The economy worked in this arrangement.
But lately, financiers have struggled to make sense of certain players in the short-term financing space. That brings us to Greensill, the Anglo-Australian supply chain finance company that was forced into a discount after a Credit Suisse fund withdrew its support.
How did it happen? Greensill was basically doing something similar to our factoring friends. He extended the funding to suppliers of large companies such as Telstra, Vodafone and CIMIC to facilitate the “early” payment, then collected the money.
But rival finance companies have been warning for some time that Greensill was actually taking a lot more risk and that an accident was likely, if not inevitable.
Right off the bat, Greensill was actually lending tens of millions of dollars to a small handful of companies at rates competitive with the banks.
It was a big step forward. Few start-up lenders can offer debt at a better rate than a bank and in the size a bank offers, because they are simply not big enough to take such significant risks against a single counterparty.
If a large construction company were to run into trouble, their bank would suffer a bit, but it would almost blow up a focused startup lender.
Greensill had racked up great exposures to only a small handful of companies that were willing to sign up for his services. And if a customer hit the wall, much of their book would be wiped out.
Friendly bond funds
So how could Greensill compete with the banks? It appeared to be able to secure favorable financing terms from some yield-hungry bond managers who felt that the loans were short-term in nature, so the risks were minimal. The presence of credit insurance, in which a well-rated institution would pay on losses for a fee, gave them more comfort.
The other way Greensill competed was by not adhering to the same levels of diversification that big banks have been constrained by centuries of experience. In fact, the small German bank in Greensill was under regulatory scrutiny for having too much exposure to a single client.
But it is evident that the lack of diversification has caught up with Greensill. Given the size of its exposures, it wouldn’t have taken a lot of problematic credits to worry insurers and force Credit Suisse bond fund to draw its lines and end the party.
All of this exposed the risk inherent in the model and reminded us that at a time when investors have been delighted with new financial ventures, the old forces are coming into play.
As venture capitalist Bill Gurley once said, “There is no industry in the world with lower barriers to entry than lending money.” The trick is always to get the money back or convince your financiers that you can.