[CF-DROP] Collateral Onboarding Risk Evaluation

Legal Disclaimer: This communication is provided for information purposes only. This communication has been prepared based upon information, including market prices, data and other information, from sources believed to be reliable, but such information has not independently been verified and this communication makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, financial or tax advice. You should consult your own advisers as to those matters. References to any digital assets and the use of finance-related terminology are for illustrative purposes only , and do not constitute any recommendation for any action or an offer to provide investment, financial or other advisory services. This content is not directed at nor intended for use by the MakerDAO community (“MakerDAO”), and may not under any circumstances be relied upon when making a decision to purchase any other digital asset referenced herein. The digital assets referenced herein currently face an uncertain regulatory landscape in not only the United States but also in many foreign jurisdictions, including but not limited to the UK, European Union, Singapore, Korea, Japan and China. The legal and regulatory risks inherent in referenced digital assets are not the subject of this content. For guidance regarding the possibility of said risks, one should consult with his or her own appropriate legal and/or regulatory counsel. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any decision. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

Outline

  1. Proposed risk parameters
  2. Background
  3. Industry analysis
  4. Peer analysis
  5. Asset originator analysis
  6. Lending process
  7. Levels of risk
  8. Borrower analysis
  9. Token issuer analysis
  10. Implementation details
  11. Proposed covenants

Proposed Risk Parameters

Debt Ceiling: 2M DAI
Stability Fee: 5%
Collateral Ratio (vault-based): 105%
Minimum Collateral Ratio (pool-based): 109%
Underlying Collateral Ratio (pool/DAI loan): 114%

Background

ConsolFreight is a SaaS freight technology provider that focuses on enabling digital transformation and integrating a network of entities engaged in international trade. The company connects a network of small/medium sized freight forwarders under its logistics platform (ForwardTogether). Their goal is to grow a trusted ecosystem of freight forwarding partners where entities can have access to digitalisation, business and financing solutions, including the use of blockchain and smart contracts. ConsolFreight, the Asset Originator, is applying to use Maker MCD as a credit line to originate new loans against both its tokenized freight invoices (CFactoring) and trade financing (Trade Forward) solutions. Centrifuge Tinlake will act as the backend tokenization platform for ConsolFreight collateralized assets.

In a global supply chain environment where trade opportunities and financing are increasingly verticalized around big players, from shipping to banking, ConsolFreight’s network is positioned as a niche ecosystem for SMEs, centred on freight operators.

References:

Industry analysis

There are two types of collateral under study for this risk assessment: freight invoice financing (factoring & reverse factoring) and trade finance of cargo.

ConsolFreight’s business model and collaterals under study are directly related to the state of the international trade of merchandise, i.e. physical goods.

Trends in Trade Finance

It is estimated that the dollar value of world exports was USD 18.89 trillion in 2019, according to the WTO. While trade was already in slight decline YoY (0.1%), due to geopolitical tensions and slowed growth, world trade of goods is set to decline between 13% and 32% in 2020 due to the Covid-19 crisis. North America and Asia exports will likely be hit hardest. Several recovery scenarios are possible for coming years. The path will depend on policy responses, impacts to global supply chain actors (manufacturers etc) and spending by businesses and households.

World merchandise trade volume, 2000‑2022
Index, 2015=100
source: WTO

Global trade is supported by financing the flow of goods through credit (trade finance). It is estimated that only about 9 trillion of the total global trade uses trade credit, mainly via banking “letters of credit” (L/C) and documentary trade. Before the pandemic that finance gap was a USD 1.5 trillion/year of unmet trade capacity. With covid19, the ICC estimates the trade credit market gap has widened to USD 1.9 - 5 trillion necessary to allow a V-shaped recovery to 2019 levels.

This unmet demand affects mainly SMEs which account for the highest rejection rates in trade credit. Globally, it is estimated that the rejection rate of trade finance to SMEs is 45%. These companies either don’t have an “acceptable” credit history or cannot afford high operational costs (see below) required to satisfy traditional lender requirements.

Industry concentration, reduced banking-originated credit and digitalisation are the other big trends of the last decade. Given their share of global trade and control over the supply chain, large corporations and the shipment industry have increasingly integrated and concentrated the market. This has led to a shift from trade credit (L/C) to open account transactions between big players where goods are shipped and delivered before payment is due. In addition, these companies have been investing heavily in platforms and digitalization of manual processes for the various actors in their closed ecosystem. A whole “Tradetech” and Blockchain industry has formed around these consortia to support their integration and financing. This includes the digitalisation of banking-led financing (L/C and documentary collection).

These trends have largely excluded the integration with freight forwarders, smaller logistic players and SMEs, left out of both digitalisation and financing opportunities. ConsolFreight’s freight forwarder network and its suite of digital tools and financing intend to fill that gap in the market.

