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Reverse Factoring and the need for better disclosure in accounts Working Capital & Supply Chain Finance Conference, Madrid Iván Palacios, Associate Managing Director, 26 February 2020 Corporate Finance Group Key messages 1. Attractions are manifest, but hidden risks can be high 2. Current poor/ inconsistent disclosure creates a challenge 3. Metrics can be affected… 4. … but the greatest risk is to liquidity Moody’s, Working Capital and Supply Chain Finance Conference, Madrid 2 A win-win-win product? Margin capture Satisfy late Off balance payment sheet regulations finance Liquidity benefit Control Lower over supply reported chain leverage Early payment to suppliers RF is safest for highly rated credits but becomes riskier when used by customers whose credit quality is less strong Moody’s, Working Capital and Supply Chain Finance Conference, Madrid 3 Poor and inconsistent disclosure creates a comparability challenge Factoring Adjusted debt Pensions » Where feasible, Moody’s Leases Reported adjusts key reported figures to debt improve consistency » If >50% of companies use RF, but <5% disclose, then there is not a level playing field Moody’s, Working Capital and Supply Chain Finance Conference, Madrid 4 Leverage metrics can be distorted Reported debt Liability funded through reverse factoring 2017 2018 » If reported leverage falls, it may appear that company is stronger, but the liability may simply have moved to another line on the balance sheet Moody’s, Working Capital and Supply Chain Finance Conference, Madrid 5 The distinction between operating and financing cashflow can be blurred » Important for stakeholders to understand whether cash inflows are operating inflows… – Suggesting operations are strong/ improving – Inflows can be repeated in future years – Low risk of reversal » … or financing inflows – Which do not imply strong operations (and sometimes suggest the opposite) – Not repeatable – High risk of reversal if and when financing arrangements are unwound Moody’s, Working Capital and Supply Chain Finance Conference, Madrid 6 How can we identify if a company might be using Reverse Factoring? Source: Moody’s. Data shown on an as-reported basis » Company with higher trade payable days than sector peers » Abnormal increase in trade payable days relative to historical average Moody’s, Working Capital and Supply Chain Finance Conference, Madrid 7 Company C Excess trade payables over 2008-12 average Accounts payable days 120 105 2,000 100 1,500 80 64 60 1,000 40 500 20 Accounts payable days Accountspayable - - 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: Moody’s. Data shown on an as-reported basis Impact on debt metrics – Estimated excess payables at 2018 year-end equivalent to ~67% of reported debt – ~37% of adjusted debt Moody’s, Working Capital and Supply Chain Finance Conference, Madrid 8 Liquidity poses the greatest risk » Risk arises if the initial liquidity benefit is consumed, and the company fails to retain sufficient committed liquidity to survive if the Reverse Factoring facility is subsequently withdrawn » Reverse factoring can make bad situations worse – Contributed to the defaults at Abengoa S.A. in 2015-16 – Contributed to the collapse of Carillion plc – Strained liquidity at a critical time for Distribuidora International de Alimentacion (DIA) A sudden liquidity shortfall can magnify operational problems and turn an otherwise manageable problem into a crisis, with a risk of default Moody’s, Working Capital and Supply Chain Finance Conference, Madrid 9 With careful use, benefits can outweigh risks Subject to better disclosure and careful liquidity management » Morrisons’ disclosure is an example of best practice, but as yet such examples are rare Moody’s, Working Capital and Supply Chain Finance Conference, Madrid 10 Appendix – Moody’s publications referenced » Reverse factoring is increasingly popular but can weaken liquidity at a time of stress, September 2019 » Audit firms urge FASB to address reverse factoring blind spot, October 2019 » Abengoa S.A.: Reverse Factoring Has Debt-Like Features, December 2015 » Carillion’s Collapse highlights shortcomings in the accounting for reverse factoring, March 2018 » Moody’s confirms DIA’s Caa1 CFR; outlook negative, July 2019 » Moody's assigns a A-bf Bond Fund Rating to GAM Greensill Supply Chain Finance Fund SCSp, March 2017 Moody’s, Working Capital and Supply Chain Finance Conference, Madrid 11 Iván Palacios Associate Managing Director, Corporate Finance Group [email protected] +34 91 768 8229 moodys.com This publication does not announce a credit rating action. 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