[HTC-DROP] Collateral Onboarding Risk Evaluation

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Executive summary

Parameters

Debt Ceiling: 7M DAI
Stability Fees: 7%
Min SPV CR: 104%
Min Vault CR: 110%
Min Vault Underlying CR: 114%
Liquidation Process: MIP22
Dust: 0 Dai

Check the RWA Documentation for more information.

References

NOTE: Since Harbor posted its MIP6 application, a set of new and more mature deals have improved the overall risk profile of the pool.

Highlights

Harbor Trade Credit (“Asset Originator”) is a supply chain finance (SCF) provider of trade payable financing programs to corporate Buyers through its proprietary platform. It has partnered with Centrifuge as a token issuance platform and Throttle Capital as an equity (TIN) co-investor and provider of debt structuring services. Harbor offers buyers liquidity via trade credit and suppliers quick access to working capital, improving their cash conversion cycle. Buyer trade invoices are the collateral assets pooled in Tinlake smart contracts and offered as short-term structured debt to investors such as Maker.

SCF is a form of trade finance that has been gaining ground over other TF products such as letters of credit over the last decade. It has an estimated 3-4% expected annual growth in the coming years. SCF payables programs are facilitated by platforms such as Harbor. This intermediary gains access to all trade documentation and direct access to buyers’ financial statements and cash-flows in order to facilitate credit underwriting as well as risk and operational monitoring. Trade invoices have a 60-120 day maturity. This form of debt has a low default rate (< 1%) across the industry, similar to other trade finance products risk profiles.

Harbor Trade Credit has set up a Delaware LLC (SPV) which purchases trade invoices from Harbor Trade Limited (“Issuer”) and receives buyer cash-flow payments at due date. Issuer will issue two tranches of ERC-20 tokens: DROP Tokens and TIN Tokens via the Centrifuge Tinlake pools. The DROP tokens (senior) will make up 90% of the pool. Harbor has attracted TIN (junior) investors to fund 10% of the subordinated tranche. The Maker vault will hold DROP with a slight discount and overcollateralisation, similar to ConsolFreight. The initial Debt Ceiling proposed is 7 million DAI. The exposure is expected to increase to 10-15M within 12 months, subject to further risk mitigation (See concentration risks covenants).

Major risks

Harbor Trade is a relatively new entity in SCF with a short operating history facilitating payables financing programs. The company has only launched its first SPV in August 2020, therefore it has limited obligor payment history, investment track record and management of SPVs. Both risks are somewhat mitigated by a managerial team experienced in trade finance markets.

The initial Harbor SCF program had a serious single buyer counterparty risk with Snakebyte Asia. While the Issuer has facilitated a successful 300K series with the obligor, changes in credit or market conditions could bring significant Buyer default risks to that kind of debt structure.

To mitigate Buyer concentration risks, Harbor will bring a more diverse set of Buyers in different sectors, with bigger and more solid balance sheets into the SPV. Harbor has a long standing relationship with the parties and has strong due diligence on obligor’s financials. An increase in Buyer numbers will also mitigate the current sector-specific concentration and the risks caused to global supply chains in the aftermath of covid19. Should any loss of market confidence occur, SCF programs are likely to be impacted and extrapolated for undiversified pools. Hence this move towards sector diversification from bigger Buyers is positive in the maturation of Harbor.

Proposed covenants

All the following covenants are considered as soft (meaning no direct action taken) and any breach (and liquidation) will be enforced by either a signal request, a proposition of a MIP46 PPC, and/or a mandated actor proposal.

Allowed investments

  • SCF trade invoices (payables and receivables)
  • Trade invoices due in up to 120 days
  • Min annualized revenue (Buyer): $10 million
  • Age of Buyers: 2+ years in operation

Concentration

  • Max single Buyer exposure: 30% of the DC limit utilisation (2.1M)
  • Single Buyer exposure by limit utilisation buckets (see concentration details)

Stakeholders rules

  • TIN ratio: 10%
  • Issuer TIN share: min 10% (Issuer) ; 90% other TIN investors
  • Non-Maker DROP holders’ share: 28%
  • The RWF team has assessed that the asset originator is financially sound and most likely will be in business in 12 months. This impression is based on an analysis of bank statements, financial statements and internal forecast models from the company.

Guidelines

  • Portfolio monitoring: monthly
  • Buyer sector diversification: expected
  • Healthy buyer ratios: expected
  • Surveillance of underwriting methodology: expected
  • Surveillance of AML/KYC methodology and documentation: expected
  • Surveillance of operational documentation: expected
  • Surveillance of risk scoring methodology (if applicable): expected
  • Future review of buyer credit default insurance with increased DC: expected

Further Research

  1. Background
  2. Industry analysis
  3. Asset originator analysis
  4. Token issuer analysis
  5. Implementation details
  6. Covenant detail

Background

Provide details about the asset originator and other stakeholders and the proposed kind of asset.

