, is known as “the spread”. Banks make good profits when the spread is large.

Then, in comes the US Federal Reserve under Alan Greenspan which attempted to kickstart the US economy in late 2001 by cutting interest rates. The economy recovered but the Fed continued to cut interest rates and fell asleep at the wheel. The economy heated up, real estate prices went through the roof and the spread upon which banks relied to make their profits, narrowed.

The banks turned to their depositors, usually the low income ones, with a sales pitch to borrow more money from the banks to fund a consumer-driven lifestyle. It’s well known just how easy it is to hook the already over-indebted US consumer, so getting them to borrow more, wouldn’t have been difficult. At the same time, the banks employed an army of barely scrupulous mortgage brokers to dangle “teaser rate” home loans, a camouflage for the notorious Adjustable Rate Mortgages which trapped so many.

These shaky income streams were packaged and marketed to institutional investors as “asset backed securities”. These in turn were used as collateral to create the Collateralized Debt Obligations (“CDOs”) which were also re-sold to institutional investors. The banks pocketed huge fees.

The CDOs themselves were then used as collateral for “doubled” and “cubed” CDOs which were shoved into Structured Investment Vehicles, (“SIV”) purportedly managed at arm’s length and kept off the Balance Sheet.

Finally, in the ultimate act of over-confidence, the SIVs were used as collateral for the short-term commercial paper that forms the basis of the commercial debt market.

It all sounds so simple, yet jaw-droppingly reckless. The US Federal Reserve continued to cut interest rates in full knowledge of the burgeoning sub-prime market and of the imaginative shenanigans of Wall Street. The latter continued to stack their derivatives knowing fully well the Fed wouldn’t do anything. In fact the Fed is on record as saying it was not in the business of regulating asset-backed securities. Which begs the question…who was?

The irony is that following the massive loss of confidence in the commercial debt market, what does the Fed do? Cut interest rates of course. And apparently there’s more slashing to come.

Sing Y'All

2007-11-29T18:24:00.000+08:00

With the sub-prime comedy heating up, financial analysts (read “professional guessers”) are falling over themselves to “estimate” the global and US losses caused by the value of sub-prime mortgage assets and mortgage-bond type CDOs heading south. For example, www.bloomberg.com has recently quoted a number of analysts offering their estimates. The figures are astronomical – in the billions - yet meaningless. Remember, the 2 issues are the direct exposure to sub-prime debt which soured, and, the widespread re-packaging of them as CDOs, which, when faced with a wall of defaults, contributed to the decline in the value of all mortgage debt, in a softening real estate market in the US.

There’s no shortage of analysts offering speculative figures, but there is a massive shortage of hard facts. Why? The banks, mortgage companies and institutional investors who bought the CDOs are still churning the best way of disclosing their exposure to increasingly annoyed shareholders and the public. After all, much of this exotic “Off Balance Sheet” financing was done via “Structured Investment Vehicles” a scientific-sounding term for a jerry-built deal.

Technically, these SIVs were managed on an “arms length” basis and the banks are reluctant to call SIV debts as their own.

Biting the bullet, HSBC Holdings PLC announced on 26 November 2007 that it would place 2 of its managed funds with mortgage exposure, on its Balance Sheet and spend US$35 Billion to bail them out. While lauded as timely and aiding in maintaining transparency and its reputation, the accolades would have made more sense had HSBC acted sooner. After all, wasn’t Bear Stearns’ inability to support its funds over the summer a prescient warning of what was to come?

Still, HSBC’s move is strategic in a number of ways: By acting first, it makes the other banks look conspiratorial, secretive and evasive. Second, it distances HSBC from the bailout plan or “super fund” that was proposed by Wall Street and only officially backed by Wachovia, after it was proposed by Citigroup, JP Morgan Chase and Bank of America nearly 2 months ago. Third, those banks that belatedly decide to place the SIVs on their Balance Sheet, may be obliged to announced larger write downs than those they have so far announced – a further blow to their reputation and credibility.

And The Winner Is....

2007-11-13T12:50:00.000+08:00

The nominees for best supporting non- performances in the category of Sub-Prime Comedy are:

Citigroup US11 Billion

Merrill Lynch US8 Billion

Morgan Stanley US3.7 Billion

Bear Stearns US3.2Billion

UBS US3.4 Billion

Deutsche Bank US3.2Billion

Credit Suisse US1 Billion

Wachovia US1.1Billion

IKB US 1 Billion

Lie To Me *

2007-11-09T12:26:00.000+08:00

It’s well known that those in the US who took out sub-prime Adjustable Rate Mortgages did so because their credit scores were lousy and were heavily influenced by the sales pitch. But that’s not the full story. It’s now apparent that the sales pitch came from unregulated mortgage brokers who, in their quest for commissions, were not averse to inflating borrowers’ incomes and their home values to the lenders, while misrepresenting the type of mortgage to which the borrowers were committing.

While sub-primes account for 1 out of 5 mortgages in the US, the figure would have been much lower. The sales pitch was so effective that a high proportion of sub-primes were dished to out to those with a perfectly normal credit rating who would otherwise have qualified for a usual or “prime” mortgage. In other words, this mortgage trap caught the inner city poor and the suburban middle class.

The Brokers were acting on behalf of banks and mortgage companies which originated the sub-prime mortgages. The banks and mortgage companies would have the borrowers’ financial credentials, whether false or accurate. The distinction was academic: many of these loans were "no-money-down" or "NINJA" loans (i.e. No Income, No Job or Assets). The same information, whether false or accurate, would also end up in the hands of the credit rating agencies.

Since the banks and mortgage companies were then re-packaging these sub-prime loans as CDOs for onward sale to investors, there was undoubtedly collusion between them and the credit rating agencies to talk up the authenticity of these “investments” as part of the “risk management” exercise.

In other words, US banks, mortgage companies and brokers were the originators and, co-conspirators with Wall Street and the credit rating agencies to perpetrate one of the biggest financial scams in America.

* The song title by Jonny Lang, one of SAW’s favourite blues singers

Town Planning By Default

2007-11-08T13:16:00.000+08:00

It’s politically incorrect to suggest that sub-prime mortgages could be used as a tool for social engineering, but that’s exactly what’s happening. News reports from various sources are replete with examples of entire neighbourhoods in the US boarded up and vacant as home owners simply walk away from the sting of their Adjustable Rate Mortgages. Those empty neighbourhoods are now subject to crime waves and vandalism. Remember that property taxes are a major source of revenue for cities and municipalities. Who’s paying now? But that’s only the first stage.

The second stage is also underway: banks and mortgage companies have commenced foreclosure proceedings against those still sitting in their houses. Some banks are acting in their capacity as agents for the investment syndicate that bought the CDOs; mortgage companies are acting in their capacity as lender (and originator of this sub-prime scam). From the anecdotal evidence in the news reports, US mortgage companies are showing a pointed reluctance to talk to their defaulting customer, give further information, explain the contract they signed, or consider re-financing.

Which all suggests one thing: the residual value of the real estate is more important than any cash flow that might be generated from it in the interim. And who would the residual value of the real estate appeal to most? Investors and developers.

Many sub-prime mortgages were issued in urban areas where the skin colour of the population implied that they might be children of a lesser god. It’s no secret that they were in economically depressed areas to begin with. But it didn’t end there. The middle class in all hues, with less than stellar credit and living in suburban belts were also enticed.

But here’s the question: if they’re abandoning their houses in droves or are evicted pursuant to foreclosure, where are they going?

And if the sub-prime scenario is as pervasive in the US as is being reported, isn’t there now a floating internal population of economic refugees?