Default rates

Default rates in trade finance banking products have remained very low in the last decade. Exposure-weighted default rate for import L/C was only 0.14% in 2018. It’s generally a very low rate when compared to other asset classes. Given the under representation of SMEs in banking trading finance it is important to note these figures (default rate, LGD, EL) may not be fully representative of that cohort.

Factoring

Factoring, receivables factoring or debtor financing, is when a company buys a debt or invoice from another company.

Overall the global factoring market has seen a growth of over 5 % to an estimated 2019 volume of 3,495 billion USD compared with the previous year’s 3,308 billion USD.

At a regional level, Europe, the largest contributor, makes up 68% of the total, with 2,372 billion USD. This shows an overall growth of more than 8%.

The Asia Pacific region accounted for 23% of the global volume with 816 billion USD which indicates a drop of just under 2% compared to the 2018 level of 831 billion USD.

The Americas together are in third position with 8% share of the total world factoring volume. The overall value was 264 billion USD, a growth of less than 5%. Within that region, South and Central America have a 5% share of the total world factoring volume with a value of 160 billion USD which is a 10% increase. Argentina (+34%) Chile (+26%) and Peru (+15%) are key markets in that region. With a value of under 104 billion USD, North America suffers from the drop in Chinese trade with a decrease just short of 4%.

Factoring is expected to grow rapidly in Africa. Currently the value of the African market sits at roughly 28 billion USD with a growth of 10%. That is due to the contribution of more mature players like South Africa (+11%) and Egypt (+13%).

Default Rates

Reliable default rates for factoring have not been identified. The exposure-weighted default rate for Supply Chain Finance (SCF) Payables Finance was low at 0.13% in 2018, a 0.02% increase compared to 2017 level of 0.011%.

Peer analysis

This section is about providing details of the asset originator main competitors. This can be used as a benchmark when comparing financials with peers in the industry to have a relative measure of health of the business.

As described above the key focus of ConsolFreight is on logistic providers that have been largely excluded from the industry concentration around multinationals and on SMEs who don’t have access to Letters of Credit. Whilst there is a movement in the industry of digitalising the Letter of Credit process this includes large multinational companies and banks, not the logistics providers who also face high operational costs as a barrier to entry.

ConsolFreight has a number of competitors in the Factoring and Trade Finance space. This analysis will look at the key ones.

Factoring

Out of the key competitors in Factoring, Paycargo is the main competitor for ConsolFreight because they both operate in the same competitive logistics market.

Paycargo was founded in 2005 and aims to simplify the payment process for faster cargo movement for their customers. Their network includes around 3000 vendors, including large companies such as Hapag Lloyd, Hamburg Sud and Air France to name but a few.

Paycargo’s headquarters are located in Florida, USA.

The company employs an estimated 50 staff and has an approximate annual revenue of $8m. In addition, it has been announced that Paycargo raised $35m from Insight for its cloud based payment and financing services.

The CEO, Eduardo del Riego who joined Paycargo in 2013 has extensive industry experience.

Qwil was founded in 2015 and offers an automated global payments and liquidity solution that allows suppliers to get paid how, when, and wherever they choose. There is no further indication of that solution being limited to specific industries. The company’s headquarters are located in San Francisco, USA.

The three founders bring IT, blockchain and start-up experience.

The estimated annual revenue according to www.owler.com is $3m.

Other competitors in the factoring space include Universal Funding Corp, Grenke and Bibby. They offer factoring across a range of industries. For Bibby this includes export and transport so there is an element of competition with ConsolFreight. However, in the case of Bibby these are just two areas out of many that they offer factoring services.

Trade Finance

TradeIX was founded in 2016 and is headquartered in Dublin, Ireland. Additional offices are located in London and Singapore. TradeIX is a leading provider of technology for global trade and supply chains that enables their customers, partners, and stakeholders to transact and exchange data smarter, faster, safer, and with more transparency. In 2017 they implemented the first ever blockchain enabled trade finance transaction.

TradeIX is an award-winning Fintech company that is proud to work with well known financial institutions and companies in the world including ING, BNP Paribas, Accenture, DHL, AIG, R3, Microsoft, and Oracle Netsuite.

TradeIX is managed by a team of over 120 staff with experience in blockchain technology, trade finance and enterprise software.

According to www.owler.com the annual revenue is just under $5m but expects it will be generating more than $100m in annual revenue by 2021.

MODIFI was founded in 2018 and is headquartered in Berlin, Germany. The company currently employs more than 30 employees and has an annual revenue of $4.9m. The amount of total funding is $8.5m. Modifi aims to empower SME businesses to trade internationally with digital trade financing.

Other competitors include Komgo, We.Trade and Tradeteq.

Asset originator analysis

Focus on the asset originator and the kind of business that will be conducted in the SPV.

Founded in 2016 ConsolFreight specialises in providing liquidity to the Logistics industry and international commerce parties (buyer/sellers).

