I NVENTORY F INANCE Nickolas Budd Consultant, IFC Ulaanbaatar, December 15, 2014.

INVENTORY FINANCE

Nickolas BuddConsultant, IFC

Ulaanbaatar, December 15, 2014

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Financing Facilities that can potentially be offered to Commercial Entities in

Mongolia Including:

• Importers and Exporters, for the purchase of equipment and consumer goods

for resale

• Manufacturers and processors, for the purchase of raw materials for

transformation, processing and resale

• Distributors and wholesalers for the purchase of vehicles, capital equipment, and

consumer goods for resale

• Retailers, for the purchase of equipment and consumer durable goods such as

vehicles for resale to consumers (sometimes described as “floor plan financing”).

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INTRODUCTION


• An Inventory finance is a line of credit or short-term loan made to a

company so it can purchase products for sale.

• Those products, or inventory, serve as collateral for the loan if the

business does not sell its products and cannot repay the loan. Inventory

financing is especially useful for businesses that must pay their suppliers

in a shorter period of time than it takes them to sell their inventory to

customers.

• It also provides a solution to seasonal fluctuations in cash flows and can

help a business achieve a higher sales volume - for example, by

allowing a business to acquire extra inventory to sell during the holiday

season.3

INVENTORY FINANCE


INVENTORY FINANCE BASIC STRUCTURE (I)

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INVENTORY FINANCE BASIC STRUCTURE (II)

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• Inventory loans are short term and self-liquidating (repaid by application

of sales proceeds)

• Inventory loans can be geared to high seasonal borrowing requirements

without reliance on land or equipment security

• Inventory loans become receivables loans when the inventory is sold

(much easier for banks to finance)

• Inventory can be liquidated by the bank if the borrower defaults

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INVENTORY FINANCE-THE ADVANTAGES


• Inventory is fast moving and value and quantity can be difficult for a

lender or trader to verify

• If the borrower is dishonest or is under severe financial pressure, he

may sell the goods without repaying the loan

• Inventory values, especially for commodities, can be volatile

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INVENTORY FINANCE-THE DISADVANTAGES


1. CREDIT FACILITIES CAN BE CONTROLLED TO ENSURE

PRODUCTION

• Loan can initially be geared to cover costs of production and inputs (raw

materials, parts, packaging, transport, etc. and only increased once the

products are finished)

• Loans can be disbursed directly to suppliers wherever possible.

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RISK MITIGATION


2. CREDIT FACILITIES ARE MONITORED TO ENSURE PRUDENT

LOAN-TO-VALUE RATIO

• Inventory value should be adjusted daily for volatile commodities

• The lender must be able to verify location, quantity and quality of the

inventory

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RISK MITIGATION


3. COMPREHENSIVE INSURANCE COVERAGE

• Insurance policy covering the inventory against fire, flood, theft, losses

in storage and transit and other usual risks

• Claims under the policy should be payable to the lender

• Policy premiums are paid in advance

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RISK MITIGATION


4. VALUE FLUCTUATION

• If the inventory is pre-sold the lender should take an assignment of the

sale contract and all sales proceeds

• If the inventory is a traded on a commodities exchange, the borrower

could enter into a futures or forward contract to hedge against a decline

in the market value

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RISK MITIGATION


• Procedures to monitor existence, value, title, quality and quantity of

inventory and receivables collateral

• Can be continual or periodic

• Can be carried out by the lender or by a collateral management

company

• Can be limited to monitoring activities (a stock monitoring agreement, or

SMA), or extended to a custodial role (a collateral management

agreement, or CMA).

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THE ROLE OF COLLATERAL MANAGEMENT


• Assure Physical Availability of Collateral

• Assure Legal Security of the Collateral

• Provide Practical and Cost-Effective Procedures for Monitoring

Collateral

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THE ROLE OF THE COLLATERAL MANAGER


STOCK MONITORING AGREEMENT Periodic visits to a storage location and certification of the stock quantity, quality, value, and other agreed matters but without any responsibility for subsequent releases. No storage or other custodial documents are issued to the bank

COLLATERAL MANAGEMENT AGREEMENT Continual and exclusive custody by the CMC of goods in a storage location temporarily leased by the CMC, with signs posted and locks in place. The CMC will usually issue a custodial document to the bank that may not have legal validity, but the CMC will take responsibility for the control of the goods under the Collateral Management Agreement.

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SMA COMPARED TO A CMA


• ADVANTAGES OF AN IN-HOUSE COLLATERAL MANAGEMENT DIVISION

• Good training for junior bankers if the bank is active in SME secured lending sector

• Staff have career path in the bank and motivated to protect the bank’s interests

• Misconduct by bank employees covered by banker’s blanket bond or similar anti-fraud policy

• Costs can sometimes be covered by separate loan administration fee

•

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LENDER COLLATERAL MANAGEMENT


• DISADVANTAGES OF AN IN-HOUSE COLLATERAL MANAGEMENT

DIVISION

• More difficult where inventory requires expertise to assess grade or

value or where inventory is significant distance from the bank

• Normally the in-house option is impractical where full-time custodial

arrangements are required

• In-house monitoring requires commitment to commercial credit as a

core business

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LENDER COLLATERAL MANAGEMENT


• Advantages of Collateral Management Company (CMC)

• CMC will offer insurance covering negligence and employee fraud in

significant amounts

• If the CMC is affiliated to an inspection company or accounting firm, it

will have staff in many major cities and ports, reducing travel expenses

• If the CMC is working in the trade or industry involved, it may have

useful information to share regarding the grade and quality of the

inventory and reputation of the customer

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THIRD PARTY COLLATERAL MANAGEMENT


• Disadvantages of CMCs

• CMC services are costly and the customer may object to reimbursing the bank

• Customers will be concerned about the confidentiality of market sensitive information

• If the CMC is doing business with the customer (as an inspection company, for example) there will be a direct conflict of interest with the bank

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THIRD PARTY COLLATERAL MANAGEMENT


• Terminal Warehousing

• Field Warehousing

• Non-Custodial Verification

• Receivables Certification and Control

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WHAT ARE THE BASIC COLLATERAL MANAGEMENT SERVICES?


• International Terminal Warehouse Companies such as Steinweg

• International Inspection Companies such as SGS

• Local Bank-Owned Field Warehouse Companies (none in Mongolia)

• Dedicated Collateral Management Companies such as CWT and Drum

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MODERN COLLATERAL MANAGEMENT SERVICE PROVIDERS


• Is the warehouse receipt recognised under Mongolian Law?

• Is the possessory pledge recognised under Mongolian Law?

• Is a CMC licensed to issue warehouse receipts?

• If the CMC is not a warehouse operator, are the procedures sufficient to

create a possessory pledge?

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PARTICULAR INSURANCE AND LEGAL ISSUES


• Are the Goods Covered Against Fire, Flood, Theft and Other Casualty

Risks?

• Will the Theft and/or Professional Liability Coverage Protect against the

appropriation of the goods by the Borrower?

• Does the CMC has adequate local Supervisory Staff to regularly Audit

the account?

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PARTICULAR ISSUES (CONTINUED)


• Financing of Inventories is necessary for the development of

manufacturing and distribution businesses, especially SMEs

• Collateral Management in some form is necessary for safe inventory

financing

• The legal and insurance foundations must be examined by both the

bank and the collateral manager

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SUMMARY AND CONCLUSIONS RE: INVENTORY FINANCING AND COLLATERAL MANAGEMENT

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Thank You !

I NVENTORY F INANCE Nickolas Budd Consultant, IFC Ulaanbaatar, December 15, 2014.

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