It Looks Good, Anyway

2007-11-08T01:10:00.000+08:00

The recent US interest rate cut looks and feels good: it seems to be the right gesture to help out the soon-to-be-evicted sub-prime mortgagors, or those desperate to re-finance. But substantively, it’s a crock, an utterly hollow gesture. The warm assurances from the US Federal Reserve that pursuant to its cash injections and twice-lowered interest rates in September and November 2007, credit is more easily available, doesn’t add up.

First, more mortgage companies and smaller banks in the US will fail.

Second, now that the conga line of superficially embarrassed, thick skinned investment bankers is forming (think Merrill Lynch, Citigroup, UBS, Northern Rock……….), the rest of their fraternity are now recalling that they were supposed to be “prudent bankers”.

After all, the final figure of failed sub-prime based credit derivatives is nowhere in sight. Christmas is coming too. There’s not much time left to act prudent. In corporate US, the yuletide tradition is that of firing employees. Banks are no different. If their figures just before Thanksgiving look so awful, the least they could do is to cut their workforce and look lean. It’s only a matter of time before the shareholder’s knives come out aimed at some turkey in a suit.

There will be a flurry of internal directives and sharp reminders to scrutinize credit applications at all levels – from retail, to corporate, to investment.

What does that mean for the business owner who’s been managing his cash flow quite well? More hassle. More paperwork. More refusals. Interest rates may be lower, but bank resistance will be higher.

The really smart business owner will start looking for finance from private funding sources.

Houston, We Have A Problem

2007-11-07T01:35:00.000+08:00

As is now apparent, the fancy re-packaging of sub-prime loans into Collateralized Debt Obligations were credit derivatives and other forms of “Off Balance Sheet” Financing, responsible for the creeping and embarrassing disclosures of previously undisclosed losses of staggering amounts, now to be recorded on Bank Balance Sheets.

“Off Balance Sheet Financing” is precisely that – it is not recorded on the Balance Sheet as either a Current or Long Term Liability. But the cash flow from the CDO (so long as it was performing well), would be recorded as revenue in the Income & Expense Statement.

How it ended up as “Off Balance Sheet Financing” was as a result of “risk assessment”. That assessment was pursuant to a computer program, that could easily be adjusted to operate within optimistic parameters, thereby giving an impression of manageability and liquidity in order to ensure the sale of the CDOs (to “sophisticated investors”). It’s not as bizarre as it sounds: ask any major bank and financial institution and they’ll tell you just how heavily they rely on computer models to purportedly assess risk.

Since these CDOs were based on notoriously credit un-worthy individuals, it doesn’t take a rocket scientist or a computer program to figure out that the moment a colossal wall of defaults sets in, your fancy credit derivative is effectively, un-saleable (and your computer program not worth the software it’s written on).

At that point, you have a major cash flow problem.

Interestingly, Factoring is also described as “Off Balance Sheet Financing”. More on that in the next posting.

The Teetering Of Icons

2007-11-06T15:17:00.000+08:00

So Merrill Lynch took a beating on its “risk management” to sub-primes. According to the BBC website report of 30 October 2007, it was one of the first to re-package sub-prime housing debt as tradeable securities. Having recorded US7.9 Billion exposure to bad debt, its CEO left the building (suitably well compensated, of course).

And he’s not alone. Citigroup’s CEO also resigned, after having reported a 57% drop in quarterly profits and losses of between US8 Billion to US11 Billion in previously undisclosed losses (hello ??) attributable to a decrease in the value of its US55 Billion portfolio of sub-prime loans.

OK…first off, Citigroup is a huge group. Second, those are huge losses which would sink most other banks. Third, those are the currently disclosed losses on the sub-prime side. Fourth, given that there was a bubble in US real estate, what is Citigroup’s exposure to that sector?

It ain’t the end of the story. As Robert Peston, the BBC’s Business Editor said in his blog posting of 5 November 2007:

"Still, his exit [Citigroup’s CEO] will cause a frisson among senior bankers all over the world, because few of their organisations will escape unscathed from the problems in credit markets.

That said, Citi’s hit from sub-prime is spectacular. And it will cause widespread concern that other banks will be forced to disclose increased losses from their respective holdings of sub-prime, CDOs and the rest of the gilded rubbish…… "

The End Of Innocence

2007-11-06T13:57:00.000+08:00

The funny thing about reality is that it hits first, then dawns later. Picture this: US home loan borrowers, many of them sub-prime, en masse, exhausted their ability to pay and defaulted on their loans. In many cases, they simply walked – and are still walking- away from their homes. An already depreciating US housing market accelerated its decline when millions of defaulting sub-prime homes flooded the market. For the lenders and buyers of the Collateralized Debt Obligations, (“CDOs”) their “assets” became non-performing loans and didn’t look that good on the Balance Sheet.

In practical terms the CDO values were being written down, or even written off. Hedge funds who had ought these high interest bearing CDOs and borrowed money against them, from banks at lower rates, faced margin calls from the banks, jittery at holding assets that were sliding in value. In order to pay the margin calls, the hedge funds had to sell their performing assets. Imagine their surprise when they discovered that their performing assets were insufficient to cover the margin calls. So much for “managing risk”.

Now that Wall Street was losing money, who better to turn to than the Politician-In-Chief and the US Federal Reserve? True to form, he made some utterances about “educating” borrowers (uh.. huh…..nobody had the temerity to suggest he might wish to “educate” the lenders and the institutional investors who fell over themselves to buy this CDO shit) and then got out of the way while the Fed cut interest rates – belatedly- first in September 2007 from 5.25% to 4.75%; and then on 1^st November 2007 from 4.75% to 4.25%.

And some of the reasons given for this cut? To make it cheaper to borrow money in the US and therefore to lend support to the US consumer in the critical Christmas shopping period. Oh please……………

Oh yeah, it’s also supposed to make it cheaper for businesses to borrow money. But that’s another story.

Not Mincing Words

2007-11-01T14:07:00.000+08:00

From his perch here in Hong Kong, SAW has been observing the summer sub-prime meltdown in the US with the resulting spike in delinquent loans and foreclosures. The global stock market ride has been fun too. Sometimes, it’s best not to say anything for a few months, then take a deep breath and assess.

Scan the international cities on Craigslist.org and there’s no shortage of implicitly desperate American sellers flogging their properties to any overseas buyer at prices that seem pretty reasonable. No doubt, real estate investors specializing in distressed sales are cashing in and flipping the property for capital gain, looking for tenants, or turning the panic stricken cash-strapped seller into the tenant.

Although this whole sub-prime loan saga received saturation global media coverage, with accompanying gloomy predictions on the state of the world’s credit markets, let’s get a few things straight.

Firstly, sub-prime mortgages have been around for years in the US for those with a low credit score, and those with a perceived lower skin colour (both often operating together). Operating below the radar, the sub-prime market generally stood at around 1% of the mortgage market. Nobody paid much attention to it.

Secondly, by 2005, it made up about 5% of the mortgage market. By 2007, it was about 15%.

Why the spike? An inflated US real estate market and exploiting the “feel good factor”. The US consumer, internationally notorious for their rampant consumerism and inability to budget or save, was a sitting duck when confronted with greed: the greed of potentially owning real estate in a ramped up market; and the greed of buying goodies – both at the same time.

Thirdly, it was a cynical ploy that exploited those with lousy credit by enticing them with initially low interest rates that hiked every 6 months. Of course, the lenders never bothered to tell these folks that their wages wouldn’t increase every 6 months and that their mortgage payments would take up an ever increasing amount of their expenses. The customer never had a hope in hell of redeeming these mortgages and for the lenders, their cash flow was locked in.

