January 30, 2017 – Secured lenders can benefit greatly by lending on A/R that is fully documented and regularly verified. Here, we offer an overview of Dopkins Asset Based Lending capabilities, and how our Field Examiners can add value to a secured lender’s collateral examination.
Dopkins & Company ABL Consulting (DAC ABL) Field Examiners operate daily in a space where traditional secured lenders provide working capital to commercial and industrial (C&I) entities by advancing funds from a revolving line of credit (RLOC) based on a formula determined by the value of a Company’s reported A/R and inventory. Our consultants are heavily experienced and highly specialized in this area and focus their testing and analysis to aid the lender in evaluating and structuring these secured lending relationships in terms of the “Five C’s” of credit.
DAC ABL professionals are also experienced interacting with companies that are led by strong operators, maintain good collateral and quality assets such as A/R due from investment grade debtors and saleable inventory but for whatever reason, do not fit the traditional bank profile. These Companies also require working capital funding, though have suffered financial losses leading to strained cash flow, are highly leveraged and inadequately capitalized or operate in tough, seasonal or sporadic industry conditions that have weathered their business model. Also, the Principals simply have chosen an alternative funding source and the traditional formula based ABL structure does not fit their immediate needs. These Companies tend to find that Factoring is the ideal fit for their working capital needs.
An invoice factoring company (“Factor”) is not a direct lender and will not lend money to the specific company or a client but will assist in funding their working capital needs through other means. In these instances, a company’s booked A/R invoices are sold to and purchased by a Factor under an A/R Purchase Agreement (ARPA). The proceeds of the invoices sold provide the company with access to working capital immediately upon invoicing the formal sale of goods or providing particular service.
Operationally, the steps are fairly straightforward.
- A Factor will buy the invoice at a discount or a factoring fee of between 2-3% for however long the purchased invoice remains outstanding.
- A Factor’s client is advanced payment on the purchased invoice at a determined 85-90% advance rate of the face value and this 10-15% holdback or reserve is used to mitigate collections issues.
- The company financed or seller simply utilizes the net proceeds to continue operations based on this expedited and immediate cash flow and the Factor or buyer is then tasked with collecting from the ultimate account debtor.
- Once customer payment is received by the Factor, a rebate of the difference between the reserve already withheld (85-90%) and all fees earned will be paid back to the client.
The relationship continues. New invoices are purchased; either individually invoice-by-invoice or purchases are made in bulk depending on the ARPA and the immediate needs of the client. Clients benefit from immediate cash on sales otherwise subject to 30 to 60-day payment terms and the Factor benefits by realizing a factoring fee for this funding and collection service.
Traditional banks and secured lenders have tended to not participate in the factoring business due to regulatory issues, perceived requirements and costs of collecting on a pool of invoices, or just lack of an understanding of this alternative method of funding. So how do traditional banks and secured lenders participate in the Factoring industry? By offering Rediscount RLOC’s directly to the Factor.
Benefits of Rediscounting and the Win-Win
Secured lenders not directly involved in invoice factoring participate in factoring and spread their portfolio risk by understanding the pool of collateral and developing a rediscount RLOC relationship with a Factor. The Factor essentially borrows to purchase their client’s invoices. The Factor’s A/R is monitored much like other C&I loans in their portfolio. The Bank’s collateral ultimately is the A/R of a book of factored clients. The Bank’s collateral is monitored by a standard borrowing base certificate (BBC) and field examinations remain a critical part of portfolio management.
Rediscount Field Examinations
Field Examiners understand the factoring process, common factoring industry software, unique industry metrics, the reserve and rebate process as well as the credit analysis and underwriting processes used by Factors.
The Field Examiner will analyze the Client A/R using standard ABL procedures such as invoice evidence testing and concentration analysis that are critical components of asset based lending. A concentration analysis will focus at the client level, opine on the industries served, and the funds employed relative to credit limits established by the factor. Analysis of net funds employed (NFE) monthly roll forward will determine A/R turnover and chargeback dilution and will aid the Lender in setting an appropriate rediscount RLOC advance rate, replacing a traditional A/R rollforward.
The one area of review that truly deviates from a traditional field examination is the addition of underwriting compliance review, both general review of policies and direct testing of compliance through documentation review. This portion of the review is critical in verifying that the Factor’s accounts remain in proper compliance with predetermined policy, and ensures that no change in policy or documentation standards develop subsequent to entering the Rediscount agreement.
Collateral examinations conducted on rediscount facilities extended to Factors require a keen understanding of the alternative funding process. Not only will the Field Examiner think outside the traditional consulting box, they must understand factoring operations that encompass the purchase and sale agreements, the diligence undertaken with both funding clients as well as documenting and verifying invoices purchased and sold. Secured lenders can benefit greatly by lending on A/R that is fully documented and regularly verified, widespread across many industries, and is already being collected by a third party.
About the Author
Joseph A. Heim CFE, CPA
Joseph Heim has over 25 years' experience investigating matters involving white-collar crime, fraud and corruption. He provides forensic accounting, litigation support and expert witness services to businesses, attorneys and commercial finance lenders. He is the Partner in charge of Dopkins Asset Based Lending Consulting Services.