The services that are provided relevant to this study include:

  • Freight Factoring (factoring of own invoices, reverse factoring of own invoices and reverse factory of supplier’s invoices) is a service provided to Freight Forwarders.
  • Trade Finance is a service provided to buyers and sellers involved mostly in international trade transactions of goods.

ConsolFreight headquarters are based in Miami, USA, with operations in Barcelona (Spain) and Dublin (Ireland) and a rapidly expanding team.

The founding team is made up of:

Ernesto Vila
CEO/Founder
20 + years of logistics industry experience.
Founded Double Ace Cargo, a Freight forwarding company with +25MM sales.

Alejandro Gutierrez
CSO/ Co-Founder
10 + years of experience in supply chain management, logistics and procurement and strong background working with high profile companies in the industry and consulting.

Jose Maria Sola
Member of the Board/ Co-Founder
15 years of logistics industry experience.
Founder of SC Line Shipping Company and Fast Terminal, from which he successfully exited.

At time of writing Consolfreight has deployed 865,000 USD in 3 pools (CF1, CF2 and CF3) of funds all using Tinlake. A fourth pool is currently ongoing with a 445K DAI value at time of writing.

The forecast for ConsolFreight is looking as follows:

Freight invoice factoring

  • By December 2020 have all 31 members of the network using the factoring solution
  • Each member submitting 10 invoices per month
  • The average invoice value of US$ 5000.00
  • Total monthly invoice factoring protected by December US$ 1,550,000.00

Trade Finance

  • By December 2020 have all 31 members of the network using the trade finance solution
  • 50% of the members submitting 1 invoices per month
  • The average invoice value of US$ 65,000.00
  • Total monthly invoice factoring projected by December US$ 1,007,500.00

During the latest seed round in November 2020 ConsoFreight raised $438.5K.

The scope of this analysis excludes fraud/ AML/ KYC assessment of ConsolFreight so no comprehensive information gathering and analysis of judgement proceedings, bankruptcies or insolvencies of the originator (current or historic) or any of its directors and related entities has been performed.

Lending process

This section describes the operational lending process used by the asset originator to originate new loans that are then collateralised. It also covers any internal due diligence processes followed to onboard assets, including how the asset originator manages risks in its loan book.

Factoring/Reverse factoring

The following diagram describes the lending process facilitated by ConsolFreight with regards to factoring (left) and reverse factoring (right) to freight forwarders. ConsolFreight provides the following lending facilities:

  1. One type of factoring on account receivable invoices from clients of freight forwarders (supplier)
  2. Two types of reverse factoring, on freight forwarders’ own invoices (receivables) and on freight forwarders’ suppliers invoices (payables)

In both cases, invoices are the collateralized assets that have been tokenized in the Tinlake pool (NFTs) against the issuance of a credit line (in DAI) to Consolfreight. However, as we’ll see later on, the major bearer of credit risk will be a different party depending on the type of factoring applied.

According to Consolfreight, a typical process of onboarding freight forwarders to provide its factoring/reverse factoring occurs like this:

  1. Freight Forwarder applies to join the Forward Together Network
  2. When the Freight Forwarder has been approved in the network, they can apply for liquidity using the portal Freight Factoring Application
  3. Freight Forwarder submits an application (if new to the platform) and uploads the assets (invoices) it needs working capital against.
  4. Consolfreight conducts due diligence on the Freight Forwarder and its counterparty. It assesses the assets and provides a proposal including terms and conditions (advance rate, interest rate, repayment terms, etc). Typical advance rate will be less than 100% of face value, plus interest.
  5. Freight Forwarder accepts terms and conditions offered by ConsolFreight.
  6. Consolfreight transfers funds in advance to the Freight Forwarder.

In the case of factoring:

  1. On maturity of the invoice or obligation the client (payor) of the Freight Forwarder (payee) pays the service (factoring) to ConsolFreight SPV.

In the case of reverse factoring either:

  1. Own invoice type: the payee will receive funds from ConsolFreight. On maturity of the invoice (receivables) the Freight Forwarder (payee) will pay the invoice directly to Consolfreight SPV plus interest.

OR

  1. Supplier’s invoice type: the payor will receive funds from ConsolFreight. On maturity of the invoice (payables) the Freight Forwarder (payee) will pay the invoice directly to Consolfreight SPV plus interest.