Those sub-prime loans were then bundled together and called Collateralized Debt Instruments (“CDOs”), split into tranches and sold to so-called blue chip institutional investors who happily assumed they were “managing risk.” CDOs would be shown as an asset on their Balance Sheets, with the cash flow from the (ever increasing) interest rates appearing on their Income Statements.

Everything was fine and rosy – so long as the sub-prime consumer with the Adjustable Rate Mortgage made his monthly (usually interest-only) payment and real estate values soared.

In an example of lateral thinking by imitation, banks, seeing the profits that private lenders were making on their sub-prime loans, quietly revised their lending criteria in the US so that those with an otherwise good credit history, suddenly found themselves at sub-prime status. They too, sold the CDOs to Wall Street who was happy to oblige in a rising real estate market.

Everybody but the borrower knew the con: in a conventional mortgage where the borrower pays down principal and interest, their home equity increases. In a Sub-Prime

Adjustable Rate Mortgage, if the interest rate goes up every 6 months (the interest component being the larger amount of the monthly payment), the borrower’s home equity shrinks notwithstanding that the home value increases in a rising market.

Convenient huh? For the lenders it was a “No Lose” situation. The borrower was forced to increase his monthly payments while the lenders got the benefit of the increased home equity and the cash flow. It was predatory lending at its worst – and most profitable.

Why? Hedge funds were buying these high interest-bearing CDOs and using them as security to borrow funds from banks at lower rates, in order to leverage returns, confident that they were “managing risk” even if the lowly sub-primer defaulted.

And besides……European Banks wanted to buy these US CDO’s too. The contagion happily spread across the Atlantic. Everybody felt great, particularly the US Federal Reserve who, of all people, knew what was actually coming down the pike and did nothing. Even when they did act in September 2007, to bring down the interest rates from 5.25% to 4.75%, it was way too late.

If you’re one of the innocents who still assume that the US Fed has your interests at heart, and as lender of last resort will charge in like a knight in shining armor, your mediaeval fairy tale ended sometime ago.

Factoring & Bank Financing

2007-07-05T22:58:00.000+08:00

The author has frequently said that factoring can be used in conjunction with traditional bank financing. What does this actually mean?

A business in the early stages of growth may not qualify for the best terms for bank loans since it doesn’t have a history. If a business line of credit or a loan is forthcoming, often it will be secured on the Receivables – in other words, every Invoice generated by the business acts as security for the loan. The problem with that, is those Invoices represent potential cash whose value is presently frozen – at least until they are finally paid by the debtor 30 plus days down the line.

For a start-up or early stage business, tying up the invoices to the bank and hoping the debtors will pay fast, is not the best strategy. It leaves the business without critical cash flow control and can hamper growth.

Since factoring requires creditworthy debtors more than it requires the operating history of the business, then (subject to good profit margins), factoring may be a better alternative.

Once cash flow has been stabilized and is predictable through factoring, the business will be in a better position to negotiate a bank loan – with the added advantage that its invoices have already been assigned to the factor and therefore out of reach of the bank.

Servicing the loan becomes that much easier since cash flow from factoring can already be calculated.

Remember also that banks tend to be conservative. Factoring companies are more flexible and forward looking in their assessment of the business prospects.

Stating The Obvious

2007-07-03T14:18:00.000+08:00

It’s mind boggling to discover just how much difficulty business owners have in grasping the concept of a “final sale” in the context of factoring.

Start with this: For an invoice to be factored there MUST be a final sale B2B.

In other words, there has to be a completed product or service that has been delivered to and accepted by the customer – and on which, payment is now due.

Forget about factoring partial deliveries where payment is not due until final delivery.

Forget about factoring invoices on returned items.

Forget about factoring invoices for sale by consignment i.e. the debtor does not have to pay until it has re-sold the product.

The Reader is also referred to previous posts under the label, “Commercial Invoice”.

The Hard Truth

2007-07-03T13:21:00.000+08:00

Frequently, companies moan that the cost of factoring is too high. Fine. In some situations, it is and would not be the best option. SAW has told companies to forget factoring and try something else.

A personal rule of thumb:

A business with gross profit margins of less than 15%: forget it

A business with gross profit margins of 15% - 20%: possible

A business with gross profit margins of 20% or more: ideal

The Personal Guarantee

2007-07-02T22:44:00.000+08:00

Many company directors choke when they look at the factoring documentation package and see the requirement for them to sign a Personal Guarantee. Some walk away from the deal altogether, claiming they’ve made enough disclosure. Others say the Personal Guarantee reeks of traditional bank financing.

Let’s make one thing very clear. Corporations, by themselves, don’t commit fraud. It’s the people behind them. The Personal Guarantee is the factor’s safeguard against fraud – and not, as is commonly assumed, an alternative means of recovering payment by going after an individual.

Factors carry credit insurance in respect of funds that they advance on a non-recourse basis. Many factors advance funds pursuant to a Line of Credit that they have with their banks. As a condition of the credit insurance and the bank Line Of Credit, factors are required to obtain a Personal Guarantee from the directors of their customers.

As and when the factor has funded an invoice for which it has not been paid by the ultimate debtor, it is far cheaper to simply off-set the amount against future advances, rather than resorting to litigation via the Personal Guarantee.

What The Factor Wants To Know

2007-04-22T14:49:00.000+08:00

Is There A Real Need For The Factoring?
Where in the business has the need for cash flow arisen? Fulfilling orders? Tax problems? Looming payroll? Inability to pay suppliers? What exactly?

When Does The Business Need The Cash Flow?
If it is needed to fulfil an expected contract, when will the contract be awarded?
When is the next payroll due?
By when do you have to pay your suppliers?

Just How Good Are Your Debtors?
Factoring is all about the creditworthiness of the debtors – the ultimate payors of the factored invoice. Factoring companies act as a Receivables Management function – they are not in the business of delinquent debt collection. There is a huge difference (and it is a different kind of financing).

Which Funding Source ? 3

2007-04-15T01:03:00.000+08:00

The author prefers to deal with funding sources that offer alternative products. If a client turns out not to be eligible for factoring, the funding source can still add value by offering say, venture capital or equipment leasing. Everybody wins and it saves the client the hassle of looking for alternative funders.

Besides, just because the client isn’t eligible for factoring at the moment, doesn’t mean it won’t be eligible in the future.

Which Funding Source ? 2

2007-04-11T14:36:00.000+08:00

Since factoring is all about timely cash flow, the best factoring companies will be able to quote on the deal, or decline it, within 24 – 48 hours of a fully complete application being submitted. Note the operative words “fully complete application”. The author has seen enough companies whining to disclose the required information on the application form. It doesn’t help their case or the speed at which they might get the cash.

If a factoring company purports to charge an application fee when you’re submitting the initial paperwork, watch out. There are no grounds for it.

When the client accepts the quote, the factoring company will respond with a contract and supporting documents for the client’s signature. The contract is subject to due diligence. At that point, it is perfectly legitimate for the factor to request the due diligence fee from the client.

Some factors have preferred industries and will specifically exclude others. Others are more broadly based. Generally construction industry related factoring is a specialized niche and not all factors handle it – the risk element is highest in this sector.

Some factors have a monthly minimum value for a deal, below which, they will not fund. This is because the administrative costs of servicing the small account outweigh their returns on it. Hey, it’s business. Besides, there is a specialist market of “small factors” who will fund monthly amounts between $US2,000 – US$20,000. The author knows of some of them.

By contrast, other factors may not have monthly minimum values, but may have maximum monthly volumes, which can be increased on a case-by-case basis, or, syndicated between 2 or more factors.

Which Funding Source ?

2007-04-11T05:49:00.000+08:00

Straight up, this author will only deal with funding sources affiliated to the American Cash Flow Association (ACFA). Several times, clients have “insisted” that the author should contact this or that funding source which a friend told them about and negotiate for them.

