Floor Plan Loans

Introduction

Floor plan, or wholesale, lending is a form of retail goods inventory financing in which each loan advance is made against a specific piece of collateral. As each piece of collateral is sold by the dealer, the loan advance against that piece of collateral is repaid. Items commonly subject to floor plan debt are automobiles, large home appliances, furniture, television and stereo equipment, boats, mobile homes, and other types of merchandise usually sold under a sales finance contract.

This type of financing involves all the basic risks inherent in any form of inventory financing. However, because of the banker’s inability to exercise full control over the floored items, the exposure to loss is generally greater than in other similar types of financing. Most dealers have minimal capital bases relative to debt. As a result, close and frequent review of the dealer’s financial information is necessary. In analyzing that data, it is important to review the number of units sold and the profitability of those sales. A comparison should be made between the number of units sold and the number financed to ensure that inventory levels are not excessive. As with all inventory financing, collateral value is of prime importance. Control over that requires the bank to determine the collateral value at the time the loan is placed on the books, to continuously inspect the collateral to determine its condition, and to impose a curtailment requirement sufficient to keep collateral values in line with loan balances.

Two important facets of the bank’s relationship with a dealer are the quality of the paper generated and the deposit account maintained. The income derived from a floor plan loan may not be sufficient to justify the credit risk. A bank often looks to the additional income derived from good quality loans to purchasers of the dealer’s inventory. If the bank is not receiving an adequate portion of loans generated by the dealer or if the paper is of inferior quality, the relationship is of questionable value to the bank. The deposit account represents both a compensating balance and a tool by which the loan officer can monitor customer activity. A review of the flow of funds into and out of the account may reveal that inventory has been sold without debt reduction, that the dealer is incurring abnormal expenses, or that unreported diversification, expansion, or other financial activity has occurred that might warrant a reconsideration of the credit arrangement. Token or overdrawn balances should trigger increased collateral inspections.

In most banks, the evidence of debt is the trust receipt. There generally are two methods by which trust receipts are created. The bank may enter into a drafting agreement, similar to a letter of credit, with the manufacturer. In this situation, the bank agrees to pay documentary drafts covering shipments of merchandise to the dealer. The drafts are payable at the time the merchandise is received or, if the manufacturer permits, after a grace period which allows the dealer to prepare the inventory for sale. The drafting agreement usually provides a clause for cancellation and limits the number of units, the per unit cost, and the aggregate cost that can be shipped at one time. These restrictions tend to prevent a manufacturer from forcing excessive inventory on a dealer They also permit the bank to cancel or suspend shipments of unwanted merchandise. Drafting agreements frequently are made in conjunction with repurchase agreements under which the manufacturer agrees to repurchase merchandise that remains unsold after a specified period of time. The merchandise and related title documents remain with the dealer until sold and are evidenced by a trust receipt. All the documents should be inspected physically during the floor plan inspection to prevent dual financing.

Trust receipts also are created when merchandise is shipped under an invoice system. The dealer receives the merchandise accompanied by invoices and titles, where appropriate. The dealer presents the documents to the bank and the bank pays the invoice, attaching duplicates of the documents to a trust receipt that is signed by the borrower. Depending on the type of inventory and/or the dealer, the title may remain in the bank or be released. Used car inventories usually are financed under trust receipts with a listing of the units and their loan values attached to the receipts. The method of perfecting a security interest varies from state to state, and there are numerous divergencies from the Uniform Commercial Code. The examiner should determine that the security interest has been properly perfected.

With title documents and collateral in the possession of the borrowing dealer, the bank must have an established procedure for flooring verification. Flooring check sheets should be on file in the bank, indicating that a bank representative has personally verified every article, by serial number and description, shown by bank records as unsold and in the dealer’s possession. The condition of the floored articles must indicate that they are available for sale. Any missing articles or other exceptions revealed by the flooring check, as well as the dealer’s explanation thereof, must be verified as proper. Missing items reportedly sold and unpaid must be verified to related contracts in process, and such processing time must be reasonable. Floored items sold and not in process of payment represent breach of trust by the dealer, and the amounts owed represent unsecured credit.

An inherent weakness in any floor plan loan is the banker’s inability to exercise full control over the collateral. The examiner must determine whether the banker is verifying the collateral, that is, the inventory being financed, on a frequent basis. The scope of inspections must be sufficiently broad to detect irregular activity. Inspection duties should be rotated among the department’s staff, and the floor planned inventory should be verified by the audit department during the regularly conducted audits.

A serious warning signal is evident when inventory has been sold and the bank’s loan has not been repaid. If inventory is missing at the time of each floor plan inspection and the dealer then remits, it is a sign that the dealer may be taking advantage of a float, i.e., using proceeds of inventory possibly sold weeks before the inspection rather than remitting promptly as required. There are very few examples of dealers selling inventory “out of trust” which are permitted by bankers. Dealers selling in large volume are usually granted a three-day leeway before proceeds from inventory sold are required to be received by the bank. This permissible time lag allows the dealer to conduct the amount of necessary bookkeeping at his place of business. If it is disclosed that a dealer is deliberately withholding funds received from the sale of pledged inventory collateral, the bank should terminate the customer relationship immediately.

Because loan advances are made on 100 percent of the collateral value, as the collateral begins to depreciate, the individual loan amounts should be curtailed. The collateral may depreciate if used as a demonstrator, is no longer a current-year model, or was previously owned (used) when floor planned.

A typical dealer of any product must maintain a reasonable inventory. It will generally be the dealer’s principal asset, and its acquisition will normally create the dealer’s major liability. The dealer’s financial statement must show an inventory figure at least equal to the related flooring liability as of the date of the financial statement. Unless the difference is represented by sales receivables, including contracts in transit, a flooring liability that is greater than the amount of inventory is an indication that the dealer has “sold out of trust.”

A dealer who, by diverting the funds received, has sold portions of his merchandise “out of trust” leaves the bank with a portion of its flooring line on an unsecured basis.

Situations where the bank only finances a portion of the dealer’s floor plan debt originating from a particular manufacturer or distributor should be avoided. Bankers are able to exercise only minimum control over financed inventory under the best arrangement. Delinquent notes, either unpaid interest or lack of required curtailments, and maturities extended beyond reasonable expectation are warning signs. These signs indicate that the dealer is hard pressed for liquid working capital and should alert the banker to conduct collateral verification inspections more frequently. Slow moving inventory, other than farm equipment or other seasonal merchandise, could be a sign of poor management on the part of the dealer.

The credit review of floor plan loans usually is assigned to the examiner who appraises indirect dealer lines in the installment loan department. Before the credits are transferred to the examiner performing the review of credit files, the floor plan examiner should have performed all procedures related to the existence of the related collateral and its value. The bank’s policies and procedures should be clearly defined with compliance noted. Controls over the borrower must be in evidence. Collateral values should be supported by source documents or bank appraisals. Any deficiencies within the department must be discussed with management by the examiner in charge of “Floor Plan Loans” before the review of credit files is undertaken.

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