Due diligence

ConsolFreight has designed its own internal counterparty onboarding, risk assessment and pricing framework to lend against collateralised invoices (factoring and reverse factoring). The framework is designed to assess risk in both the parties involved (e.g. buyer and freight forwarder) as well as in the transaction. Here is a summary of the assessment steps:

  1. Suitability assessment: vetting process as FFs need to be onboarded as members into ConsolFreight’s Forward Together network before submitting invoices.
  2. External assessment: credit information data gathering on the freight forwarder applicant using company registration via Euler Hermes (insurance) oracle.
  3. Internal assessment: operational assessment on technical capabilities of FF to operate efficiently and legally (licenses, years in operation, media presence, customer/partner references). Approval at this stage enables applicants to request for liquidity on invoices.
  4. Risk scoring: scoring will be the first gate for a transaction approval on request for liquidity. Scoring methodology and pricing terms will change depending on type of service from the freight forwarder’s (FF) perspective and the bearer of risk.
  • Factoring own invoice: ConsolFreight uses a 5 point scale over 4 criteria focused primarily on payor (Buyer): payor creditworthiness, frequency and length of relationship between parties (payee-payor), industry health rating, country rating
  • Reverse factoring of own invoice: ConsolFreight uses a 5 point scale over 4 criteria focused primarily on payee (FF): payee creditworthiness, frequency and length of relationship between parties, industry health rating, country rating
  • Reverse factoring of supplier’s invoice: ConsolFreight uses a 5 point scale over 4 criteria focused primarily on payor (FF): payor creditworthiness, frequency and length of relationship between parties, industry health rating, payor country rating
  1. Pricing: the sum of the scores obtained is then mapped out to an overall score and related rating (A-F). For each risk bucket, ConsolFreight defines terms of funding (advance rate, financing cost of money APR). Terms can change for:
  • Factoring: From no financing to 100% advance rate
  • Reverse factoring (both types): From no financing to 95% advance rate

Note that ConsolFreight is going through a model enhancement process with Experian. Updates are pending and the Risk team will be notified.

Default handling process

ConsolFreight claims to have a 0% default rate on its portfolio. The following diagram describes a typical mitigation process followed whenever a risk of non payment arises:

The write-off schedule for the Tinlake pool is as follows:

Write-off Event
10% If overdue by 2 days and no payment arrangement set up (step 4)
25% If no agreement is set at beginning of collection process (step 5)
50% If the invoice is sent to collection agency (step 6)
75% If no agreement is set after 60 days (step 7)
100% Final write-off after all recoveries are collected

Trade Finance

The following diagram describes the lending process facilitated by ConsolFreight with regards to its trade financing service. As opposed to factoring, ConsolFreight here offers a service and risk assessment focused on buyers (importer) and sellers (exporter) of goods.

Freight Forwarders act as intermediaries recommended by ConsolFreight in the organisation of shipment of cargo with carriers. Most importantly, Freight Forwarders are bearers of the custody of the physical goods via the Bill of Lading.

This document is the main proof of a contract between a shipper and a seller. It serves as a receipt when the goods being shipped arrive at their destination. It is evidence of shipment and proof of receipt of the goods by the carrier from the company providing the goods for shipment.

From Maker’s perspective, the associated invoices and Bill of Lading (title of goods) are the collateralized assets that have been tokenized in the Tinlake pool (NFTs) against the issuance of a credit line (in DAI) to Consolfreight.

According to Consolfreight, a typical process of onboarding buyers and sellers to provide its trade financing service occurs like this:

  1. A buyer has a request for trade finance service from ConsolFreight
  2. The buyer, if new to the platform, will apply to be accepted in the platform Trade Finance Application loading all data requested for KYC and AML
  3. Consolfreight will assess data submitted by the user and approve or deny the application
  4. If application is accepted, the user/buyer will be able to apply for Trade Finance loading the required documentation and assets.
  5. Consolfreight conducts a due diligence on the transaction and if accepted provides a proposal including terms and conditions (advance rate, interest rate, repayment terms, %deposit, etc)
  6. The buyer accepts terms and transfers deposit to Consolfreight SPV bank account
  7. Consolfreight SPV transfers funds (prepayment) to the seller of the transaction.
  8. The seller starts a transaction for manufacturing or preparing goods to be shipped
  9. When the product is ready for dispatch, Consolfreight nominates a freight forwarder of the network that will take custody of the goods transported.
  10. Consolfreight proceeds to finalise payment to the seller.
  11. Goods arrive at destination and buyer pays the service to Consolfreight
  12. When payment is received Consolfreight proceeds to release Bill of Lading.

Due diligence

ConsolFreight has a different risk assessment process for trade finance, although keeping a multi-phased approach. Process is somewhat stricter and more comprehensive on both parties of the transaction (buyer/importer and seller/exporter). Here is a summary of the steps:

  1. External assessment: credit information data gathering on the buyer and seller using company register inputs via Euler Hermes (insurance) oracle. Both parties require clearing.
  2. Internal assessment: further documentation required to assess legitimacy, health of business and creditworthiness on both parties (articles of incorporation, bank account ownership, 3x bank statements, proof of transactions between parties). Validation of documentation at this stage enables applicants to move to scoring and pricing terms.
  3. Risk scoring: scoring will be the first gate for a transaction approval on request for liquidity. ConsolFreight uses a 5 point scale over 5 criteria focused on both buyer and seller: frequency and value of transactions within the network, frequency and length of relationship between parties (buyer-seller), seller industry health rating, buyer industry health rating, buyer country rating
  4. Pricing: the sum of the scores obtained is then mapped out to an overall score and related rating (A-F). For each risk bucket, ConsolFreight defines terms of funding (advance rate, maximum deposit, financing cost of money APR). Advance rate terms go from 0-80% and maximum deposit up to 20%.