Forget it.

Secondly, the author is not in the business of playing one funding source off against the other, merely at the behest of the client. Within the ACFA group of funders, word gets around pretty quickly as to what’s going on. The client shouldn’t be surprised if the funding sources flatly refuse to play his game and dump the company’s applications.

The funding sources of ACFA are inherently flexible, more so than others and exponentially more so than banks. If a business is turned down, it’s not for a lack of interest, but a lack of “fit” or the due diligence didn't pan out.

So, what goes into choosing a factoring funding source? That’s the subject of this and the next posts.

Equipment Leasing Criteria 3

2007-04-10T13:58:00.000+08:00

Once it’s clear that a business requires additional capital by way of Equipment Leasing, the funding source will require a list of the existing assets of the business to see if they are un-encumbered. If there are no un-encumbered assets, that pretty much kills the notion of Equipment Leasing.

Relevant assets (plus a Valuation Report) may include:

Land
Building
Machinery
Equipment
Inventory
Accounts receivables

Royalties, trademarks and goodwill are not included. This is because the funding source only considers those assets for which there is a ready market if the Borrower defaults.

Having evaluated the assets, a loan amount will be arrived at. Invariably, this is a percentage of the derived value of the assets

Equipment Leasing Criteria 2

2007-04-10T13:44:00.000+08:00

Equipment Leasing is an Asset Based Loan with the 3 fundamental characteristics of a loan:

The use of the equipment as collateral for the loan;
Defined payments to the funding source;
The payments to be made over a specific period of time

Unlike Factoring, a debt is created and the funding source will look more closely at the Borrower’s financial position to determine cash flow strength for repayments. Specifically:

List of assets and any encumbrances against each one
Valuation report of the business assets – this must be higher than the loan amount, after taking into account any encumbrances.
2 years audited financial statements from the Borrower
2 years corporate tax returns
Purpose of the loan
Amount of the loan
Likelihood of repayment
Any recent contracts to verify increased business
Bio on principals of the business
Background and credit checks on them
Additional data that will give the funding source a complete view of the borrower

Factoring Denied 2

2007-04-06T13:28:00.000+08:00

6. Invoice Cannot Be Verified or Verified In Time

This is a problem in large organizations where there may be problems in tracking or approving invoices for payment in a timely manner

7. Contingencies, Offsets Or contracts Between The Client And The Customer

These would cover indemnities, holdbacks, chargebacks, allowances or discounts. If they significantly reduce the amount of the future invoice or allow the customer put a stop to all payments, factoring will be denied.

8. Client’s Customers Are Not Creditworthy

Remember that factoring companies always do credit checks on the Client’s customer. If there are no independent records of the customer’s payment history, factoring will be denied.

9. Potential Federal Tax Liens

The Client has not paid payroll, excise or income taxes on time.
There is an agreement with the IRS for late or deferred payment, but the IRS will not approve a subordination agreement with the Factor.

10. Lawyers And Accountants

Those unfamiliar with Factoring may advise against it, since they still see it as a loan rather than the outright sale of the invoice at a discount.

These 10 deal killers will become apparent during the factoring company’s due diligence. Every factoring company will react differently to these 10 items, depending on their risk tolerance.

Source: Peter Pirri, Deal Killers: 10 Reasons That A Factoring Deal Dies In Compliance, American Cash Flow Journal, October 2002.

Factoring Denied 1

2007-04-06T13:02:00.000+08:00

Factoring is certainly easier to obtain than bank loans. But not all deals will be funded, just like not all bank loans are approved. Business owners might be surprised and disappointed to find their factoring applications rejected, especially where there is an urgent need for the cash flow.

Below are 10 reasons why a factoring application might fail. The author acknowledges the article by Peter Pirri published in the American Cash Flow Journal October 2002, entitled, Deal Killers: 10 Reasons That A Factoring Deal Dies In Compliance.

1. An Incomplete Application – The main reason that funding fails.

The client may be reluctant to disclose confidential information to the factor
The client refuses to allow the factor to contact its customers to verify invoices during due diligence
The invoices presented with the application are not properly prepared and cannot be relied on by the factor to obtain payment from the customer.

2. The Factor cannot obtain a first security interest in the Client’s Receivables

A prior creditor e.g. a bank, another factor or an equipment leasing company has a prior interest There are existing federal or state tax liens
Assets are pledged to an insurance company to obtain a performance bond.

3. Payment Terms On The Invoice Are Invalid Or Poorly Documented

Terms of payment are greater than 60 days from the receipt of goods or services
There is a dispute between the Client and the customer on the terms of payment
Payment is contingent on payment from a third party that will be available at a later date
Invoice does not comply with the Purchase Order and fails to show terms of payment, delivery method, product or service description.

4. Invoice Does Not Represent Fair Value For Goods Or Services Delivered

The Client may be overbilling, or billing in advance
Discrepancy between what was ordered and what was delivered

5. Payments Cannot Be Assigned

The Client’s customer is unwilling to send current and future payments to the factor. This used to be a problem with municipalities and state governments, who were reluctant to deal with third parties. Changes in federal law have removed their ability to ignore a properly drafted Notice Of Assignment.

Source: Peter Pirri, Deal Killers: 10 Reasons That A Factoring Deal Dies In Compliance, American Cash Flow Journal, October 2002.

Factoring In A Strong Economy

2007-04-04T13:32:00.000+08:00

By way of contrast to an earlier post entitled Recession & Factoring 20 March 2007, here’s an overview of how Factoring is just as relevant in a strong economy.

The obvious sign that the business is doing well, or that the economy is good, is that the business sells more product or services. Additional staff may be taken on and overheads such as rent and salaries are paid without the usual hand-wringing. Gross margins and profitability increase.

What is not so obvious is that inventories may be stretched and only just keeping up with customer demand. Just-in-time production may not be able to keep up with increased capacity as product demand soars. The ability and the need to have access to guaranteed quick capital is critical. It’s no accident that many businesses fail immediately after their biggest ever sales period.

In profitable times, a business will be eligible for bank loans, even though interest rates may be higher during these periods.

It is important to remember that Factoring remains relevant during a sustained economic upswing. Why? Factoring grows exponentially with the business – debt free. In other words, the greater the sales and the better the customers, the greater the amount of factoring funds potentially available. Traditional bank financing cannot offer this flexibility.

As mentioned previously in this blog, factoring companies offer credit checks on customers (because this is where the factoring risk lies). This is a Risk Management service to clients that banks do not offer.

2 Points About Equipment Leasing

2007-03-22T12:36:00.000+08:00

The lease does not show up as a long term debt on the financial statements of the business. The business will not own the equipment until the lease is over. Many companies resort to leasing equipment precisely because it does not show up as a debt – and thus makes the company more attractive to shareholders or potential investors.

Leasing allows companies to avoid budgetary or lack of authority restraints. Rather than spending large amounts of capital on an outright acquisition of equipment – which might need the approval of superiors and result in further delay – a company manager can lease the same equipment knowing that he is acting within his financial limits to do so.

Recession & Factoring

2007-03-21T06:33:00.000+08:00

If the analysis of the 2 previous posts is correct (i.e. a potential US real estate meltdown, large numbers of mortgage defaults leading to a liquidity crisis), then it suggests that a US recession is taking shape – despite optimistic statements to the contrary from the Fed.

The first thing that will happen is a reduction in consumer spending as individual bankruptcies increase. Remember the average US consumer is maxed out on their credit cards as well. This will affect purchasing power and cause a retail slowdown.

This in turn will affect manufacturing. Production will slow, inventories will increase, job layoffs will start. While interest rates will remain relatively low, getting a business loan will become harder. Banks already hurt by mortgage defaults, will look for strong financial ability on the part of the business, to make the monthly payments and underlying assets to secure the loan.

