Made in China: For Asset-Based Lenders, the Boom in Foreign Imports is a Mixed Blessing
The seismic shift in the scope and scale of overseas manufacturing continues to create opportunities for asset-based lenders. Seizing those opportunities, however, is more complicated — and risky — than it was during the era when inventory was produced, shipped and sold primarily in the United States.
Contrary to popular belief, companies do still make things in America. In fact, the United States is still the world’s largest manufacturing economy, producing 21% of manufactured products worldwide. Nonetheless, globalization clearly has reshaped the landscape for U.S. manufacturing in dramatic ways: The Manufacturing Institute noted that by 2008, almost 37% of all manufactured products bought in the United States were imported, compared to a third as recently as 2003 and less than a tenth in 1967. In recent years, American businesses have increasingly relocated their factories to places like Central America and the Caribbean, the Indian subcontinent, Mexico and, of course, China. Indeed, U.S.-manufactured imports from China in 2008 were $329 billion, or seven times larger than U.S. exports to China of $48 billion. Examine nearly any product — from a remote-control toy car, to a bluegrass banjo, to a stainless-steel gas grill, to a random “chotchkie” at your local dollar store — and you will likely find a stamp with the words: “Made in China.”
The seismic shift in the scope and scale of overseas manufacturing continues to create opportunities for asset-based lenders. Seizing those opportunities, however, is more complicated — and risky — than it was during the era when inventory was produced, shipped and sold primarily in the United States. Today, for example, asset-based lenders can be put in the sometimes difficult position of making loans on collateral that has been produced a world away and, therefore, will be beyond their reach until it has been shipped here on massive cargo vessels, wended its way through customs and been offloaded at the warehouse.
The additional considerations created by this shift have been a part of life for asset-based lenders ever since globalization ramped up in the 1990s. However, the onset of the global economic crisis has made the potential impact of these variables even more pronounced. In stark contrast to the go-go years of the housing bubble, when capital was abundant and retail demand was booming, asset-based lenders today are more likely to find themselves dealing with borrowers that go belly up. This can lead to scenarios in which they are forced to try to collect on merchandise that is, say, sitting on a dock in Hong Kong or stuck in a holding tank at the Port of Los Angeles. The crunch has also shrunk the customer pool for asset-based lenders. In a bid to woo harder-to-get customers, lenders are more likely to offer lower rates and fees on the loans they make, or to lend larger amounts of money in relation to the overall collateral value. In other words, the world might be shrinking, but not the risk.
Nailing Down True Costs From Afar
Coming up with an accurate estimate of the manufacturer’s true cost and profit margin has always been a top priority for asset-based lenders. But when the company in question is located in Guangzhou, China, rather than Burlington, NC, doing so can be quite a bit more complicated. Psychologically speaking, if a Chinese contractor can make a shirt for $4.17, versus a cost of $7.50 or $8 in the states, it might seem natural to focus on how much money has been saved rather than whether that contractor provided cost and profit estimates that were inflated. The onus is on lenders to work with appraisal firms that know the going rates in international markets and rely on solid due-diligence methodologies to ferret out such overcharges. This work is critical: The cost for that shirt could easily rise from $4.17 to $10 if fictitious management fees, bogus freight charges and other unforeseen markups are allowed to go unchecked.
Likewise, lenders sometimes fail to pay adequate attention to legitimate intermediate costs that can affect the appraisal value of the collateral — things like freight, duty and customs fees, brokerage fees and ground-transportation expenses that can add significantly to the cost. Appraisals of this type, as in real estate, are all about location, location, location. For example, when lending to a U.S.-based borrower that has goods in both its domestic warehouse and halfway across the ocean en route to that warehouse from China, chances are that freight, duty and other intermediate expenses will have been paid and added to the appraised value only for those goods already in the warehouse. The in-transit goods, once title has passed and the Freight on Board (FOB) invoice has been received, are in the borrower’s possession in name only. Banks need to realize that in-transit inventories are essentially worthless until they can literally get their hands on them. And that means paying freight, duty and other intermediate costs. When a shipment is stuck in a holding tank, liquidating and selling those goods is not an option.
