Meaning
Credit adjustments reduce the borrowing base of a facility during periods when inventory levels are expected to be volatile. A seasonal haircut is a specific percentage reduction applied to the value of collateral during the off season. This mechanism governs lending limits for cyclical retailers and ends when the inventory levels return to normal.
Collateral Discount
The size of the collateral reduction depends on the historical volatility of the asset’s price and its liquidation speed. For example, winter clothing loses value quickly in the spring, so a lender might apply a seasonal haircut to increase the discount from ten percent to twenty percent. This change directly affects the amount of cash the company can borrow.
Cycle Analysis
Monitoring the production yield and sales velocity helps a bank decide when to apply a discount. Companies that produce goods year round but only sell them in a few months face the highest risk of a liquidity crunch, which the seasonal haircut addresses. The adjustment prevents them from using all their credit before the peak selling season arrives.
Rate Adjustment
Standard advance rates are lowered to arrive at a safe lending limit. This is the primary function of the seasonal haircut.