Further, businesses will see that their customers are taking longer and longer to pay for goods and services supplied to them. Credit terms that are extended by one business to another, only make liquidity issues worse.

This is where Factoring can be helpful:

1. The business may find it hard to qualify for the bank loan. Factoring is not a loan. It is the outright sale of the invoices.

2. Reduced sales and rising payment times from existing customers mean slower, unpredictable cash flow. Factoring regulates cash flow, with almost immediately available cash.

3. Since Factoring is based on the creditworthiness of the customer, Factoring companies often provide helpful information about the credit standing of the customer. The business will know beforehand whether to do business with that customer and if so, on what terms.

Debacle In The Making 2

2007-03-20T13:37:00.000+08:00

In case you thought that the subprime mortgages were solely to blame for high rates of default and the nervous jitters now surrounding the US economy, here’s something else to consider. In an article entitled “Why The Subprime Bust Will Spread” published in Asia Times Online on March 17, 2007, Henry C.K. Liu analysed the subprime contagion in the US and said:

"The nationwide proliferation of no-income-verification, interest-only, zero-equity and cash-out loans, while making financial sense in a rising market, is fatally toxic in a falling market, which will hit a speculative boom as surely as the sun will set. Since the money financing this housing bubble is sourced globally, a bursting of the US housing bubble will have dire consequences globally.

Through mortgage-backed securitization, banks now are mere loan intermediaries that assume no long-term risk on the risky loans they make, which are sold as securitized debt of unbundled levels of risk to institutional investors with varying risk appetite commensurate with their varying need for higher returns. But who are institutional investors? They are mostly pension funds that manage the money the US working public depends on for retirement. In other words, the aggregate retirement assets of the working public are exposed to the risk of the same working public defaulting on their house mortgages.

When a homeowner loses his or her home through default of its mortgage, the homeowner will also lose his or her retirement nest egg invested in the securitized mortgage pool, while the banks stay technically solvent. That is the hidden network of linked financial landmines in a housing bubble financed by mortgage-backed securitization to which no one until recently has been paying attention. The bursting of this housing bubble will act as a detonator for a massive pension crisis."

Debacle In The Making

2007-03-20T12:57:00.000+08:00

Unless you’ve been living under a rock, or just fallen out of a tree, the increasing rate of default in US Subprime Mortgages, could have far reaching implications.

It’s now apparent that well known banks and Wall Street firms are affected because they securitized the loans i.e. extended credit or short term loans to subprime lenders, or bought collateralized mortgages to hold in their own portfolio or, as is widely suspected, used subsidiary companies to write their own subprime mortgages.

Their stellar earnings that these finance houses reported over the past few years may be due to subprimes. The feeling is that Wall Street was just too close to subprime mortgage lenders, deliberately recommending to investors to buy their stock.

Simply put, every debt that the subprime mortgage companies owe to banks and Wall Street firms, are carried in the latter’s books as an asset. If the loans remain unpaid, the banks and Wall Street will have to “write down” the value of those assets from their Balance Sheets.

Effectively, billions of dollars of corporate value disappears – and that will shake the US economy.

It also results in a liquidity crisis for banks. They will reduce the number of new loans and impose tighter criteria for borrowers. Of course, it begs the question, why this wasn’t done earlier and to what extent subprime lenders, banks and Wall Street fuelled a bubble in the subprime market. In case you hadn’t realized, subprime mortgages are given to those with very damaged credit histories.

Criteria For Equipment Leasing

2007-03-06T15:03:00.000+08:00

What the funding sources look for:

1. Size Of The Deal

The smaller deals, US5,000 - $100,000 stand a greater chance of being funded, compared to multi-million dollar items.

2. How Long Has The Business Been Operating?

In general, startups and new businesses less than 2 years old, would not usually be funded. There are exceptions and some funders will gladly consider newer companies and harder to fund deals.

However, if the startup itself is intending to provide “Vendor Leasing” i.e. a leasing option to its customers that are buying its products, financing might be available – so long as its customers have been in business much longer than the startup vendor.

3. Type Of Equipment

Computer equipment, telecommunications, construction equipment, turcks, machine tools and generic machinery that is regarded as having a defined value and considered to be a liquid asset, are the ones most easily funded.

Specific purpose-built machinery is less likely to be funded, as well as equipment that has an inherent liability issue e.g. tanning beds.

4. Creditworthiness Of Proposed Lessee

This is very important as it is the Lessee that will be making the payments on the Lease.

Bankruptcies, credit card delinquencies, tax liens and judgments could damage the chances of funding.

Equipment Leasing in the US

2007-03-06T15:00:00.000+08:00

It would probably come as a surprise to a small and mid-sized business to discover that Equipment Leasing in the US is a 300 Billion Dollar industry, with huge growth potential.

Think about it: to acquire a business asset, you can either pay cash upfront, get a bank loan or enter into an Equipment Leasing contract.

Equipment Leasing is a form of Asset Based Lending. Not only is it a stand alone financing product, but it can be combined with other financing such as Factoring.

While Factoring generates predictable and faster cash flow, Equipment Leasing allows a business to make strategic decisions as to the USE of that cash. Why? Because it is the use – not the ownership – of the equipment that generates cash, and ultimately profits.

Given the rapid rate of technical obsolescence, a business might decide to lease the equipment rather than pay a wad of cash for it. This allows them to get the most use out of the equipment for the time they need it, while protecting their cash reserves.

The First 3 Months Of The Year

2007-02-11T12:56:00.001+08:00

It may come as a surprise to realize that January, February and March are difficult for businesses, even during good times. Why?

During these months, companies analyze and plan their objectives for the year. It might include expansion of product lines, production facilities, more employees, upgrading the marketing.

The company needs to project where the additional funding will be coming from, while still having cash on hand to pay expenses incurred at the end of the proceeding year. It is important to note that while the cost of expansion will be recovered at some point in the future, the costs of expansion are payable now.

It’s at this time of year that a company should be considering factoring. The cost of factoring will be offset by the additional revenue generated by their expansion plan. For example, if a business concludes that an expansion of its sales and marketing staff will generate more revenue in the coming 6 months, they could factor the revenue during those 6 months in order to have the cash resources to grow beyond that period.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring And Insolvency 2

2007-02-09T06:13:00.000+08:00

The business is then required to obtain and unsecured loan. At first glance, it sounds paradoxical since the business is likely insolvent and lenders require collateral. Banks might not step up to the plate and the business will initially look to individuals or angel investors.

In reality, assuming that the business still has customers, the only tangible security it can offer are its new sales, evidenced by the invoices (which are technically, commercial paper).

For the purposes of Bankruptcy, factoring is not regarded as being in the ordinary course of business and the business must obtain the Court’s permission to factor its receivables. The Court will hear the factoring proposal and any objections from the creditors.

If the Order is made, the business will be allowed to factor the receivables which came into existence on or after the date of the filing of the Bankruptcy Petition. The factoring may be for a specific period of time (which can be extended by further order) and may require the factor to pay a portion of the advance into a designated account in favour of the creditors.

It is important to note that the Court’s Order is as good as a UCC filing.

Note: this posting is in general terms only and is not to be taken as containing specific or implied legal advice. A business must consult its lawyers and accountants where Chapter 11 is contemplated.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring And Insolvency 1

2007-02-09T05:31:00.000+08:00

There is no doubt that factoring enhances cash flow for a business operating as a going concern. But what about a business that is unable to meet its current debt obligations and is facing insolvency?

In the US, a business may seek temporary protection from its creditors by filing a Chapter 11 Bankruptcy Petition in the Federal Bankruptcy Court. The effect of the Petition is to create an automatic stay that suspends the ability of any creditor, secured, or unsecured, to obtain payment from the company or to enforce the security.