It is worth noting that Euler Hermes (Allianz) assesses every shipper before providing credit insurance coverage. They may also underwrite based on their own risk scorecard.

Default handling process

ConsolFreight claims to have a 0% default rate on its portfolio. The following diagram describes a typical mitigation process followed whenever a risk of non payment arises:

The write-off schedule for the Tinlake pool is as follows:

Write-off Event
10% If the cargo is moved to a bonded warehouse and there is no payment arrangement (step 4)
50% If the cargo is offered to the FF network or loaded into the liquidation partners webpages (step 6)
100% Final write-off after the cargo is liquidated

Levels of Risk

This section describes and analyses the different categories of risks possibly impacting the collateralized assets. The goal is to provide a summarised approach to assist Risk teams in the overall Risk Management of these assets through policies and covenants.

Credit risk and operational risks are the biggest risks for the collateral under study.

Credit Risk

Credit risk is the risk that a counterparty in a transaction is unable or unwilling to make payments on its obligations. In international trade, it also includes a counterparty’s ability and willingness to make physical delivery of goods (trade finance). Third, global trade includes the counterparty’s ability and willingness to produce the ordered goods.

Other risks associated with credit risk are country, sector and type of security for pledged collateral (e.g. invoices, goods). Country risk gives a macro-level assessment of a country associated with a transaction and the risk of non-payment for companies in that country. ConsolFreight summarises this risk using a medium-term country grade (A-D) considering macroeconomic, business environment and political factors. Sector-level risk considers the outlook for industrial sectors in a given country and the risk of non-payment of those companies. It looks at demand, profitability, liquidity and business environment, then summarises this risk to a qualitative metric (from “very favourable” to “recognised crisis”). ConsolFreight uses Euler Hermes’ framework for determining both country and sector risk on a collateral transaction level.

Based on the first 3 Tinlake ConsolFreight pools, we can state that:

Factoring

  • Factoring (factoring and reverse factoring) made up 74% of all collateral
  • One single freight forwarder accounted for 23.4% (197K) of all factoring portfolio
  • The top 4 freight forwarders accounted for more than 53% of all factoring portfolio
  • 58% of invoice value is linked to payors from medium-higher risk graded (B-D) countries
  • 41% of all invoice value is associated with one single country, though an A graded one
  • Factoring had some sector diversity (38% logistics) while reverse factoring (83% logistics) is very concentrated, however reverse had 3.6x higher collateral value
  • Given the relative size of reverse factoring, the primary credit risk is on freight forwarders themselves, both as payee (own invoice) and payor (supplier’s invoice)

Trade Finance

  • Trade finance made up 58% of all collateral value in CF3
  • One single buyer represented 76% of the trade finance loan advanced and as much as 67% of all loan advanced in CF3
  • Small portfolios for trade finance concentrate single buyer and single loan risk as trade finance deals tend towards 50-150K in size
  • Both country and sector risks were concentrated. But the data sample is too insignificant
  • Credit risk lies on the buyer (capacity and willingness to pay) as well as on the exporter i.e. capacity to produce and deliver the goods.

ConsolFreight mitigates the seller’s delivery risk through its incoterms (EXW), transferring risk to the freight forwarder/buyer early in the shipping process.

Market Risk

Market risk is the risk that changes in market factors can affect the value of a transaction. Two primary sources can be interest rate risk and foreign exchange risk. Rising interest rates can reduce the present value of future interest and principal payments while changes in foreign exchange can reduce the value of payments when translated back into the base currency used.

For trade finance and invoice factoring, we consider both risks to be low and mostly mitigated by the structure of the loan-backed portfolio.

  • These loans are of short maturity, so floating rate commitments can be well managed through careful governance.
  • Foreign exchange risk is also low. Nearly all transactions performed by the asset originator and end borrowers are denominated in USD. So the risk is on keeping the stability of the DAI peg through the maturity of the pools (30-90 days mostly).

Liquidity Risk

Both collateral assets have a different degree of liquidity. Underlying freight invoices (receivables or payables) can be a relatively liquid market with a number of factor companies operating. Trade finance is illiquid by nature.

A few characteristics related to trade finance liquidity:

  • There is no or little secondary market for trade finance assets (yet)
  • Both liquidation and redemption requests on existing assets can take more than 30 days
  • On the bright side, short maturity allows the Risk team to propose input parameter adjustments to credit quality in a period of market insecurity

Operational Risk

Operational risk in global trade can be complex and involve a lot of documentation and legal oversight and monitoring. There are various jurisdiction boundaries and agreements that may impact the ability to secure payments and collateral. Relying on the asset originator having a well designed legal and administrative process is crucial.