Harbor Trade provides supply chain financing (SCF) programs to buyers in its platform. Buyers can improve their liquidity through trade credit and extended payment terms. Suppliers have access to faster working capital, often at a discounted value. Most SCF activity comes from trade payable financing (“payables finance”), where buyer-led trade invoices are the collateral in the pool. The market for SCF is expected to continue to grow consistently in the coming years, while industry obligor default rates are likely to remain low (<1%). SCF enjoys similar or lower risk profiles than other trade finance (TF) products such as letters of credit. Both the increasing digitalization of SCF platforms and companies in need of liquidity due to covid are important factors in the recent demand increase for SCF.

Sources: ICC survey and ICC Trade report

Industry analysis

Provide an overview of the industry where the SPV asset will be, especially what are the risk, benchmark and historical behaviour. A market comparison with other lenders can be useful as well.

Harbor Trade provides its SCF solution to a number of industries. But its current main corporate buyer is the Snakebyte group, which buys consumer electronics and video game accessories from Asia and sells to retail chains in US/Europe since 1997. Snakebyte also started developing its own consumer electronics products in 2012.

SCF as a sub-category of trade finance (TF) has been one of the fastest growing TF products since the GFC of 2008. The global market is worth about 16 USD Trillion in merchandise trade/year. Revenues derived from it reached between $50B and $75B in 2019. In the first three months of 2020, income from supply chain finance grew by 3% to 4% globally. In 2020, one-third of global banks expect more than 50% growth from SCF in the next five years, according to the ICC.

Despite growth in SCF, trade credit had different impacts depending on the buyer industry during the covid crisis. Consumer products, such as electronics, had a slight decrease in outstanding trade payables balance between Q4 2019 and Q1 2020. Average days beyond terms (DBT) which breaks down trade payables balances by overdue status (i.e. delinquency) has also had very minor effects on consumer products, where existing HTC buyers operate. An increase in DBT shows a deterioration in liquidity. Other industries, such as automotive and travel, had greater deterioration in SCF conditions.

In terms of credit risk, SCF payables finance default rates were 0.13% on an exposure-weighted basis and 0.23% on obligor-weighted basis in 2018 (source: 2019 ICC Trade Register). This is comparable to other TF risk profiles. Exposure at default (EAD) and Loss given default (LGD) datasets are not available industry-wide for SCF yet. We can only assume they may be similar to other TF products (EAD = 100%, LGD = 30-38%).

Key facts:

  • Merchandise trade/year: 16T USD global market
  • SCF volume 2020: $1.31T USD
  • Annual revenues from SCF: $50-$75B USD
  • Annual growth SCF: 3-4%
  • Industry default rate SCF payables: 0.13%

Asset originator analysis

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

Harbor Trade Credit LLC (“Asset Originator”) is a fintech firm focused on Supply Chain Finance (SCF) and working capital solutions to improve the cash conversion cycle of buyers and sellers. The company was founded in 2018 and is still in the startup phase. It developed its own proprietary software platform to facilitate trade financing programs (payables and receivables) with corporates. Its SCF payable enables early payments to suppliers and allows trade credit to Buyers to optimise their liquidity.

Harbor is a so-called “alternative provider” of SCF. Its core business, relevant to this assessment, is to arrange supply chain finance programs directly with corporates (Buyer-led), then to package and sell the assets (trade invoices) to investors via its SPV, Harbor Trade Credit Series LLC (“Issuer”).

Harbor has launched two SPV series: in August 2020 and December 2020 (open). Its first pool had a total of DAI 289,863 invested (89.9% in DROP) in a 65d term structure for an annualised DROP return of 9.47% paid in full on due dates. Series 2 has currently 1,252,303 DAI in pool value for an average 11% APR on DROP. The current pool is essentially financing Snakebyte invoices.

There are a number of counterparties involved in the debt structure: asset originators, co-investors and servicing entities. Due to confidentiality and competitive reasons, the originator has required that their respective roles should not be disclosed.

The asset originator managerial team is composed by a mix of supply chain finance specialists with a background in commercial banking and technologists:

Bryan Maloney, President & Co-Founder

  • 10+ years experience in SCF
  • Director at Stenn International and other senior positions in trade finance

Andy Suen, Lead Engineer, Product & Technology

  • 20+ years in IT across banking and fintech
  • 13 years in IT and product development with HSBC

Joaquín Jiménez Krijgsman, Head of Structuring & Risk

  • 25 years of industry experience in trade finance
  • Senior positions at ING Commercial Banking
  • Consultancy to IFC of World Bank, the ADB, Factor Chains International

Katie Newton, Head of Marketing and Origination

  • 5+ years in finance and marketing
  • Senior positions in marketing at Stenn International