Further, the Petition generally prevents the company’s future assets from being appropriated by creditors – notwithstanding any language to the contrary in any security agreement.

That means that a creditor who, in its agreement with the business, used typical language to secure “all the accounts receivables of the business whether currently existing, or hereafter arising, no longer holds an interest in those receivables which come into existence after the filing date of the Bankruptcy Petition.

Effectively, the business can make a fresh start with those receivables and negotiate with the creditors to formulate a Cash Collateral Order (which allows the business to use existing cash to meet at least a portion of ongoing obligations) and the Plan of Reorganization.

However, before Factoring can be implemented to assist the business, a few more steps are required. These are set out in the next post, entitled, Factoring & Insolvency 2.

Factoring Flexibility 6

2007-02-07T14:58:00.000+08:00

Invoice Batching

This is most commonly done where there are a series of invoices for small amounts. The invoices would be batched and treated as a single invoice. Once enough invoices from that batch are collected to cover the advance and the factoring fees, the batch is deemed “closed”. Thereafter every invoice of that batch which is collected from the debtor, is paid over in full to the client.

The effect is that the client is charged a lower discount fee, normally reserved for larger invoices, instead of being charged a higher discount fee normally charged on small invoices.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Flexibility 5

2007-02-07T14:52:00.001+08:00

Invoice Splitting

In order to save the client some fees, the factoring company might split an invoice i.e. notionally splitting it into sub-invoices. This is usually done where the debtor makes partial payment on the invoice over a period of time, instead of paying it all off at once.

The effect of splitting the invoice is that higher fees are charged only on the later partial portions, instead of the full face value of the invoice.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Flexibility 4

2007-02-06T15:11:00.000+08:00

Partial Funding Of Invoice

Since factoring is all about generating predictable cash flow for the client, it sometimes happens that the client wants to control the amount of cash flowing in. For example, a client may have factored a large invoice, but the present cash flow needs of the business are sufficient.

In order to save the client from paying unnecessary factoring fees on the full amount of the invoice, a factoring company may agree to partially fund that invoice for an amount set by the client. Factoring fees will be paid on the partial amount only.

Once the full amount of the invoice is paid by the debtor, the factoring company will keep the advance and its fees, calculated on the partial amount, and remit the unfactored amount to the client.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Flexibility 3

2007-02-06T14:46:00.000+08:00

Discounts On Fees

If a debtor takes a long time to pay on an invoice, the factoring company might give a discount on the fees to the client, for the sake of the business relationship. There might not be a contractual obligation to do so, but it could be done.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Flexibility 2

2007-02-06T14:41:00.000+08:00

Buyback Or Replacement Of Invoices

The cost of Factoring is paid by factoring fees. These are determined by how long an invoice remains unpaid. Factoring companies will allow the client to buy back an ageing invoice; or substitute it with a fresh invoice. This stops further fees on the previous invoice or prevents the old invoice from exceeding the ageing limit imposed by the factoring company.

Buyback - the client pays cash to cover the advance and the factoring fees on that invoice;

Replacement – the client replaces the ageing invoice with a fresh invoice of a suitable amount so that the advance on the fresh invoice covers both the advance and factoring fees on the old invoice.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Flexibility 1

2007-02-06T14:27:00.000+08:00

Fast Payment Of Reserve

From the factoring company’s view, each invoice that is factored, is an individual transaction. Therefore, once the full face value of the invoice has been recovered from the debtor, the Reserve is theoretically payable to the client immediately.

Some factoring companies will pay the Reserve to the client the same day. For smaller amounts, daily payments of the Reserve might not be administratively practical. In such cases a factoring company might pay the Reserve amount to a client weekly.

That’s not necessarily a bad thing. It could be agreed beforehand that if Reserve payments are made weekly, then they must be paid before payroll is due,

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 13

2007-02-01T10:57:00.000+08:00

Why is it necessary for the business to sign the factoring documentation, only to have it backed up by a Director’s Personal Guarantee?

Corporations by themselves don’t commit fraud. It’s the people behind them.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 12

2007-02-01T10:50:00.000+08:00

Why is it necessary to pledge all the business receivables as collateral on the UCC-1 if the business is not factoring all the receivables?

The term “accounts receivables” may sound like a plural, but technically, it is one class of collateral and cannot be divided.

Further, as far as the factoring company is concerned, there is no collateral value in having recourse only to the non-performing receivables.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

The Cost Of Extending Credit

2007-02-01T10:37:00.000+08:00

When a business extends credit to its customer, the business effectively becomes their banker. This is because the business has lent money to the customer, free of interest for 30 days or more. In the meantime, the business has lost the use of that cash, while hoping that it will be paid.

Extending credit on a regular basis affects a business in 3 ways

1. The business loses interest income that it could have earned – even in a low interest savings account.

2. The business may not have enough liquid funds to pay for volume discounts or early payment discounts from its suppliers.

3. The business may lack the working capital to begin the next job or project and thereby risk losing potentially profitable business from creditworthy customers.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring & Inventory Financing

2007-01-21T11:01:00.000+08:00

For the avoidance of doubt, they are completely different.

Factoring requires the completed delivery of goods or services, for which an invoice has been issued, awaiting payment. The invoice is sold at a discount to a Factoring company in return for an initial cash advance.

Since Factoring is the sale of an invoice, it is not a loan. It allows a company to grow debt-free.

Inventory Financing is a line of credit secured by physical inventory. It makes the cash tied up in your Inventory available to you. It is a LOAN and therefore repayable – It is a Lender / Borrower arrangement.

It is usually available to businesses with good credit and sales history. By contrast, Factoring focuses on the credit worthiness of the debtors of the business i.e. the customers who are responsible to pay the invoice.

When Is Inventory Financing Available?

1. When you have a warehouse of goods ready to ship, but find yourself short of cash to buy supplies for your next production cycle;

2. When you have to maintain high levels of inventory to conduct ongoing business that keeps too much of your cash tied up.

3. When you have good turnover in your inventory, but are short on cash flow and you have to keep replenishing your stock.

When Is Inventory Financing Not Advisable?

When you have a storeroom full of out of date or hard to sell merchandise. It will add interest charges and will make a bad situation worse.

Potential Problems With Inventory Financing

1. High interest rates or other fees.

2. You may have to pay off the Line of Credit every 12 months – regardless of the state of your Inventory.

3. If sales slow down, you may have to unload your Inventory at a loss, undermining your ability to stay current on your line of credit.

4. The interest on the loan may sap your ability to keep production or shipment on schedule.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

9 More Reasons To Factor

2007-01-19T13:13:00.000+08:00

1. Meet Payroll and Payroll taxes.

2. Pay off outstanding debt.

3. Service existing debt promptly and improve the business credit rating.

4. Fund new Marketing strategies.

5. Fund new E-commerce strategies.

6. Increase available cash on the Balance Sheet while reducing the amount of Accounts Receivables.

7. Reduce or eliminate the need for outside investment in the company

8. Makes the company more attractive to outside investment because of guaranteed cash flow.

9. Factoring operates as a stand-along product, or, it can work alongside traditional bank finance or venture capital or loans from Small Business Organizations.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring And Outsourcing

2007-01-19T12:06:00.000+08:00

Much has been written about Outsourcing and the apparently detrimental effect it is having on the workforce. Regrettably, we are being conditioned to automatically assume that Outsourcing means having your skills exported halfway around the world where your job can be done for a fraction of your salary.

In Factoring, when the invoices are sold, the Factor becomes the company’s Receivables Management arm. If a company always has its eye on the bottom line, the hard truth is that chasing up on unpaid invoices is neither efficient in terms of cost or time.