Here are some operational risks in trade finance: (non-exhaustive)

  • Eligibility risk: some jurisdictions may have restrictions on financing arrangement and impose controls on transactions and freeze assets e.g. OFAC in the US
  • Counterparty & fraud risk: inability to obtain timely, reliable and accurate information from the counterparty (buyer, seller, carrier, freight forwarder) to manage risk at each point in the cargo transaction
  • Legal risk: poorly designed and monitored documentation that can lead to loss of securing collateral
  • Payment risk: risk of not being able to collect collateral assets through collection agencies in overseas jurisdictions
  • Damage or loss of goods: risks of having goods damaged in transit or incorrect quantities/qualities than specified leading to disputes and delayed payments

A thorough review of all these risks is out of the scope of this assessment. However, ConsolFreight claims to have in place a number of risk mitigants including:

  • Use of offshore companies for liquidation of distressed assets
  • Independent inspection and valuation of collateral (cargo) by third party agents.This service is contracted depending on collateral estimated value e.g. SGS, Bureau Veritas
  • Enforcement of shipping insurance before approving financing to collateral
  • Presence of IoT (RFID) to track and monitor flow of cargo. This will depend on value of collateral
  • Internal due diligence on both buyer and seller described above
  • Use of its own internal freight forwarder network and trade financing as the hub for exchange and hosting of both physical and financial information

Borrower analysis

The borrower analysis takes a closer look at the top six customers of ConsolFreight by invoice loan advance value (loan value > $30K each). The total list of borrowers provided by ConsolFreight includes 32 entities.

Borrowers

TechCargo presents itself as a strategic partner with a full suite of transportation services and logistics solutions who focuses on expanding digital freight forwarding capabilities to drive efficiencies and add value for customers and freight forwarders of all sizes, primarily in the United States, Latin America, and Europe.

The company was incorporated in June 2018 in the USA (FL) but its CEO Alberto Campo presents more than 20 years freight forwarding industry experience. Information on credit ratings and revenue is not available. Company has 7 employees and an annual revenue that cannot be publicly disclosed.

Globalog S A is a company based in Colombia, with its head office located in Bogota D.C… The enterprise operates in the General Freight Trucking industry. It was first established on April 21, 2010. As of 2020 it had a total number of 21 employees. From the latest financial highlights, Globalog S A reported a net sales revenue drop of 26.44% in 2019. A negative growth of 4.24% was recorded in its total assets. Globalog S A net profit margin decreased by 5.17% in 2019. Data on the website emis indicates that the business is currently undergoing a reorganisation (as of August 2020). A reorganisation is a process usually started with the objective of restoring profitability of a troubled business. Globalog’s annual revenue cannot be publicly disclosed.

Despite this recent bad performance, ConsolFreight informed us Globalog has passed the Euler Hermes credit score assessment stage (see Due Diligence above).

Ceramic Expo Centre is located at Port-au-Prince, Haiti. Further research did not reveal clear data to provide further information on the borrower.

ADEKO was founded in 2008 and is headquartered in Port-au-Prince, Haiti. The scope of services provided by ADEKO includes freight forwarding, custom’s clearance and project handling. No further financial information about ADEKO could be located. ADEKO’s annual revenue cannot be publicly disclosed.

Agro & Construction Solutions is a business which sells, exports, distributes and provides services related to agriculture. More specifically this includes poultry, swine and industrial machinery. The company’s head office is located in Miami but also operates out of Mexico, El Salvador, the Dominican Republic and Colombia.

The company was founded in 2009. According to Dun & Bradstreet the company has 11 employees across all locations and generated an annual revenue of USD 9.5m.

Global System Cargo Sas is an enterprise based in Colombia with its main office located in Bogota D.C… It operates in the Other Business Support Services sector. Global System Cargo Sas was incorporated on May 25, 2015 so at the time of writing this report it has been operating for a bit more than 5 years. As of 2020 it had a total number of 3 employees. The company’s latest financial report indicates a net sales revenue increase of 7.8% in 2019. During that time, Global System Cargo Sas’s total assets decreased by 22.01%. In 2019, Global System Cargo Sas’s net profit margin decreased by 20.87%.

Issuance platform analysis

ConsolFreight has partnered with Centrifuge to facilitate tokenization of its assets (invoices and bill of lading). Centrifuge is a German start-up that was founded in 2017 and provides decentralised asset finance. Centrifuge is known to Maker from previous POCs, community proposals and the extension of its platform to integrate with Maker vaults and smart contracts.

