Management of Risk, Mitigation strategies, Fraud, & Exit Strategies

Accra December2011

Risk Management • There are many aspects of risk in the

factoring industry such as:- • Paper Trail risk • You buy debts – paperwork supporting invoices you

buy and finance…….. • Specifications, Quotation, Acceptance, Contract

of Supply, Proof of Delivery, Invoice, Verification, Payment/Remittance

Risk Management • There are many aspects of risk in the

commercial finance industry such as:- – Paper Trail risk – Industry risk

• Recruitment/Staffing, Trucking, Printing, Graphic Design, Construction, Retail, Automotive Parts and many others

• All carry different levels of risk to you as the financier in the event of a collect out

Risk Management • There are many aspects of risk in the

commercial finance industry such as:- – Paper Trail risk – Industry risk – Concentration risk – $1,000,000 sales ledger with 1000 debtor names – $1,000,000 sales ledger with 2 debtor names

• Which one would you prefer?

Risk Management • There are many aspects of risk in the

commercial finance industry such as:- – Paper Trail risk – Industry risk – Concentration risk – Fraud risk – Fresh air invoices, fictitious debtors, recycling

factors money, pre-invoicing…………

Risk Management • There are many aspects of risk in the

commercial finance industry such as:- – Paper Trail risk – Industry risk – Concentration risk – Fraud risk – Technology risk – Out-dated client systems, Constantly improving

technology, inability to link systems, total reliance on technology

Risk Management

• Your clients are only valuable to you if they: – Are really happy with the service you provide – Do not generate excessive workloads – Enjoy strong but controlled growth – Never have problems with their collateral – Stay with you for many years – Pay you lots of service fees, discount (and other)

income

Risk Management • Now it is time to wake up, stop dreaming and

face reality- we are in a global economic crisis !!!! • Factoring companies traditionally support

undercapitalised, financially stressed and rapidly growing clients

• There are lots of those about now! • Outstanding Invoices are the most current

security taken to support client advances • Outstanding Invoices as security are dynamic

and can weaken in value very quickly

Risk Management

• There are many elements to successfully managing risk in a lending portfolio – Strong Field Audit Procedures

• Pre- and Post- Funding – Verification of collateral processes – Experienced people in all parts of the process

• Salesman, Surveyor, Take On, Input, Client Manager, Field Auditor, Collectors, Credit Managers etc.

– Luck!!!

Risk Management

Q. How to Lose Money in Factoring

Uncollectable invoices Client banks the cash

THIS IS NOT ROCKET SCIENCE

Risk Management

The consequences of losing money in Factoring

Termination of employment End of your company

The Fraud Triangle

Pressure

Opportunity

Rationalisation

The Fraud Triangle

Pressure

Opportunity

Rationalisation

The client’s business is struggling: • Sales slowed down • Needs cash for payroll/pay

creditors • Factory is behind schedule on

product build • Delivery will be late

The Fraud Triangle

Pressure

Opportunity

Rationalisation

Client knows that invoices can be raised and sent to the factor at any time. Even before delivery!! Advances can be taken against the invoice. He knows it’s wrong but……......

The Fraud Triangle

Pressure

Opportunity

Rationalisation

The client truly believes this will only happen once. He will get the money and save his business He might even think about telling the factor……………

Two types of fraudsters • Criminals who, from the very start, intend to

defraud the factor – Often in collusion with false debtors – Often in collusion with a couple of other staff members

• Previously good business people who hit

difficulties and turn into desperate individuals – Desperate people will do desperate things

• A factor is the easiest type of financier to

defraud !!!

Risk Management • There are a number of ways factors can protect

themselves from fraudulent actions by clients…….

• People - there is no substitute for the knowledge, experience and vigilance of your risk managers and other staff – everyone has a role to play

• Defined Policies and Processes - correctly followed by everyone are a key to effective risk management

• Information Systems – providing the right information, at the right time in the right format

Risk Management • Risk Management is all about the detection of

change - and a portfolio of receivables changes every day

• Frauds suceed and financial losses occur because something changed and it was missed

• Situations can change very quickly so that……

Very Nice Client Limited

Fabulous Factors Limited

Quite Helpful Bank plc

Top Quality Debtor Limited

Invoices for goods or services supplied

Copy debtor invoices for financing

Prepayment advances against real invoices

Payments for factored invoices

Payments on discounted invoices

Payments on discounted invoices

Prepayment advances passed back to VNC Limited

What begins this way….

Nightmare Client Limited

Deceived Factors Limited

Secret Greedy Bank (Cayman) Inc.

Copy debtor invoices for financing on transactions that never happened

Prepayment advances against “fresh air” invoices

Quite Helpful Bank plc

Prepayment advances siphoned off to separate Bank account

Sometimes turns into this…

Client uses your money lying on a beach in the Caribbean

Trends

• Given the option of tabular data or charts which is the quickest way to spot a trend?

Trends

Month Commitment Dilution Disapproved January 181544 0.3 12.44

February 189663 0.54 11.86

March 209887 1.03 13.42

April 238673 1.54 11.95

May 247889 2.45 10.83

June 286543 5.33 13.82

July 302448 4.56 14.72

August 328654 6.96 8.99

September 348997 6.56 7.26

October 375239 7.34 4.22

November 394521 9.54 2.01

December 404557 10.23 0.34

Trends

The Post-Mortem

• In almost every case where factoring advances are written off the signs were always there when viewed in hindsight

• Q. Why didn’t you see them before the event? • A1. Because you never had enough time to

spend analysing your portfolio • A2. Because the information you were

working with was not appropriate • A3. Because you chose to believe the client

Your best client is defrauding you now !

