Dilution is a product event: lending to veterinary distributors

The Commercial Finance division has financed veterinary and animal-health distribution in Latin America since 2021, and the book now stands at US$34 million of drawn receivables facilities across nine obligors. The invoices look ordinary: a distributor sells vaccines, antiparasitics and diagnostics to clinics, feedlots and public animal-health programmes, and borrows against what is owed. The behaviour of those invoices is not ordinary. Three features move the advance rate away from the 85 per cent that a general trade book would attract, and each of them can be measured from twenty-four months of ledger data before a facility is written.

The first is dilution. A vaccine that leaves the cold chain cannot be sold, and the credit note that follows is not a credit event but a product event. Across the nine obligors, credit notes ran at 4.1 per cent of gross invoicing, against 1.3 per cent in the general distribution book the division finances in Panama. We reserve for dilution at the observed rate plus two standard deviations, measured monthly rather than annually, because dilution in this sector clusters in the hot months. That reserve, not the credit quality of the buyer, is the largest single deduction from the advance rate.

The second is seasonality. Vaccination campaigns for food-producing species follow a calendar set by breeding cycles and by public programmes, and two thirds of annual invoicing can fall in five months. A borrowing base tested at the seasonal peak flatters the facility. We size the limit on the trough, test the base weekly rather than monthly, and set a concentration cap of 20 per cent for any single obligor. In the two facilities restructured this year, the trough test was the change that removed the need for a covenant waiver.

The third is the public purchaser. National and state animal-health programmes are good credit and slow payers. Days outstanding on public invoices in the book average 118, against 46 for private clinics, and the distribution has a long right tail tied to budget cycles rather than to creditworthiness. We finance public receivables at a lower advance rate and a longer eligibility period rather than excluding them, because excluding them pushes the distributor towards more expensive local funding and weakens the borrower we have underwritten.

Rising funding costs pass through this book faster than through term lending. Facilities are priced on a floating base plus a margin, and the base has moved by more than 200 basis points since the start of the year. Distributors with gross margins near 14 per cent cannot absorb that and continue to hold inventory at the same level. The response has been to shorten the eligibility period from 120 to 90 days, which reduces the funded balance and the interest cost together, and to price the facility on the funded balance rather than on the commitment.

Advance rates in the book now sit between 74 and 82 per cent, against 85 per cent for general trade receivables of similar tenor. That difference is not caution. It is the arithmetic of dilution, seasonality and public payment behaviour applied to a sector the firm originates in directly. The same origination work that supports animal-health equity positions supplies the ledger data that prices these facilities, which is why the division lends here and does not lend against invoice pools it cannot decompose.

Published 2022-08-16 by the Commercial Finance division. Research is prepared for eligible counterparties and does not constitute advice.