- I’ve heard of lending against unpaid invoices, but
- … lending against invoices that haven’t yet been issued
- … on work that hasn’t yet been done
- … for clients that haven’t yet been won
- … you what?
- Better call Fred!
When I was a kid growing up in the 1980s and watching repeats of Dad’s Army, there was always something that slightly irked me about the power dynamic in the home-front sitcom. It wasn’t that I failed to appreciate the comic genius of having the dull-and-dutiful Captain Mainwaring in charge of the Walmington-on-Sea Home Guard platoon. What rankled my young mind was how he came to be the manager at the local bank. Surely the philandering deputy manager, Sergeant Wilson, should have had the top job seeing he was obviously so much more creative, quick witted and insightful than his boss. Think of the economic boom Walmington would have enjoyed with Wilson running the town’s principal lender.
However, as I have understood banking a bit more – I still can’t claim to understand much – I have come to appreciate that prudence is the character trait that should probably trump all others in a banker. Debt is dangerous stuff. Handling it with care should be a banker’s chief concern, even if it does stifle some innovation.
Recent events in the banking industry serve as a reminder of this. They have echoes of the kind of behaviour we witnessed during the credit crunch. They are the reason all investors should all be grateful of the banking world's Mainwarings, even if they are a perennial cause of frustration.
To take the allusion to Mainwaring a little further, let's imagine our protagonist in his youth. He surely would have been the type of kid who would have sat on the bench at the village disco trying (but normally failing) to muster the courage to ask a boy or girl on the other side of the hall to dance. Nothing to worry about with this kid. The kind of banker we should all be worried about is the one that's like the kid in the middle of the dance floor with the jazz hands. The one surrounded by admirers and acolytes.
We may be starting to see bankers with jazz hands once again.
This is not said in reference to fintech fraud Wirecard. Distressing as that situation is, Wirecard is more akin to the kid at the village disco skulking in the shadows trying to sell amphetamine. And neither is it reference to the disastrous dalliance of several banks with blown-up hedge fund Archegos. At this stage, the kind of poor assessment of risk that was behind that debacle looks more akin to the kid at the disco who thinks they can break dance but ends up being taken to casualty with a fractured wrist after over-enthusiastically launching into the caterpillar.
Nope, jazz hands is in reference to freshly-collapsed supply-chain finance lender Greensill. Greensill appears to have been doing something that everyone should worry about from bankers: 'innovating'.
Sure, innovation can be good, but all too often in banking it means packaging up risk in a way that makes it seem less risky than it is. It then will frequently get passed to other banks and investors that don’t really understand what they’re getting.
This is the kind of behaviour that happened in spades before the credit crunch when the repackaging of high-risk mortgages fed a massive banking boom. The demand was so great that 'synthetic' versions of this debt was even created by ingeniously repackaging the other side of short bets against dodgy mortgage bundles. For a while it was genius and banks made shed loads in fees. Then the music stopped as the housing market crashed and the losses almost bought the system down.
The jazz-hands banker that became synonymous with the sub-prime loans blow-up in the UK was Fred 'the shred' Goodwin. He was the boss of Royal Bank of Scotland when it was funnelling huge amounts of bad debt through its balance sheet.
There’s no reason to think we are looking at anything on that scale now, but we may be witnessing jazz hands at work nevertheless. The particular development that suggests aggressive innovation has been afoot is the revelation that before its implosion, Greensill was lending against “prospective receivables”.
Lending on receivables commonly involves offering money in advance of payment of a valid invoice for work completed by the borrower but not yet paid for by its client. Financing “prospective receivables”, however, would seem to involve lending against work that has not yet been done or invoiced for yet. What’s more, it is work that may not have even been won, or could be not-won work from a client that the borrower does not yet do business with.
At this point you may be scratching your head. Don’t worry, this is where we can bring in a bit of jazz hands; a thread of logic that should help us bop along to the boogie.
If a borrower has already secured financing to fund work for a 'prospective' client, then it should be able to offer payment terms to the 'prospective' client that will enable it to win some actual work. Once (okay, it’s actually if) the business is secured, dealings with the new client are sucked into the lender’s supply-chain finance ecosystem. There's the potential for self-perpetuating growth for all involved for as long as the lender's balance sheet allows it. So everyone continues to dance merrily… until the music stops.
Hopefully the music stopped at Greensill before anyone got too carried away.
The trouble with funky banking and risky finance, though, is that it can spread through the opaque system remarkably easily. Not only are the loans passed around, once others see what the regulator is allowing one jazz-hands banker to get away with, there’s the temptation to copy the moves. Indeed, Fred 'the shred' was only copying the moves he’d seen others pull off so coolly Stateside. His lesson from history for us today is just how quickly and silently 'innovation' can spread in banking and how quickly it can also unravel.
The trouble with a jazz-hands kid at the village disco is that she or he tends to be the one who spikes the punch, starts the fights, breaks hearts and generally creates the illusion of fun while sowing the seeds of future regret for all. Give me a Mainwaring banker any day. If she or he ever works up the guts to ask their heart's desire to dance, there’s at least the chance it may lead to something special.
Having tortured the village-hall disco metaphor to death, resurrected it and driven a stake through its heart, and all by way of Dad’s Army, the conclusion to our lesson from history is that now looks like a time to stay on one’s guard.