The reality is that the company has to focus on Sales, Marketing and Production.

Therefore, Factoring effectively allows a company to outsource non-productive work, without attrition or loss of critical people skills and guaranteeing themselves a steady cash flow, without additional debt.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Telling The Customer

2007-01-15T15:43:00.000+08:00

For starters, Factoring is not new. It’s been around for several hundred years and that in itself is a surprise – particularly to small and mid-sized companies who habitually look for traditional financing via a bank. Large and very well known publicly listed companies factor all the time.

The business has decided to rationalize its cash flow in order to guarantee future expansion. The fact that you are not using a traditional bank, but private financing, shows that the company is financially attractive. It therefore has a range of financing options.

The customer’s payment terms will not change.

The customer will still have the routine contact with the business and its personnel. Nothing will change there.

All the business invoices to the customer will come via the Factoring company, with a written instruction that the customer is to make full payment on that invoice direct to the Factoring company.

The Factoring company is not a collection agency, but they will be providing real time online status of unpaid and paid invoices to the business. This will allow the business to objectively monitor its cash flow from all or any of its customers.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

14 Reasons To Factor

2007-01-14T15:22:00.000+08:00

1. Leverage your customers credit.

2. Factoring is faster than a bank loan. The documentation is straightforward

3. Factoring company acts as your Receivables Management company, providing real time status of your outstanding invoices. They will be in charge of collections.

4. The Business can concentrate on Sales and Marketing instead of chasing up unpaid invoices.

5. Factoring companies will do credit checks on your customers and warn you of potentially high risk customers.

6. Faster incoming cash flow to meet overheads plus capital investments either by way of outright purchase or equipment leasing. If leasing, then guaranteed cash flow will help the business calculate lease payments.

7. The business can choose which invoices to factor, how much they want in factored funds and for how long. Alternatively they can factor all invoices indefinitely.

8. Increased cash flow means the business can take advantage of early payment discounts from its suppliers.

9. The Business can stop offering early payment discounts to its customers. In practice, customers who have more time to pay, buy more goods and services more frequently.

10. Faster incoming cash flow means a business can build or repair its credit and service debt more confidently.

11. Accounts Receivables become an immediate liquid asset, instead of a contingent asset on the Balance Sheet.

12. Factoring reduces the amount of Bad Debt which appears on the Balance Sheet.

13. Since Factoring is the sale of invoices for cash, no new debt is incurred.

14. No need for the business to surrender equity.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 11

2007-01-14T14:57:00.000+08:00

If the Factoring company is buying the invoices, does our business actually get to bill the customer?

The business prepares its invoice to the customer in the normal way, showing the delivery of completed goods or services. The original invoice is sent to the Factoring company, who will bill the customer, pointing out that payment is to be made to the Factoring company.

The Factoring company would also verify the invoice with the customer and then make the advance to you.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 10

2007-01-14T14:42:00.000+08:00

Factoring Question 9

2007-01-08T13:27:00.000+08:00

Where the bank has security over the invoices, how does Subordination work if we need Factoring?

In practice, the Factoring company, the business and the bank will negotiate. The objective is to allow the Factoring company to have priority over at least a portion of the invoice values. This is done by way of a Creditors Agreement.

For example, if there are $100,000 worth of invoices, the Agreement might allow the Factoring company to have priority on the first $50,000 worth of generated invoices, with the Bank secured over the remaining $50,000 (with or without additional collateral put up by the business).

In that case, now that the Factoring company has obtained security over the first $50,000 worth of invoices, they could factor the company up to that amount.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 8

2007-01-08T11:59:00.000+08:00

Is it necessary for our customers to know that our invoice to them have been factored? Does it affect our business credibility with them?

Yes it is necessary for your customers to know that your invoices to them have been factored. This is because there has been a legal assignment of them in favour of the Factoring company. Your customers are legally bound to now pay the full face value of the invoice to the factoring company. That’s why they require notice.

Further, Factoring companies have a duty to notify your customers and a duty to verify that the invoices relating to that customer are genuine.

Factoring companies are very sensitive when it comes to dealing with your business customers. This is because they have taken over the management of your Receivables. This involves tracking how quickly they are paid by your customers and very often allowing you to see it online in real time.

Factoring companies are fully aware of the relationship between a business and its customers. It’s not in their interests to sabotage it. Many Factoring companies will discuss this with you and customize their approach to your customers.

Don’t forget: the fact that a third party is funding your Receivables, is an important signal to your customers that your business is regarded as being in a good financial position and poised for future growth.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 7

2007-01-08T09:33:00.000+08:00

If the company has an existing bank loan or is drawing on a bank line of credit, can its invoices still be factored?

That depends on the cooperation of the bank. Frequently a start-up, or an established growing company requires capital and will approach a bank (after getting initial capital from family or friends). Collateral for the bank loan may be by way of home equity, stocks or using a third party as Guarantor.

However, the bank usually assigns to itself the tangible assets of the business, as additional security. This covers the invoices, which are technically, commercial paper and therefore a business asset. The document by which the bank receives security over the invoices, is known as the UCC-1 Financing Statement.

If in future the business wishes to factor its invoices, it must disclose the UCC1-Financing Statement to the Factoring company. Since the bank now owns the Receivables, the Factoring company must obtain the bank’s approval to subordinate those Receivables, and thereby relinquish ownership.

Only when that is done and the Receivables assigned to the Factor, will factored funds be available.

Banks are generally open to subordinating, but it must be dealt with on a case by case basis. If the bank has concerns, then either factoring will not go ahead, or the business will first have to pay off the loan or make a significant payment towards its reduction.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 6

2006-12-30T13:45:00.000+08:00

If banks tighten their credit facilities, does it make it harder for me to obtain factoring?

No. Factoring that is done through reputable, well capitalized factoring companies is not affected by bank policies towards small and medium sized businesses.

Factoring is not a loan and is not about getting credit. It is about the sale of an asset that you own – the receivables – to guarantee cash flow and obtain working capital.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 5

2006-12-29T14:39:00.000+08:00

We are a brand new start-up. Can we factor immediately?

No. You need clients. You need to supply them with goods or services under a fully completed contract. You need to have an invoice under which they are liable to pay. In that order.

For a brand new start-up, initial funding may have to come from the founders, family and friends, a line of credit, or a bank loan.

However, start-ups should talk to factoring companies and present them with a list of serious potential clients who have expressed a written interest in their product. Factoring companies do credit checks on debtors as a matter of course, and where there is an intention to establish a factoring relationship, they will often advise the start-up as to which potential clients may cause delays in paying invoices.

Once invoices are generated, start-ups can factor and the cash will be available within days.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 4

2006-12-29T14:19:00.000+08:00

If my company is facing bankruptcy, is factoring still an option?

It could be the only option. However some funding sources will only consider purchasing receivables under US Chapter 11 Bankruptcy protection i.e. where there is a reasonable prospect of the company emerging from bankruptcy and continuing as a viable operation. This will involve negotiations with creditors about debt restructuring.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 3

2006-12-29T14:07:00.000+08:00

How long will it take to receive the initial funding?

This varies depending on the factoring company. Since factoring is all about the speed of guaranteed cash flow, you can expect the factor to move quickly on Due Diligence, invoice verification, credit checks on the debtors and client investigation.

Initial funding should take place between 3 – 7 days after all documentation is signed. Funds are usually sent by wire transfer, but can also be sent by cheque if requested.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 2

2006-12-29T13:49:00.000+08:00

Can I sell only a portion of my invoices?

Yes. The decision of how much to factor is up to the client. Sometimes a client knows precisely how much cash flow they need in a month and will only factor invoices up to that amount. Similarly, a client may only wish to factor invoices from a certain client every month.