The Centrifuge tokenization platform Tinlake allows Asset Originators to access a decentralized line of credit backed by their real-world assets. The Asset originator can issue DROP tokens that are deposited into a Maker vault in order to borrow DAI against these redemption tokens. Simultaneously, other DROP (junior tranche) and TIN (senior tranche) tokens are offered to external investors or purchased by the asset originator itself. TIN tokens offer protection to junior tranches by absorbing the first losses in the portfolio.

The protocol coordinates the various parties required to structure, administer, and finance collateralized pools of assets categorized by type and risk (for example, invoices, mortgages, auto loans, or royalties). Asset Originators using Tinlake can benefit from financing flexibility through simplified processes and reduced cost. This allows them to optimize risk allocation and access instant funding from DeFi or their traditional investors.

Any Asset Originators using the Centrifuge platform are expected to deal with defaults in their portfolio following usual processes. The Maker liquidation model must account for this accordingly, discussed below.

Implementation details

ConsolFreight’s implementation uses the Centrifuge Model. Let us cover some important dynamics.

The issuance of senior (DROP) and junior (TIN) tokens is managed by Securitize. It follows AML/KYC compliance based on US securities rules. For US residents only accredited investors can invest in these instruments. The SPV (ConsolFreight) issues DROP tokens for the Maker vault so that the SPV can mint DAI against NFTs deposits.

The liquidation mechanism of Maker vault is defined by MIP22. Liquidation is triggered when the TIN value falls below the minimum collateralization ratio set by the governance to the asset originator (ConsolFreight). As opposed to crypto-native assets, there are no keeper auctions to liquidate assets in the vault. Centrifuge has developed some mechanisms to stop new loan generation should the liquidation be triggered.

The following process map shows the sequence of possible events at different stages of the risk mitigation process:

Centrifuge has designed an internal feature to protect DROP tokens. A TIN-adjusted collateral ratio (set at 118% for ConsolFreight) is triggered by the Centrifuge NAV model when the value moves below its expected point (TIN is 15%). It causes the Tinlake pool to freeze further investment in DROP until the asset originator either increases its TIN investment or adjusts the portfolio. Once adjustments are done, the pool continues its operation.

Whenever a liquidation is activated, all DROP from the Maker vault is withdrawn and any funds reaching the Tinlake pools will be “reserved” to redeem DROP token holders. To prevent this extreme measure, a multi-staged approach has been designed to capture any warning signs coming from the underlying portfolio that allow time for preventive actions. This involves working closely with the asset originator to implement Risk mitigations (See Covenants).

At each stage of the mitigation process, the Risk team will assess the course of action and propose either to reduce the debt ceiling or to activate liquidations. Given the nature of ConsolFreight’s business model, it is recommended to allow sufficient time so that they can implement mitigations in the portfolio, including engaging in a debt collection process. For factoring and trade finance this can be a relatively quick process, from a few weeks to a couple of months.

The Risk team will ensure other preventive actions are in place by analysing the performance of the portfolio on a monthly basis and through monitoring dashboards.

7 Likes

Proposed covenants

This part describes every rule that needs to be met for the safety of the vault. If one rule is broken, there is a liquidation.

Allowed investments

List the kind of investment that the SPV can make. Try to be as specific as possible.

The investments allowed by the SPV are freight invoice financing (factoring and reverse factoring) due in up to 75 days and trade finance on cargo of up to 120 day duration. Advance rate allowed are up to 100% and 95% for A-rated entities for factoring and reverse factoring, respectively. Maximum advance rate for trade finance deals is 80% where a maximum deposit rate of 20% applies, both for A-rated entities only.

Exceptionally, the SPV may carry complex trade financing activities of up to 180 days in duration. These deals may only be approved on a case by case basis, subject to review of due diligence documentation by the Risk team. By default, advance deposits on these are capped at 10%.

Any changes to scoring inputs or methodology needs to be communicated to the Risk team. A Risk team member will join a model change committee led by the SPV to ensure transparency in the methology used.

Also, the mapping between SPV risk scores and financing terms must be consistent.

A table of ConsolFreight internal ratings and financing terms is provided below:

Factoring

Risk rating Score Advance rate
A 17-20 Up to 100%
B 13-16 Up to 100%
C 9-12 Up to 95%
D 5-8 Up to 95%
F 1-4 No financing approved (“Risk cut-off”)

Reverse factoring

Risk rating Score Advance rate
A 17-20 Up to 95%
B 13-16 Up to 90%
C 9-12 Up to 80%
D 5-8 Up to 70%
F 1-4 No financing approved (“Risk cut-off”)

Trade finance

Risk rating Score Advance rate Maximum Deposit %
A 45-50 Up to 80% 20%
B 40-44 Up to 70% 20%
C 30-39 Up to 60% 10%
D 20-29 Up to 50% 10%
F 5-20 No financing approved

Minimum overcollateralization ratio

Maker sets a minimum collateralization ratio to protect collateral in the Maker vault. This ratio is set between the pool value (100%) and the TIN-Adjusted Collateration Ratio (TACR). TACR is set at 118% (Pool / DROP = 100% / 85%). Given an average loan of $9K, a vault size of $2M and an average LGD of 25%, the TACR could decrease from 118% to 112% if 10 average defaults occurred. To allow for 15 defaults, the Minimum Collateralization Ratio is set at 109%.