The counterparty entities involved are separate companies with with the following Directors:

  • Harbor Trade Credit LLC: Bryan Maloney and Katie Newton
  • Harbor Trade Limited: Katie Newton
  • Harbor Trade Credit Series LLC: Bryan Maloney

Risk mitigation and defaults

At time of writing, Harbor had no defaults in pooled assets assigned to the SPV. Tinlake Series 2 is pending final default results. Outside the SPV, Harbor claims to have originated more than 16M in trade payables through its programs with no defaults to date. In credit risk terms, Harbor provides a buyer-led SCF program therefore it has Buyer default risk. Given the current concentration of trade credit assets assigned to the SPV with a single buyer, buyer default risk is significant. Default rates are in line with industry (0.13%) defaults for SCF payables at < 1%.

Harbor plans to mitigate these risks by onboarding bigger Corporate Buyers from different sectors in the coming months. Also, to gain access to even bigger corporate clients, with investment grade ratings, Harbor is working on a loan syndication project with other financial institutions.

Note: The RWF team had access to financial documents relating to the upcoming corporate Buyers in the pool

Harbor mitigates default risk with:

  • Rigorous credit underwriting process on Buyer and counterparty risk
  • Operational risk management on relationship between Buyer and Seller
  • Operational & Risk monitoring on Buyer trade documentation, compliance and financials
  • Collection & validation of company, trade and credit data provided by Buyer with independent 3rd parties (e.g. D&B, ImportKey, OpenCorporates)

In case of an obligor missing payment, Harbor has structured collection procedures in place for its SCF payable assets. It consists of an automated notification system (up to 3 dpd), followed by internal collection management (at 7 dpd), workout payment schedules (7-29 dpd) to formal collection and legal action by 3rd parties (at 30 dpd). Formal default is declared at 30 dpd. Asset value is marked down to 80% of its par value at 7 dpd and to 20% at default (30 dpd). At recovery, Harbor either reclaims and sells goods or sells payables invoices to distressed asset buyers. Unjustified outstanding balance post-due leads to obligor credit limit decrease.

Due diligence links:

Key facts:

  • Harbor Trade Credit founded in 2018
  • Activity: SCF platform offering trade financing programs (payables and receivables)
  • Collateral: Trade receivables
  • Maturity: 60-120 day terms
  • Default rate (short history): < 1%
  • Main obligors/buyers (assets in SPV): Client Runway
  • Management: experienced trade finance specialists

For analysis, the RWF team had access to financial statements and projections from Harbor Trade entities involved in the debt structure as well as financial reports from obligors.

Issuance platform analysis

Harbor Trade uses the Centrifuge Model, and details about Centrifuge can be found in the ConsolFreight risk assessment.

Implementation details

Provide the mechanics of the vault management. This can follow the Centrifuge Model, the Trust Model or something specific. Please detail any deviation from the model if applicable.

Harbor’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 (Harbor Trade Credit Series) 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 (Harbor Trade Credit). 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 minimum SPV collateral ratio (set at 104% for Harbor) is triggered by the Centrifuge NAV model when the value moves below its expected point (TIN is 10%). 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.

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 Harbor’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 supply chain financing 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.

Covenants Detail

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 supply chain finance trade invoices (payables and receivables) due in up to 120 days. Advance rate is the Purchase Price of the underlying asset. For example: If the applicable discount rate is 6.00% p.a. and the Invoice payment term is 90 days, the purchase price would be 1.50% discount to the face value.

Harbor uses its own proprietary credit underwriting methodology to assess credit risk and credit quality of Buyer invoices. This methodology does not involve a formal credit scoring. Any changes to underwriting methodology must be communicated to the Risk team.

The Risk team will have access to any underwriting calculations performed on obligors for auditing purposes.

Minimum SPV CR ratio

The minimum SPV Collateralization ratio at the SPV level ensures the safety of the vault. This will likely be lower than the max number asset / DROP in the case of Centrifuge as we want to allow at least one default before liquidation.

Maker sets a minimum SPV collateralization ratio to protect collateral in the Maker vault. The SPV CR is defined as SPV CR = SPV Assets / SPV Debt. Assuming an SPV debt of 10,6M (Vault 7M DC), an average loan size of 141K and an hypothetical default rate of 6.65% (~ 5 loans), the Minimum SPV CR is set at 104%.

SPV Collateralization ratio formula

E.g. Asset / debt amount with an explanation on how to get the asset valuation.

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

Harbor 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. The Risk team will provide a monitoring dashboard to report performance.

Total SPV debt (i.e. DROP) is the sum of DROP in the Maker Vault plus DROP provided to other co-investors. Harbor will be the primary TIN investor along with Throttle Capital.

Collateralization ratio proposed threshold

Harbor proposes a TIN proportion of 10% of the Tinpool. The DROP proportion will be 90%.

