Why Lenders Should REALLY be Concerned About Supply Chain Issues

 

There have been numerous articles and economic analyses written about the cause and effect of supply chain issues throughout 2021. It’s quite interesting however, to review how opinions have changed during the year.

At one point, many economists felt the supply chain issues were “transitionary” and would be resolved by year end 2021. Other economists were not as optimistic.

It’s now very clear that supply chain logistic issues will last longer than anticipated and may well last into 2022 or beyond.

 

PROBLEM WILL PERSIST UNTIL …

There are many reasons cited for the extent and length of this problem, however, it’s clear it will continue to be an issue until the economy starts to rebalance itself into more of a normal cycle and the current and prolonged spike in consumer demand levels adjusts back to a pre-COVID level.

This supply chain problem is having a significant impact on most businesses and in particular small to medium size businesses.

Additionally, businesses that are dependent on imported products or materials to produce finished goods are being more heavily impacted.

 

IMPORTED PRODUCTS vs. IMPORTED PARTS …

While some businesses are not directly importing products from overseas, they may be dependent on parts or materials from suppliers that are importing components from overseas sources.

Think for example, any product that includes a microchip. Orders for microchips now take around 22 weeks to fulfill, up from nine weeks pre-COVID, according to the Susquehanna Financial Group, and that delay has contributed, for example, towards out-of-stock gaming consoles, cameras and computers.

Supply chain problems should be of the utmost concern to banks and private lenders.

 

MAINTAIN REGULAR COMMUNICATION …

While many bankers have expressed concerns over these issues, particularly with their portfolio companies that are being impacted, the main gauge of the health of portfolio companies are based on monthly or quarterly financial statements provided after the fact.

Lenders may well find that revenue and profitability has suffered significantly and rapidly. Finding out about this after the fact may not provide sufficient time for lenders to react.

The key here is to maintain regular communications with portfolio companies and make sure to ask about how they are dealing with supply chain problems.

 

INCREASED INVENTORY LEVELS …

Not every company is impacted in the same way. For example, the cost of transportation has risen significantly, as well as the length of time it takes to transport and process shipping containers.

Moreover, many companies have had to change the way they operate just to survive. For example, a number of businesses have changed their inventory policy, from “just in time” to “just in case”, or ordering more inventory than is currently required, in case they have a delay in future shipments.

The cause and effect of this change has led to increased inventory levels and increased usage of working capital. Many companies are required to prepay for imported products or materials or open letters of credits to guarantee payments.

Given that it is taking longer for products to be produced, to be shipped and actually transported and processed, additional working capital is required to support the increased time required to finance the importation of products.

 

IMPACT ON WORKING CAPITAL …

Companies that sell products or materials to other businesses may see an increase in their outstanding accounts receivable as a result of supply chain related longer or delayed payment cycles.

This can also have a significant effect on a company’s available working capital.

Lenders must take a proactive approach to gain an understanding of just how supply chain problems impact their portfolio companies.

While many CEOs are dealing with the operational problems, they may not have the experience to assess the financial impact of their decisions.

While lenders always think of themselves as business partners with their clients, the need to be proactive under these circumstances is extremely important.

 

TAYLOR NEEDED SOLUTIONS …

The lender must assess how each of their portfolio companies are being impacted and propose ideas or viable solutions to help.

For example, a company that imports products that are supported by letters of credit, may need an increase in their letter of credit sublimit, or an increase in their overall credit line to accommodate longer transit times.

Companies that have increased their levels of inventory may need a temporary adjustment to their borrowing base advance rate, to help finance this spike in inventory.

Companies impacted by higher outstanding accounts receivable balances as a result of longer payment cycles may need some modification to their loan agreements to allow for an increase in the length of time in which payments must be made.

Otherwise, a company’s borrowing base may be negatively impacted by circumstances that are entirely out of their control if these outstanding accounts become ineligible to be included.

There are many ways lenders can be helpful.

 

A PROACTIVE APPROACH …

However, it requires a thorough and proactive approach to understand their clients’ unique requirements.

In doing so, the lender will not only be a hero in the eyes of their clients, but they will also take a big step towards mitigating future write-downs of loans related to poor performing clients.

 

All of us at Revitalization Partners wish all of our readers and their families a very
Happy Thanksgiving holiday.