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No time to analyse the portfolio

• Too often you spend too much of your time being confused by:- – The volume of client data to analyse – The number of places where the data is held – Looking into every client even if you don’t have to

• Client problems tend to be like buses in Accra, you wait for a long time, then 3 or 4 come along together

Answer 1

A Difficult Role

• Account Managers with shortage of experience are often asked to: – Develop a strong relationship with the client – Increase the revenue stream from the client – Extend the clients’ life with the lender

• AND be the policeman when things go wrong • AND look after more and more clients • This is a recipe for disaster!!!

Answer 1

What can be done to help?

• Make client management targets achievable for people and reward them accordingly

• Only allow them to be responsible for a manageable number of clients – We would recommend a maximum of 40/45 at most so

they have a chance to “Know Your Client” in all cases • Centralise all information related to risk management in one

area to allow ease of access • Develop a system of exception reporting so that

management time is aimed at the clients with most need

Answer 1

Inappropriate information

• Most back-office factoring systems don’t present information in a format you can easily use as risk managers

• One option is to extract data from the core operational system and export it to spreadsheets or analysis software so that trends can be detected

Answer 2

A Test of Consistency

• In your company, how many places can you get risk management information from? – Operational system – Clients

• Financial data, ID reports – Third party credit bureaux – Spreadsheets

• Audits, visits, verifications, covenants, etc…

Spreadsheets

• How many spreadsheets are compiled in your company to help manage risk?

• Many still manually produced! • Many late and often containing misleading or

purely inaccurate data

You choose to believe the client

• No software can replace the human element, the “gut feel”, and experience..

• But in far too many cases a client or risk manager will allow their judgement (or inexperience) to be affected by emotion

• The statistics never lie…!!!

Answer 3

What can be done to help?

• Try having a two tier structure where your risk manager does not interface with clients, but only with client relationship managers

• This can take the emotion out of lending decisions

• It becomes easier to challenge change in a client

• Statistics related to client performance are more easily accepted by a detached risk manager

Answer 3

Two Tier Approach

•Risk Manager •Little contact with client

•Analyses client performance daily

•Interacts with Client Manager

•Monitors responses and actions

•Client Manager •Regular contact with client

•Feeds information back to Risk Manager

•Interacts internally with Risk Manager

•Carries out agreed actions on client

Client

First Test • You are the Managing Director of XYZ Trading

Limited • Your Bank overdraft is personally guaranteed • You also have a factoring facility with Fabulous

Factors Limited • Your marital home secures the bank overdraft • You’ve just signed a big new order • The product is not ready to be shipped for about

10 days • XYZ Trading Ltd has been struggling to meet it’s

bills lately • You need to pay the wages this Friday • WHAT WOULD YOU DO?

First Test Results

• Score 1 point if you said you would go to the bank and ask for more facility from them

• Score 1 if you thought of another (acceptable to me) way out of the problem

• Score -2 if you let XYZ Trading go bust • Score +5 if you would raise the invoice to

Fabulous Factors to get the money

First Test Results

• If you chose to raise the invoice then what would you expect your client to do in the same circumstances?

Second Test • Client 1234 has the following characteristics:

– Established 15 years – Very experienced Management – Profitable - Six figure positive net worth – High quality debtors (banks and financial services

companies) – Debt turn of around 40 days – Outstanding sales ledger of $500,000 average – Well spread debtor ledger – Very little dilution of debt

Second Test

• Would you factor or discount company 1234’s debts?

Second Test Results • This is a software company supplying unique

applications

• Majority of sales are done on stage payments

• Others are done on rental basis

• Very occasionally there are retentions held by the debtor

• THE STATISTICS MIGHT BE GOOD BUT THE DEBT IS UNCOLLECTABLE WITHOUT THE PARTNERS BEING THERE

Second Test Results

• Score 0 points if you said you would factor/discount the debts under any conditions

• Score +5 if you asked for more information about the debt before going ahead

The fraud lifecycle • The client always want to draw maximum availability-

showing high utilisation on their facility

• If they are hitting a facility limit they will regularly be asking for an increase

• They “forget” to raise credit notes- dilution is always minimal in fraud cases

• They artificially inflate the value of invoices they are factoring causing unexplained growth in their business

• They ask debtors to send them their payments against invoices – they bank debtor cash –

• They create “fresh air” invoices –

Effects of “fraud” Behaviour

• Debt turn on invoices increases dramatically • Cash turn statistics go out dramatically • The client goes overdrawn more regularly • Unapproved invoice values often reduce as the

client often re-invoices older invoices and creates new debtors not affected by funding or non recourse credit limits

• The signs of problems occurring with a client can be varied and no one measure or statistic may be conclusive

• The measures and outputs have to be viewed as a package

• Statistics are not a “Silver Bullet” solution • They merely point you in the direction of a

problem more quickly

Effects of “fraud” Behaviour

Results of “fraud” Behaviour

• If you don’t have processes in place to uncover the problem early enough – and if you don’t follow those processes - you will lose money

Conclusions

• Technology can make your work easier if used correctly

• But technology will never replace the human element in a portfolio management role

• There is no substitute for knowing your client • But always be aware that your client may not

be as good as you first thought………. • REMEMBER – your best client is defrauding

you now

Risk Management

• SITUATIONS CHANGE • You will be the loser if you don’t stay on the

case – identify changes and be rigorous in following them through

• STAY LUCKY

Risk Management

Exit strategy – the 6 Rs

1. Re- finance = find a bigger fool to take the client from you

2. Regaining = Collect out / manage out 3. Rehabilitation = help turn the business around 4. Reinvestment = New money 5. Restructure = Phoenix 6. Repayment = Business/asset sale

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Management of Risk, Mitigation strategies, Fraud, & Exit Strategies

Accra December 2011