Maker vault will likely be the largest DROP holder. It will have a collateralization ratio of 110% which creates a discount of DROP for the vault. The stability fee proposed for the vault corresponds to a high-yield bond index at ~7%. We believe Harbor exposures need to be further diversified by industry, obligor and credit quality. This is expected to come into play with new deals to be onboarded and a loan syndication scheme in the coming months.

We propose to review the SF downwards once some concentration risks are mitigated and a longer pool performance track record is in place.

The proposed Debt Ceiling is 7M DAI. We recommend reviewing the Debt Ceiling subject to Harbor’s evidence of mitigation in concentration risks (see below).

Minimum Vault CR ratio

In case the vault is again overcollateralized with the SPV debt token.

Maker proposes a minimum vault collateralization ratio of 110% of all SPV debt tokens (DROP).

Minimum Vault Underlying CR ratio

This is the result of SPV CR * Vault CR if all the SPV debt is used as Vault Collateral. Check the RWA Documentation for more information.

Finally, we propose a Minimum Vault Underlying CR of 114%.

Concentration risks

The current Harbor pool has significant concentration risks around single buyer credit exposure and sector-specific risks. It is understood this is common in supply chain finance corporate-led programs and risks are in part mitigated by short-term debt maturities. Also, with the pool increase under this deal, this concentration risk must be mitigated.

To further mitigate risks with increasing exposure in the pool assets we propose the following covenants:

The asset originator must be transparent about any changes affecting its internal risk assessment, underwriting, risk and operational monitoring and default handling methodologies. A monthly data file provided must reflect consistency in approach. The Risk team is allowed to conduct spot checks on any methodology or data affecting the pooled assets.

The maximum credit exposure to any single obligor (i.e, Buyer) must not exceed 30% of the maximum vault debt ceiling i.e. 2.1M DAI. We recommend the following maximum single buyer credit limit exposure as the vault debt limit utilisation increases:

Limit utilisation Limit Utilisation Amt Max Single Buyer Exposure Buyer Credit Limit
20% $1,400,000 100.0% $1,400,000
40% $2,800,000 75.0% $2,100,000
60% $4,200,000 50.0% $2,100,000
80% $5,600,000 37.5% $2,100,000
100% $7,000,000 30.0% $2,100,000

The above maximum single buyer exposure must also be tempered by healthy obligor financial ratios, particularly in regards to buyer’s leverage and liquidity ratios. Also these ratios will be established based on security or collateral obtained by Harbor when applicable.

Existing Harbor pools have high sector concentration risks in consumer electronics. While this reflects an “opportunistic” allocation strategy and historical relationship with buyers, covid19 has shown the risks for sector-specific SCF program providers. As the credit limit utilisation grows we will need to review this sector concentration in the pool.

Last, Harbor SCF programs do not have credit insurance against buyer defaults. Harbor claims this represents a significant operational cost for low exposures, reducing margins.

We recommend credit insurance requirements to be reviewed over time as diversification and credit quality of underlying assets in the pool increases.

Stakeholders rules

The stakeholders risks should at least be the financial stability of the asset originator. This part should be assessed even before the vault is opened.

The risk team has assessed that Harbor Trade Credit is financially sound and most likely will be in business in 12 months. This impression is based on an analysis of historical financial statements and internal financial projections from the company.

TIN investors are providing equity in the pool. The Asset Originator will be the primary investor in TIN along with Throttle Capital. In addition, we suggest a minimum level of 28% of DROP to co-investors, as they could assist in enforcing contract rights, benefitting Maker.

Harbor should keep a minimum exposure of $50K in the TIN tranche of the pool. Final Issuer TIN share for the full limit utilisation is pending update.

The MakerDAO vault should not have more than 72% of the SPV DROP debt share.

For corporate governance, the risk team recommends assigning an independent director to Harbor Trade Credit Series LLC. The main duty will be to avoid the SPV filing for voluntary bankruptcy. This director will also be required for performing any Material Action on the SPV.

13 Likes

Outstanding thorough researching and reporting! Thank you William.

In your opinion is this something that should be required for RWAs once we get to DC in the 9-digits (000M)?

The independent Director will be one of your teammates, or an external auditor? (Not sure if auditor is the right word)

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@ElProgreso Very likely at that level yes, everything else remaining constant. The most probable scenario here is that once we reach the hundreds of millions for SCF, possibly before, borrowing would occur through a loan syndication scheme rather than a single originator underwriting. That allows access to even bigger corporates and ratings graded ones, i.e. scaling.

Most likely an independent company that is experienced working day and night with management of SPVs in the real-world. We’re in conversations at the moment. More updates in the future.

Updated stakeholder rule: Issuer TIN Share: minimum 10% (Issuer)
Issuer will assess the future feasibility of creating a fund to pool capital from other TIN investors in order to increase its min TIN share.

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