Advance rates on living inventory

Asset-based lending assumes that inventory can be counted, valued and sold. Biological inventory fails all three assumptions at different points in its life. A crop in the ground cannot be counted precisely, a growing animal is worth less than the feed already invested in it until a threshold weight, and neither can be sold quickly without destroying the value being financed. The firm lends against both, and the structure that makes it work is an advance rate that changes through the cycle.

We set advance rates by stage rather than by asset class. Early in a growth cycle the collateral is worth close to its input cost and the advance is low, because a forced sale realises little. In the middle the value compounds faster than the debt and the advance can rise. Near harvest or slaughter the inventory approaches a market price with an observable reference, and the advance is at its highest for a short and well-defined period. A flat rate misprices the whole cycle.

Verification is the operational heart of the facility. Counting biomass in water, animals across paddocks or tonnage in a field requires an independent method, and the method has to be agreed at closing rather than argued at a default. Our facilities specify who counts, how often, by what technique and at whose cost, and they permit the lender to appoint its own inspector at any time. Borrowers who resist that clause are telling the credit committee something useful.

The licence sits underneath the inventory and is frequently the more valuable asset. A farming concession, a water permit, a quota or a site authorisation determines whether the collateral can be produced at all, and in most jurisdictions it cannot be assigned without consent. Where consent is available in advance we take it. Where it is not, the facility carries a covenant against any act placing the licence at risk, and the advance rate falls to reflect an enforcement that would deliver assets nobody may operate.

Insurance completes the structure and is the part borrowers most often under-buy. Mortality, weather and disease are the events that convert a performing facility into a loss, and the market for cover is uneven across the jurisdictions where we lend. Our practice is to require cover where a market exists on commercial terms, to price the absence of cover explicitly where it does not, and to record the assignment of proceeds at closing rather than at a claim.

The result is a book that behaves differently from generalist private credit through a cycle. Reference rates have risen this year and these facilities have repriced with them, but the risk that matters to this book is not the reference rate. It is a warm summer, a border closure or a disease notification. Pricing that risk requires a desk that knows the species, and the return for knowing it has not narrowed in the way that ordinary corporate spreads have.

Published 2022-05-18 by the Commercial Finance division. Research is prepared for eligible counterparties and does not constitute advice.