May 5, 2022

	I. Inflation, Supply Snags Lead to Higher Credit Limits
	II. Deutsche Bank Predicts Major US Recession

	III. Are We Facing the End of Globalization?
	IV. Specially Fabricated Materials Can Affect the Construction Supply Chain

Credit professionals walk a fine line when determining how much credit to set for a specific customer. Extend too high of a credit limit and a distressed customer could buy more product than it can pay back. But if the credit limits you set are too conservative, your company could miss out on potential sales.

According to a recent eNews poll, 71% of credit professionals are extending more credit than usual. Most respondents (93%) are extending that additional credit to existing customers, and 40% are extending more credit to new customers (some credit professionals are doing both).

Supply disruptions are partly why customers have been requesting more credit so they can stock up on product, but inflation may be an even bigger reason for the sudden increase in limits, said Barry Rose, CBF, CCRA, credit manager with Diamond Plastics Corporation (Grand Island, NE).

“Our experience has been that over the last few years, the PVC pipe market started having a lot of price increases for our inputs,” Rose said. “The block price today is easily three times what it was a few years back. So, what that does is, it blows everyone’s credit limit out of the water. Even if [customers] are buying the same amount of pipe, we are talking about three times the dollar so we have had to start looking at everyone’s credit limit and determining what would be realistic in this particular economy.”

But inflation alone is not enough for a credit professional to blindly raise credit limits. “Since the consequences of a late payment or default can damage the lender’s own balance sheet, it takes more than a simple gut-check to arrive at this number,” reads an article from Dun & Bradstreet.

The financial health of a customer should still be the leading factor when adjusting credit exposure, Rose said. “Credit limits are based on the qualifications of the customer, not on how much their product costs,” he explained. “So, if the product drops in price over a period of time, I don’t know that you would need to immediately drop limits if they were a qualified customer to begin with.”

Getting a hold of additional information to feel more comfortable with extending higher limits can be difficult, said Juanita Reyes, credit manager with Eastern Quality Foods (Ponte Vedra Beach, FL). “We always need more information to support giving out more credit to make sure they have the wherewithal to handle additional credit because with more credit comes more risk.”

If a customer requests more credit, you should request more thorough information before making a decision, Rose explained. “Any credit limit over a quarter of a million dollars requires financial statements. So, I am requesting financial statements a lot more than I have in the past. Sometimes I am successful and in some cases I’m not. It puts a bit more of a burden on the credit department to get more information to back their decisions for limit increases.”

Even though extending more credit often comes with more risk, both Rose and Reyes have experienced faster payments from customers regardless of the increase in limits. “Our business and many of our customers’ businesses have been more profitable lately and delinquency has gone down,” Rose said. “Even with prices going up three-fold, customers are paying faster—maybe because they are worried about getting product with the current supply chain issues.”

Deutsche Bank last week intensified its prediction for a U.S. recession. “We think the risks are skewed towards a much more significant recession, as inflation proves more persistent than is generally expected,” according to research by three of the bank’s economists.

The update was released the day after the U.S. Department of Commerce announced U.S. GDP fell 1.4% in the first quarter. In an interview with CBS News, Matthew Luzzetti, chief U.S. economist for Deutsche Bank, stated that the two events were not related. Luzzetti attributed the decline in GDP to “net exports in trade data, which has been quite volatile. It was also driven by inventories where we saw a bit of a destocking and actually government spending.” Net exports alone subtracted more than three percentage points, he added.

“We do expect we're going to see a recession by the end of next year,” Luzzetti continued. “But this was not the start of it. We do expect you're going to continue to see relatively solid growth throughout the course of this year—around 2% on average over the course of this year—[and] that the economy should bounce back in the second quarter.”

The change in recession forecast hinges on “the inflationary pressures that we are seeing in the economy and the likely necessary response that we have to have from a monetary policy perspective,” he explained.

In its research report, the bank outlines five reasons for its perspective:

• Broader trends such as demographics and a reversal in globalization are set to put upward pressure on prices over the coming years.
• The drivers of inflation have broadened out and the labor market is extremely tight.
• Inflation psychology has shifted dramatically, with sellers increasingly willing to pass cost increases onto their customers.
• Expectations of future inflation are rising, and we expect them to rise further still given they are usually influenced by what’s happened to actual inflation recently.
• The moves from the Fed currently envisioned by markets will be too slow to restrain inflation, and would still leave the federal funds rate substantially negative in real terms.

On Wednesday, the Fed raised interest rates by 50 basis points. Deutsche Bank expects the Fed to continue its aggressive approach by raising the federal funds rate 50 basis points in June and July as well. “They will have to bring monetary policy to a restrictive stance by the middle of next year,” Luzzetti told CBS News. “Our baseline is a mild recession towards the end of 2023 with risks that it is more severe if inflation pressures really do not subside at all.”

When asked what if anything U.S. officials could do to mitigate the risk of a major economic downturn, Luzzetti acknowledged the challenge. The typical measures would be to provide support for demand, he said. However, “There’s too much demand relative to supply that is creating the issues that central bankers are dealing with today and that policymakers are dealing with today. It’s creating the price pressures.”