The impact of these costs varies by merchandise category. Because furniture is big, bulky and heavy, for example, it incurs higher freight costs. Additionally, duties are higher in order to protect the remaining U.S. furniture makers. For a $100 chair made in China, those costs could amount to $40 or so — a full 40% of the previously invoiced FOB value. Possession, as the saying goes, is nine-tenths of the law.
Time is Money
Timing is another key consideration, one made more complex by the congested ports, long shipping delays and intensive customs inspections that come with international manufacturing. Sometimes, lenders fail to appreciate the way that time lags can undermine collateral values, particularly if the borrower is in financial trouble. Let’s say the bank forecloses on a borrower that sells a lot of home-décor goods from China. At the time of the foreclosure, a huge shipment of these products has just left the port in Hong Kong. Title has passed. The goods technically belong to the bank. But within a week of the foreclosure, a liquidation firm has started selling the inventories at a deep discount that will have grown to 50% or more by the time those branded goods land in the U.S. warehouse. Although these goods are new and in-season, they are unlikely to fetch anything close to full price. In most cases, in fact, they will have to be sold at whatever the prevailing discount is for the rest of the inventory.
This holds true for both wholesalers and retailers. In today’s economy, it is not uncommon for wholesalers to run into financial trouble and be forced to liquidate their existing inventories. In such a scenario, their longtime retail customers have little reason to pay full price for merchandise. The retailer, after all, will get no support or service after the sale and will have no opportunity to negotiate for further markdowns or more advertising money. “You guys are in liquidation,” the retailer might say. “What is my incentive to buy these goods at full price? Give them to me for 50% off or forget about it.”
Asking the Right Questions
Overall, lenders that make loans against collateral produced overseas need to ask probing questions about the nature of that inventory, and they need to have a lot of confidence in the accuracy of the answers they receive. What costs will be incurred in the process of getting in-transit goods into the warehouse prior to sale? How long will it take? How much of the in-transit inventory is still sitting on the dock in China? Has title passed? Is the documentation finished?
Globalization is clearly here to stay. Even as lenders closely scrutinize today’s deals, they will also need to keep an eye on long-term trends that could affect collateral values in coming years and decades. Transit costs could go up in the future as a result of shipping challenges and rising fuel prices. Already, transit experts are concerned about issues such as today’s excessive reliance on the Port of Los Angeles and the inability of the Panama Canal to accommodate today’s massive container ships. The prospect of longer delays, once the economy rebounds, looms. Economists talk of the eventual impact of rising wages in China and how it could create further disruptions as factories relocate.
Appraisal firms that have extensive experience in dealing with overseas manufacturers can help lenders negotiate this tricky territory. When asked to do an appraisal on in-transit goods, for example, the firm should always include an estimate of what it will cost to get those goods landed, through customs and into the warehouse. Ideally, it should have direct experience with the specific markets and transit channels in question, and know the customs fees and duties that apply to manifold categories of goods.
The United States has come a long way from the days when a shipment took 48 hours to get from a factory in Little Rock, AK., to a warehouse in Atlanta. No, we are not in Kansas anymore, but companies also don’t have to deal with exorbitant union wages, stifling regulations and the other notorious cost pressures that plague domestic production. It is still cheaper and more profitable to ship goods from halfway around the world — this translates into more business for lenders. The added headaches are just one more cost to plug into the equation.
Jim Siebersma is executive vice president and head of the Asset Appraisals for Buxbaum Group, Agoura Hills, CA, a North American liquidator and appraiser of retail and wholesale inventories. Stevan Buxbaum is president of affiliate company Buxbaum Jewelry Advisors, which offers a wide range of services to profitable and financially distressed jewelry retailers and wholesalers, and their asset-based lenders.
 The National Association of Manufacturers. See http://www.nam.org/Resource-Center/Facts-About-Manufacturing/Landing.aspx
 The Manufacturing Institute: The Facts About Modern Manufacturing, 2009. See http://www.nam.org/~/media/0F91A0FBEA1847D087E719EAAB4D4AD8.ashx