Financing the batch before it is released

A sterile pharmaceutical batch is not saleable when it is finished. It is saleable when a qualified person releases it, and release waits on sterility testing, endotoxin testing and a review of the batch record. In the manufacturers this division finances, the interval from end of fill to release runs from 21 to 45 days, with a median of 31. During that period the manufacturer has paid for the active ingredient, the containers and the labour, and holds an asset that its lenders will not count. For a contract manufacturer running four lines, the excluded stock is routinely between US$6 million and US$9 million.

The standard answer is to fund the gap with equity or with an expensive local overdraft. The better answer is to underwrite the release. We advance against quarantined stock at 60 per cent of cost, against 85 per cent for released finished goods, and the difference is set by three measurable items: the historical rate of batch rejection, the shelf life remaining at release, and the strength of the offtake contract behind the batch. Where the manufacturer runs to a tolling agreement and the sponsor owns the active ingredient, the exposure is smaller again and the advance rate rises to 70 per cent.

Batch rejection is the item most often misread. Across the four sterile manufacturers in the book, rejections have averaged 1.4 per cent of batches over three years, but they are not independent events. A rejection caused by an environmental excursion is usually followed by a second on the same line within the quarter, because the cause is the room rather than the run. We therefore model rejection at the line level, apply the observed clustering, and require notification within one business day of any excursion recorded in the environmental monitoring log. That notification covenant has been used twice, and on both occasions the borrowing base was adjusted before the quarterly test rather than after it.

Shelf life is the second control. A finished product with 36 months of dating and 33 months remaining at release is good security. The same product with nine months remaining is inventory that must move at whatever price clears. Eligibility in our facilities requires at least 70 per cent of the dating period to remain at the point of release, and stock below that threshold moves to a separate sub-limit priced on liquidation value. This is ordinary discipline in perishable goods finance. It is unusual in pharmaceutical lending because most lenders treat a sterile product as durable.

Recall is the risk that cannot be reserved for. A recall removes released and unreleased stock at the same time, and it usually arrives with a regulatory hold on the line that produced it. The facility documents address this by requiring the manufacturer to carry product liability cover at a stated level with the facility noted, by cross-defaulting to any regulatory suspension of the site, and by capping single-line exposure at 35 per cent of the drawn balance. A lender that cannot survive one line being suspended for a quarter has not underwritten the sector.

The economics work because the analysis is specific. Pricing on this book has averaged 380 basis points over the funding base, which is not a distressed margin, and losses since inception have been nil. The manufacturers get a facility that follows their production calendar instead of fighting it. The firm gets exposure to inspected sterile capacity, which is the scarcest asset in the sector, without paying an equity multiple for it. The four tests are satisfied at the level of the facility rather than at the level of the company.

Published 2022-09-20 by the Commercial Finance division. Research is prepared for eligible counterparties and does not constitute advice.