Munidollars and Factoring

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The core of the Munidollar concept is a disruption of the way Municipal Banking is practiced. As a result of that disruption, we believe that cities, states, and counties can recoup some of the expenses that are baked into the cities vendor contracts as a result of the current financial infrastructure.

To understand how the savings works, we need to have a basic understanding of a banking concept called factoring. Rather than discussing the theory and history of account receivable financing, we will focus primarily on the practice.

A company provides an invoice to a city for services rendered or goods delivered. Once accepted by the city, there is generally a contractual delay of 30, 60 or 90 days before payment is received by the company. Since companies have to pay material and wage bills to deliver the goods or services, the mismatch between when the invoice is presented and when the company receives funds is an opportunity for financial service companies to provide funding to bridge the gap. For companies, cash flow is king and as long as the terms are not too onerous, there is a market.

The finance company is interested in the business because the risk that the money will not appear is evaluated at the payor level, in this case, the city, while the interest rate charged is evaluated at the payee level, the company providing the service. As long as the creditworthiness of the city is greater than the vendor, there is an opportunity to profit from the difference.

So, everyone wins. The company accepts a discount on the invoice of say 3% on a net-90 basis. That’s 97 cents on the dollar today to run the business. Not terrible when you consider credit card swipe fees for retail vendors. The finance company waits 90 days to collect 100 cents on the dollar from the city and is backstopped by a bank or similar financial institution that probably lent them capital at less than 6% a year. So, for a $1m invoice, the company gets to use $970,000 right away. The finance company makes $30,000 gross and pays $15,000 or less to finance the trade, leaving at least $15,000 in profits for arbitraging the credit differential for three months. That $30,000 cost of providing the $1m contract is priced into the bill the city pays for the goods or services.

With Munidollars, the need for the factoring company is significantly reduced. Instead of accepting an invoice and starting a net-90 process, the city will issue Munidollars to settle the contract. Munidollars may have other uses but at their base level, they can be converted into short term municipal bonds for which there is a significant and knowable amount of demand. For argument’s sake, let’s say that the going market for 1 year A-rated municipal paper in California is 1.5% and that there is a broker that will bid 1.6% (or 10 basis points premium) for any available munidollars as a result.

For the company selling to the city, that means a $1m invoice will be paid with 1 million munidollars. Those munidollars can be sold immediately at roughly $984,000 (1.6% for a year) because the broker is willing to make $1000 converting them into a zero-coupon bond and selling them to a money market fund at roughly $985,000. The fund uses that paper to support a tax-free money market fund that it offers separately.

By packaging its credit rating in the form of a Munidollar and passing it directly to the vendor, the city will effectively save $14,000 because the vendor now only needs to bake in a $16,000 financing consideration into its bid (vs. around $30,000 under today’s structure).

The city also saves from only having to pay the financing once rather than twice. If the city were to issue a one year bond to pay net-90 cash under the old factoring system, it would still pay $15,000 to the eventual money market fund buyers (plus underwriting costs) but it would also effectively pay the $30,000 that the vendor would have to bake into its bid to undertake the business. In this example, $1,000 extra is baked in to be paid away for market-making and conversion but set against the overall $30,000 potential savings by eliminating the factoring layer, this is a good trade for the city. From an accounts payable view, the city has now pushed out its payment terms from net-90 to net-365, which is another way to account for the savings.

Would “Ron Swanson” approve? We will let cities decide for themselves.

Tradition finance guy looking to use new tools to remake the financial landscape

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