Collateralization ratio formula

This Risk team is setting up a model to track the value of the underlying trade finance and freight invoice portfolio. This will allow us to monitor the change in value on the Tinlake pool.

Due to confidentiality requirements, this sheet won’t be made publicly available unless consented otherwise by the SPV/ConsolFreight.

ConsolFreight will provide updates of their loan portfolio on a monthly basis to enable the Risk to perform ongoing monitoring and raise any concerns on its performance. We expect this data to be enhanced with as many third party data sources as practical to allow cross validation of data on the health and value of the portfolio, such as inspection and valuation of cargo goods and data ensuring mitigation of operational risks (see “Levels of risk”).

The debt amount is the one on the Maker vault but also the amount subscribed by other co-investors.

It is important to note that the DROP supply is the sum of DROP in the Maker vault plus DROP allowed to other co-investors. Other investors can participate in the pools with either TIN or DROP. ConsolFreight will be the primary TIN investor at the start.

Collateralization ratio proposed threshold

ConsolFreight proposed a TIN proportion of 15% of the Tinpool. As a result, the DROP proportion is 85% and the pool/DROP ratio of 118%, also referred to as TACR (see above). Maker proposes a minimum collateralization ratio (MCR) of 109% of all pool DROP.

Maker vault will likely be the largest DROP holder. It will have a collateralization ratio of 105% which creates a discount of DROP for the vault. The stability fee proposed for the vault corresponds to a single-B yield bond index at 5%. We believe ConsolFreight needs to take steps toward diversifying the risk in its portfolio. In the future, the Risk team can review the SF downwards given some concentration risks are mitigated.

Finally, we propose an underlying collateralization ratio of 114% (collateralization ratio * minimum collateralization ratio), also called pool/DAI loan ratio.

To sum up, there will be three levers for action:

  • TIN-adjusted collateralization ratio, triggers Tinlake pool actions
  • Minimum collateralization ratio (MCR), triggers Maker actions
  • Vault collateralization ratio (CR), relates to DROP in the Maker vault

The initial proposed Debt Ceiling is 2M DAI. We propose to review this upwards every new pool opening subject to ConsolFreight evidence of reduction in concentration risks (see below).

Concentration risks

Given the levels of risks observed in past ConsolFreight pools (See “Levels of Risk”) we propose the following covenants to mitigate risks:

The asset originator must be transparent about any changes affecting its internal risk assessment score and methodology and how it impacts payment terms (e.g. advance rates, fees, maximum deposit rates). At a minimum, the monthly data provided must reflect consistency.

A single loaned asset (either cargo or factoring) must not exceed 15% of the pool i.e. 300K

The maximum exposure to any single borrower entity must not exceed 30% of the pool size (600K). It’s expected that the percentage of exposure decreases as the vault size increases to mitigate risks. The following is the recommended maximum exposure for any single borrower:

Debt ceiling Max borrower exposure %
$2,000,000 30.0%
$3,000,000 20.0%
$4,000,000 15.0%
$5,000,000 12.0%
$6,000,000 10.0%

Additionally, for entities with a low creditworthiness factor in the risk scoring (less or equal to 3), the maximum borrower exposure in the portfolio is 10% of the pool i.e. 200K.

Current pools have also a relatively high concentration risk on single countries and on countries with high risk grades, based on Euler Hermes ratings. No single country must have more than 40% of the pool (i.e.800K) and no high risk country (rated D) must exceed 25% of the pool i.e. 500K.

The following are some limits on portfolio allocation by country risk grade:

Country grade No more than Amount
A - AA 50% $1,000,000
B-BB 40% $800,000
C-CC 30% $600,000
D 25% $500,000

Another point of concern is the sector concentration in ConsolFreight pools. Unfortunately, due to the nature of the freight forwarder network, it is a risk hard to mitigate at this stage. As the business grows we will need to review this sector concentration.

Stakeholders rules

The risk team has assessed that ConsolFreight is financially sound and most likely will be in business in 12 months. This impression is based on an analysis of internal forecast models from the company. Analysis of past financial statements is pending.

TIN investors are providing equity in the pool, and therefore it makes sense for the Asset Originator to be a primary investor in TIN. In addition, it could make sense to require a minimum level of DROP co-investors, as they could assist in enforcing contract rights, benefitting Maker.

ConsolFreight should keep an exposure of $20K in the TIN tranche of the pool.

The MakerDAO vault should not have more than 75% of the outstanding DROP.

7 Likes