Greensill Capital Collapse — Dodgy Assets and Crafty Accounting
In today’s Money Morning…crafty accounting…trouble is, as is often the case with debt, eventually someone defaults…value investing takes the limelight…and more…
Amidst a week of market jitters and volatile bond outlooks, the likely collapse of Greensill Capital has taken something of a backseat.
Or, at least, it was taking a backseat up until the point that the finer details became clear…
If you’ve got no idea what I’m talking about, let me fill you in.
Greensill Capital is a financial services company run by Lex Greensill. One of the sons of Lloyd Greensill, who built a farming empire around the family name.
And while Lex still has farming in his blood, he decided to pursue a white-collar career over blue. Studying in London with a focus on finance. But always retaining the crucial lessons he learnt working on the land.
From these two distant worlds, Lex found a niche for Greensill Capital in ‘factoring’. Or, as the company referred to it, ‘supply chain financing’.
Whatever name you want to give it, this process is fairly simple. Factoring works by allowing a company (usually a supplier of goods) to immediately collect payment for the sale of goods.
However, this upfront cash doesn’t come from the buyer (customer) of said goods. Instead, it comes from a third party that agrees to buy the supplier’s ‘trade receivables’. Money that will be paid for the sale of goods but could take some time to actually process.
Effectively, this third party is acting as a stopgap for the time lag in payment. Collecting a small fee or sum by agreeing to take on the risk of these receivables.
An easy way to ensure suppliers are paid quickly, that is usually pretty low risk…
Lex Greensill, coming from a family of farmers, was obviously well aware of the impact of factoring. A tool that no doubt helped the Greensill empire expand their operations.
But, when it comes to Greensill Capital, he took things one step further…
Earlier this week, Lex’s company had its accounts frozen by Credit Suisse — locking him out from a reported US$10 billion worth of funds.
Well, turns out that some of the ‘assets’ at Greensill Capital may be a bit dodgy. With Lex not only using factoring, but also reverse factoring at his company.
See, what makes factoring work well is the fact that the transaction is beholden to the supplier. They are simply getting paid earlier for a good that they have already supplied. A fairly low-risk agreement.
In reverse factoring though, the transaction is flipped. Instead, the customer — typically some sort of retailer — is the driving force behind the transaction. Agreeing to funding from the third party to pay suppliers in advance in order to get the goods it desires.
Problem is, unlike in regular factoring, this means the third party is financing goods that haven’t actually been sold yet. They are in reality, providing a quasi-loan to help the retailer conduct their business. But, because it all technically revolves around ‘trade receivables’, it isn’t classified or treated like a regular loan.
You can probably tell where this is going…
Here’s where it gets worse though. Greensill decided to take a leaf out of the pre-GFC bank playbook. Turning these reverse factoring transactions into securitised assets. Just like the collateral debt obligations that blew up the global economy.
Then, they packaged all these factoring transactions up into funds. A typical investment vehicle that was freely available for people to invest in. And because it was assumed that these ‘factored’ funds were low risk, individuals and groups with large sums of cash poured in. Looking to make a better return from their money in the low interest rate world we now find ourselves in.
Trouble is, as is often the case with debt, eventually someone defaults.
Value investing takes the limelight
What this all means for Greensill is that it is probably doomed. Another victim of self-inflicted circumstances and greed.
And while the story probably still has a few twists and turns left, it is a timely reminder. Showcasing just how out of tune ‘value’ has become. Whether it be sneaky accounting, or through plain old greed.
It is precisely this kind of thinking and market movement that has our own Editorial Director, Greg Canavan, on watch. Holding a firm belief that much of the market that has flourished over the past 12 months is now heavily overvalued. Leaving shareholders open to the possibility of a swift and vicious correction.
However, Greg also knows that now isn’t the time to jump out of the stock market either.
Instead, he believes the best remedy for risk-averse investors is good value. Because god knows you’d have an easier time drawing blood from a stone than growing your wealth with cash right now.
You’d best get used to this idea too.
Because our ‘life at zero’ interest rates aren’t likely to go away anytime soon. Which is precisely why Greg has put together a strategy to make the most of this tough monetary environment.
That’s why you need to check out his latest webinar. Detailing what exactly is going on right now, and how to handle it.
Because at the end of the day, no matter what investing strategy you may prefer, value will always have a place.
You can never underestimate the importance of a strong balance sheet. Especially in the wake of such crooked practices, as seen within the Greensill saga.
Whether it is just the tip of the iceberg though, or simply an outlier, we will have to wait and see.
One thing is for sure though, it is clear that some have failed to learn the lessons from our past. Which makes the possibility of another GFC-style debt collapse all the more frightening.
Editor, Money Morning
Ryan is also the Editor of Australian Small-Cap Investigator, a stock tipping newsletter that hunts down promising small-cap stocks. For information on how to subscribe and see what Ryan’s telling subscribers right now, click here.