Whilst flexibility is built into factoring, remember that the higher the number of receivables purchased by the factor on a regular basis, the more competitive the rates will be. Generally, invoices that are payable by a larger (rather than smaller) group of creditworthy debtors, will attract more favourable rates.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 1

2006-12-28T13:52:00.001+08:00

Can we sell invoices that were billed before the date of the factoring contract and are still outstanding?

Yes. In practice the first funding usually consists of those invoices – provided they are to creditworthy payors and are within 30 – 45 days outstanding.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Types Of Factoring

2006-12-28T13:01:00.000+08:00

When a factoring company decides to buy the invoices from their client, the factoring contract will state whether the funds supplied are on a Non-Recourse or Recourse basis.

What’s the difference?

Non-Recourse
In buying the invoices from the client, the factoring company assumes the full risk that the payor of the invoice will not pay them in full or at all. To cover themselves against this risk, factoring companies carry credit insurance. That’s why factoring companies are so interested in the creditworthiness of the ultimate payor.

Recourse
Sometimes referred to as Full Recourse. After a certain period of time, usually 90 days after the invoice was due for payment, the client will have to owe the advance back to the factoring company. In practice, the factor may set-off this amount against an advance on a later invoice which the client offers for factoring.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Focusing On The Best Clients

2006-12-27T14:11:00.000+08:00

A business that is seriously considering Factoring as an important part of its cash flow strategy, needs to focus on 2 things:

Acquiring good clients – i.e. clients who pay invoices promptly, preferably within 30 days. The more creditworthy the payor, the better the discount rate the funding source will quote. It is important to remember that a funding source does its own creditworthiness check on the payor BEFORE agreeing to factor. They can therefore assist their clients in identifying potentially problem payors. This is an important service that a business client does not get from a bank.

Selling consistently to those clients - Why? Once the funding source sees a pattern of prompt payment on the factored invoices by the payor, the client may receive a better Advance rate and in due course, a better discount rate.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

The 3 Parts Of Factored Funds

2006-12-27T07:13:00.000+08:00

The previous post alluded to the 3 parts of factored funds:

"Having purchased the Receivables, the funding source will initially advance 75% - 90% of the invoice amount up front and will pay the remaining amount – minus a service fee – after the Client’s Debtor pays the full value of the invoice to the funding source. The service fee is expressed as a discount from the face value of the invoice. The discount varies according to the length of time the invoice has remained outstanding."

Advance
This is the dollar amount the funding source will fund initially. It is always expressed as a percentage of the face value of the invoice

Example: if an invoice of $100,000 is being factored and the funding source says it will advance 90%, the client will receive an initial funding of $90,000.

Reserve
This is the dollar amount held back until the ultimate debtor pays the funding source. Once it is paid, the funding source releases the Reserve to the client (minus the service fee i.e. the discount)

Factoring companies have differing policies and time lines as to when the Reserve will be released to the client. Some funding sources like to keep a semi-permanent Reserve as partial security for the risk they are incurring in factoring.

Discount
This is the service fee for funding the invoice and is expressed as a discount from the face value of the invoice. The discount varies according to the length of time the invoice has remained outstanding.

Example: 2% 30 days

Obviously, the longer the invoice has remained outstanding, the higher the discount from its face value since the risk of the factor not being paid by the ultimate debtor, increases. That’s why it’s usually a good idea for a business to factor the invoices of its best clients i.e. its fastest paying clients, first. They will receive a lower discount rate on those invoices whilst increasing their cash flow.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring 101

2006-12-11T14:18:00.000+08:00

Where a business has already supplied goods and services to another business (not an individual consumer), it can sell the Invoice to a 3rd party for immediate cash at a discounted value, rather than waiting for its customer to pay up. Factoring is the sale of commercial paper. The 3rd party, having bought the Invoices from the business, now assumes the risk of obtaining payment from the customer.

The company that BUYS the invoices is the Factor (or funding source). The company that SELLS its invoices (also known as Accounts Receivables) is the Client. The company to whom the invoice was addressed, and which remains liable to pay the Client’s invoice, is the DEBTOR.

Having purchased the Receivables, the funding source will initially advance 75% - 90% of the invoice amount up front and will pay the remaining amount – minus a service fee – after the Client’s Debtor pays the full value of the invoice to the funding source. The service fee is expressed as a discount from the face value of the invoice. The discount varies according to the length of time the invoice has remained outstanding.

Factoring is NOT a loan. The Client sells its invoices to the Factor at a discounted amount in return for virtually immediate capital. There is no need for the Client to wait 30, 60, 90, 120 days or longer for its debtors to pay its invoices, or run the risk of declaring them as Bad Debts. In other words, the business that sold the invoices for cash, capitalized on the time value of money.

When a bank extends a line of credit, it means that the company is, or soon will be in debt. In private Factoring, there is no loan and there is no debt. The amount of money available pursuant to a sale of the invoices is based not on the creditworthiness of the company – but of its customers. As the company sells to creditworthy customers, more money is made available and the business can grow exponentially – debt free.

When deciding to factor, the funding source is more interested in the creditworthiness of the Debtor i.e. the payor of the Invoice, because the funding source, in buying the Invoice from the Client, will look to the Debtor for payment.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Business Cash Flow Cycle 2

2006-11-30T15:16:00.000+08:00

OUTGOING CASH

1. Interest on debt servicing – payable periodically. If the company defaults, a full range of legal consequences can follow including removal of Directors, appointment of Receiver/Manager, rescheduling of company debts, restructuring the company, selling collateral, or winding-up the company.

2. Operating Expenses – also known as Overheads. These are usually all expenses that are not directly related to Production.

3. Plant & Equipment – Also the subject of Capital Budgeting, companies have to decide whether to buy or lease such equipment and how long to keep them to claim Depreciation expenses in their Accounts.

4. Manufacturing Expense and Inventory Control – A major cash flow drain, which does not operate at constant levels. High levels of sales, or large variety of products, require high levels of inventory. Also Inventory builds up to reduce the cost of Production, and as a result of uneven sales.

5. Dividends – both private and public companies pay them, sometimes several times a year. There is no legal obligation to declare or pay dividends.

6. Corporate Taxes – may require to be estimated and paid in advance.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Business Cash Flow Cycle 1

2006-11-30T14:47:00.000+08:00

This 2 part breakdown given an overall understanding of how cash moves through a business.

INCOMING CASH

1. Shareowners capital – these are the individuals who really own the company. They provided the initial cash injection when the company was incorporated (or contributed to the business if it was a partnership). In return, they received shares in the company. They can be asked for money periodically, in return for additional shares. Shareholders capital also includes angel investors and venture capitalists. They will however, seek to be repaid on terms and within a certain time frame and should be regarded as private lenders. Whilst they are invested in the company, venture capital shareholders might wish to direct the management of the company.

2. Borrowing – from private lenders or banks. Can either be short term or long term and are the company’s Lines Of Credit. Some can be negotiated beforehand and some companies resort to short term borrowing several times a year. Security or Collateral is required and interest is payable to service the loans.

3. Marketable Securities or Commercial Paper – usually available to the largest and financially strongest companies only. Essentially, the company goes into the Money Market and issues an IOU to obtain large amounts of cash which it will repay on terms at a future date.

4. Accounts Receivables – theoretically the main source of cash into a business. It is generated through sales and timely payment of invoices. In practice, many companies have poor control of their Receivables. This means that their invoices are not properly followed up and their cash flow becomes unpredictable. This impacts the company’s ability to fulfil new orders, grow, invest in marketing, and pay operating expenses such as salary and debt servicing. Poor control of Accounts Receivables can make or break a company.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved