"The invoicing crunch
There’s a hidden credit crunch going, according to UBS economists Paul Donovan and Larry Hatheway — a crunch relatively unreported because it is occurring within the more opaque realms of inter-company credit.
As their note explains, companies have access to three forms of credit:Bank credit, vendor financing and credit stemming from normal terms of payment such as invoicing, vendor financing and credit stemming from normal terms of payment such as invoicing.
Bank credit contraction is, of course, well documented thanks to the vast amount of public data available from banks and central banks. Data regarding vendor financing or invoicing, however, is much harder to collect.
Nevertheless, anecdotal evidence points to an abrupt tightening in this form of financing, according to UBS. And, as they point out, this is relatively out of historical context:
Indeed, it may be subject to a more drastic tightening than in some previous economic downturns. This suggests that a more vicious inventory cycle may result in the initial stages of the current downturn. It also increases the challenges faced by policy makers and suggests that economic normalisation requires a broader stabilisation in the economy than the banking system alone.
Specifically worrying Donovan and Hatheway are invoice time periods, which are narrowing. This they say inevitably raises the cost of holding inventory:
Essentially a reduction in the duration of invoice credit will raise the cost of holding inventory. If invoice terms go from 45 days to 30 days, there is logically an incentive to reduce the level of inventory by a third (because the period over which inventory is costless to hold has declined). The alternative to a reduction in credit terms is that the supplier takes out insurance against the risk of default on the part of the customer (with the customer holding stock that has not been paid for). This increases the cost to the supplier, which may or may not be passed on to the customer depending on the conditions in the sector.They go on to highlight examples where credit tightening in this way has now led to corporate failure and to what degree it leaves small companies vulnerable in particular (our emphasis):
Some of the recent instances of corporate failure have been preceded by the reluctance on the part of suppliers to offer invoice credit. Linens ‘N Things and Circuit City in the United States and Woolworths in the United Kingdom reportedly saw suppliers refusing to supply goods without prepayment, in advance of these companies’ failures. Large corporate failures are, of course, more readily anticipated a priori (by suppliers). Large companies in good health are less likely to be subject to changing invoice terms, as their health is also more visible and their suppliers can thus discriminate between strong and weak customers.
Smaller businesses have less readily visible credit health. As such, in a risk aversion environment, there is more likely to be a “lowest common denominator” approach, and for strong companies to be treated the same as the weaker companies by their suppliers.Because inter-company credit tightening spills through to the freight and transporting business, negative air freight traffic in Asia does provide some evidence for the above. The link comes because companies having trouble holding inventory cut down on their shipment of goods. What is most worrying about the numbers (see chart below) is the speed with which the deterioration in traffic has taken place.
Meanwhile, it appears, those companies with greater clout in their markets are demanding longer durations for invoicing. This is particularly the case for purchasing-power heavyweights like Tesco and its relationships with non-food suppliers, as well as for the advertising industry in general.
As the UBS economists explain:
The advertising industry offers a mirror image of what we contend is happening in the broader economy. The advertising industry has a degree of monopsonist bargaining power — a small number of large purchasers of advertising and a large number of media outlets competing for that advertising. Anecdotal evidence suggests that the payment terms for invoicing are increasing in this sector. The large companies are insisting on (for instance) 120 days settlement of invoices rather than the traditional 60 days. In a similar example, the UK supermarket Tesco asked its non-food suppliers to double their invoice period from 30 to 60 days.
And then there’s the speed, severity and variance of the inventory correction according to the business size:
As UBS explain (our emphasis):
In addition the European retail trade survey is suggestive of some divergence in inventory levels when characterised by size of firm. The volume of stock indicator for large store retailers has been rising, while for “others” has been falling. This would seem to suggest that the small business sector has been under greater pressure to de-stock.
Consequently:
It is not enough to argue that the hidden credit crunch is taking place in the current economic downturn. We wish to go further, and argue that the hidden credit crunch is more abrupt than in previous downturns. Inventory data from the US and Euro economies certainly suggests a more abrupt shift in inventories amongst small businesses than is typical in even a severe economic downturn.( NB DON )
Related links:
Corporate credit, the pachydermic herd in the room - FT Alphaville
Brace yourselves for record corporate defaults in 2009 - FT Alphaville
The cash crunch and Silverjet’s silver lining - FT Alphaville
Does the US have an inventory problem? - FT Alphaville
BU57 - FT Alphaville
Apr 2 15:16
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