Diary of a Financier

Vendor Finance: German Entanglement As Illustrated by GE Capital

In Economics on Fri 14 Oct 2011 at 12:12

I’m going to show you two charts:

Current Account Balance- Germany & France

Those are the current accounts of Germany & France since the Euro’s inception, and yes, they’re neatly inverse charts. I could show you Spain, Italy, Greece or Ireland too, but they’re more of the same. As a “core” state France’s operating under such a compounding deficit really drives a message home: Germany used its AAA rating like an AIG, allowing outsiders to tap into her credit pool for lower cost of capital.

~~~~

Look up the term “vendor finance.” For the Class of 2013, I’m sure Harvard Business School is already working on a case study of GE Capital, John Deere Capital and Caterpillar Capital. Along with the auto-dealers, these subsidiaries of blue chips really took it in the ear when their clever forays into capital markets (vendor finance) failed–a pyrotechnic display of leverage’s explosive properties. Particularly GE Capital (GECS) was the snake that almost swallowed the entire parent company.

Much of GECS’s function pertained to vendor finance, which helped GE sell inventory today while its customers could defer payment until tomorrow. GE would effectively book payment as an asset (loan bearing interest) instead of plain current receivables, then restock inventories. If this sounds like a circuitous modus operandi–like a hamster wheel–it should. GE held very little of its sales revenue (cash flow) in hand to finance ongoing operations. Liquidating inventory today, worrying about payment tomorrow, and rebuilding inventory today puts GE under the same yoke as its customers: GE’s credit is only as good as its customers’.

At the height [of stupidity] in 3q2008, GE’s 10Q reported $413.2B in net Financing Receivables, compared to a mere $22.4B in Current Receivables. Granted, some of the Financing number includes traditional loan business from the GECS segment… considering that 63% of 3q08 revenue derived from Sales of Goods & Services away from GECS, I used simple algebra* to approximate that GE offered vendor financing for 91.4% of these sales (i.e. ex-traditional GECS loan activity). That’s 91.4% of GE’s vanilla, blue chip business mutually dependent upon the credit of its customers. So while GE boasted a AAA rating, its levered exposure to its ecosystem put it on far shakier ground than advertised.

~~~~

Germany is one such vendor, not merely on the corporate level, but all the way up to the sovereign. Whether consciously or not, Germany seems to have wielded her AAA credit rating like GE & AIG before her. The rest of Europe has also embraced the arbitrage opportunity presented. When the Euro single currency began, it removed the barriers that once stopped a Spanish caja from wholesale financing itself via German banks, who bore the lowest interest rates in the Eurozone. On the other side of the ledger, German exporters were able to start financing the purchase of their goods by foreign importers, particularly to defer payment when the latter (deficit countries) grew bloated & cash flow poor. This kept Germans employed, factories bustling, and the national surplus mounting.

In this way, Germany has entangled the Euro nations. Her AAA credit rating really should be called into question.  Germany is just a giant shell, a conduit, a SIV through which debtors’ cashflows circulate.  A SIV’s integrity is really the integrity of the underlying credit it holds.  Germany is now faced with a choice between:

  1. Bail out her vendors = Domestic inflation that depreciates the real value of her Financing Receivables.
  2. Let her vendors unhinge from her teat (the Euro), devalue their own currencies, then settle their debts = Domestic deflation from a loss of competitive exchange rate.

Rock meet hard place.

–Romeo (hattip CreditWritedowns)

* 0.63 x $413.2B = $260.3B / $22.4B = ~11.62 (ratio of Vendor Financed to Current Receivable assets ex-traditional loan assets) or 8.6%

Advertisements
  1. […] either explicitly or implicitly. Perhaps the Germans know something. Perhaps the coverup of a systemic vendor finance issue will level the contours of Europe’s disparate economies. Perhaps that’s the grounds for […]

  2. […] even discovered this.) Somehow, I underestimated the effect, even though I was one of the first to call attention to it: German exporters were able to start financing the purchase of their goods […]

  3. […] bottom line (net-net).  Germany can have 100cents of her TARGET2 credits, bailout assets, and vendor financed receivables repaid in devalued Drachmas/Pasetas/Lira.  Or, Germany can pay for bailouts, forfeiting her own […]

Comment

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s