If transportation costs are skyrocketing and global supply chains are no longer reliable, why don’t companies just bring production closer to home? It may sound like a reasonable solution on the surface, and some companies already have started the process of nearshoring their goods. But with more independence comes a few tradeoffs that businesses should consider.

“There has been a trend toward de-globalization for several years,” said Jay Tenney, managing director of Trade Risk Group (Irving, TX). “A lot of people just did not want to acknowledge it. COVID accelerated the trend, Ukraine hyper accelerated it, and now you’re going to see more regional trading blocks.”

For years, cross-border trade and globalization have facilitated technological advances, price competitiveness and economic growth. But rising geopolitical risk and supply disruptions have raised the question of whether that is worth risking product security.

“These issues have brought to light the need for local production and local supply chains,” said Fred Dons, director, head CTF flow Netherlands for Deutsche Bank. “Businesses are being forced to make a decision of whether or not to bring production home because supply chains keep getting disrupted all over the world.”

But globalization also comes in the form of investments, not just imports and exports. Roughly 82% of all foreign direct investment (FDI) stock in the U.S. is held by European, Canadian and Japanese entities, according to a report from the Hinrich Foundation.

And the U.S. manufacturing sector accounts for 40% of the country’s inward FDI totaling nearly $1.9 trillion. Finance and insurance (US$565 billion), wholesale trade (US$515 billion), the information sector (US$243 billion) and depository institutions (US$240 billion) are the next four largest sectors, accounting collectively for another third of the total stock.

In 2019, FDI generated 21% of U.S. manufacturing GDP and more than one-third ($2.1 trillion) of the manufacturing sector’s revenues, per the report. It estimates that without the participation of foreign companies, the U.S. manufacturing GDP growth rate would have been anywhere between $1.8 million to $2 million, instead of the $2.2 million it stood at in 2019.

With less foreign direct investments, U.S. manufacturing could pay a serious price. “Through the operations of U.S. affiliates of foreign-headquartered companies, foreign direct investment has been essential to the success of the U.S. manufacturing sector, which, contrary to the populist political narrative, has truly thrived in the global economy,” the Hinrich Foundation report reads.

If globalization continues to erode, the U.S. could lose up to 3% of GDP and China could lose up to 4%, according to the International Monetary Fund (IMF). “Just as there can be big losers from globalization even if the winners gain much more, the effects of deglobalization are likely to hit some sectors much harder than others, which can in turn amplify the aggregate effects,” Thomas D. Cabot, professor of Public Policy and of economics at Harvard University, wrote in an IMF article, The Long-Lasting Economic Shock of War.

To learn more about the future of globalization, be sure to check out the June issue of Business Credit magazine.

Construction projects sometimes require materials that are not stocked by suppliers and that require special fabrication to make them suitable for certain fixtures. Specialized materials can be both expensive and difficult to obtain, said Sam Smith, regional finance manager at Crescent Electric Supply Company (East Dubuque, IL). In addition, these items tend to have longer lead times and typically cannot be returned. “Many times, these orders require a heavy deposit up front or even 100% prepayment,” Smith added.

The unique nature of these products can put the supplier of these specialized materials at additional risk. If fabricated materials end up not being used on site, they cannot be resold and the supplier would be at a loss for what it spent on acquiring or manufacturing the items, said Connie Baker, CBA, director of operations for NACM Secured Transaction Services.

Although manufacturers of specially fabricated materials are much like any other vendor within your supply chain, it can be difficult to determine their quality, ability to deliver on time or financial stability if you do not work with them on a regular basis, Smith said.

And it is not always clear where a supplier of specially fabricated materials falls within the construction hierarchy. “When involved in a construction project, it’s always important to know what tier you are in to determine whether or not you have lien rights,” Smith said. For example, if you are a supplier working on a job with a subcontractor, general contractor and the owner, you will find yourself in the third tier. In order to have lien rights, in certain states, you must remain within the three tiers from the owner, Baker said.

Manufacturers of specially fabricated materials could be considered fourth tier because they are supplying materials used on a job by other suppliers—which makes them ineligible to file liens. A supplier of specially fabricated materials may still lack lien rights if it is viewed as a second-tier supplier if it is recognized as a supplier to supplier.

However, lien rights are state driven and specific state statutes must be reviewed to understand any potential requirements relating to lien rights for parties providing specially fabricated materials, Smith said. “Every state will have different laws that govern who would have rights and what needs to be done,” Baker said.

Specially fabricated materials are items that many suppliers do not normally sell, so their knowledge of the product may be limited, Smith said. Therefore, suppliers should refrain from aiding with installation or operation of the material and should attempt to sell items they have experience with.

Also, suppliers should be aware of the risks when vendors require them to make a large deposit for the custom order, or make them pay in full ahead of time, Smith said. It gives you “little recourse if something goes wrong. Negotiate these terms,” Smith said. “On special order material, a deposit seems to be reasonable, but a portion should be held until inspection of the product has taken place. An example of such terms could be 25% deposit at the time of the order, 25% at the time of shipment and a net 30 balance. With terms like this, both parties assume some of the risk.”