April 2010

A Borrowers’ Sector Report Card Shows Some Improvement

Given the extraordinary credit crisis American businesses have been weathering, we thought that Merchant Factors’ outlook on various borrower sectors is an excellent barometer for commercial finance companies. Adam Winters, the company’s president and CEO offers a sector by sector report card. Some sectors move to the head of the class, some show scant improvement and others aren’t making the grade.

Our firm has been around more than a quarter of a century, and while we aren’t the largest commercial finance company, and we aren’t the smallest either. Our track record of working “in the trenches” with many industry sectors enables us to provide a knowledgeable report card on the performance of different industries. Here’s what we see head into the final half of 2010 and look toward 2011.

Textiles: This sector has been decimated over the last ten to 15 years. It is pretty much departed with few sparks of activity. Most of the converters have gone out-of-business. The clients needing credit that we see have been importing finished goods, mainly from the Far East, and this trend continues to grow. It pretty much eliminates the need for commercial finance firms here. From a national perspective, the relatively “little” textile manufacturing that endures, is concentrated in the Southwest. The large immigrant, unskilled labor pool in these states has enabled these companies to exist. To some degree, there are “new generation” emerging entrepreneurs. Predominately, these sources are providing mid-priced to high-end goods. Many of the textile enterprises in question have downsized. Even though they may be profitable, they do not meet the minimum volume criteria for larger factors. Thus, the remaining $1 million to $3 million (sales volume) companies find it difficult to match up with compatible factors, asset-based lenders or banks.

Apparel: This sector has had a very rough time mainly due to an awful retail climate. Mom & Pop businesses and boutiques have had a very difficult time obtaining credit. While I have no conclusive evidence other than my gut instinct from my daily involvement in this sector, I sense a slight pick-up in consumer spending and retail. The street buzz is that the worst is past — but my colleagues and I have not actually seen it.

Electronics: There’s a lot of recent excitement despite the severe drop in consumer sales in the past two years, recent weak holiday season performances and the like. Clearly computer hardware/software products, television set innovation and DVD players galvanized this sector going back five or six years. But it is a complex sector for a factor or lender to worry about, with many variables such as retailer fitness, product standards, consumer returns, minimums and value depreciation. Whether or not the new tablet notebooks or the latest 3-D televisions will really take off with consumers, remain to be seen. Unless I am funding a Panasonic or Samsung, I am not likely to take the risk on some undistinguished, small player.

Giftware: Even though this sector is growing, I am not enthusiastic about it. The impact of Internet mail ordering is not completely fleshed out and discounting remains an unknown quotient.

Accessories: This sector is one of the few bright spots in an otherwise weak economy. With a number of startups, client volume has been holding up, even more so than apparel. In a severe recession, people are more apt to buy accessories to improve their wardrobe rather than to invest in entirely new garments. It is the less expensive approach and works better in a scale-down period. That this sector has held up as well as it has is a pleasant surprise for many factors and lenders. It should be pointed out that most of our accessories clients are importing from overseas. There is scant domestic manufacturing.

Toys: Because of the difficulty of this sector with just a handful of major players, toys are generally an unappealing proposition for a factor or lender. In recent years, there is the exposure, liability and risk with manufacturing elements like lead or warranty issues. With high insurance costs, consignments, returns, guaranteed sales, guaranteed margins, a lender has to be dealing with very experienced executives. A credentialed management is even more important here than the balance sheet.

Luggage: There are almost no factories in America, even among the once “great American” brand names. The industry is lifeless because of the major drop in travel. More than ever before, consumers are relying on cheap import totes or carry-on throw-away bags. All of this has little collateral value, which a factor or an ABL can service. This is a dead-end pursuit.

Furniture: This sector has been hit pretty hard, but we’re starting to see more opportunities here. The quality of retailers is essential. It is perplexing for the furniture manufacturer to determine where they should sell right now. A strong customer base is hard to come by since the credit profile among many of these retailers is so shaky. There is a huge base of information about liquidation and insurance data on retailers. Deal flow is primarily in the Southeast. Similar to textiles, this sector was once dominated by American manufacturers. Today, the growing trend is imports from the Far East. (I just looked at a loan deal with a North Carolina furniture manufacturer that has begun importing from China and needs the cash to do it.) This is the response through demands by retailers that they must sell through lower-end pricing. There are still some old-line American furniture factories, but reliance on imports is expanding.

Shoes: This is a relatively unscathed economic segment that affords good prospects for factors and lenders. My experience is the low-end and middle appears relatively stable. The high-end has suffered. Shoe manufacturing is almost totally overseas.

Costume Jewelry: Again, low-end seems to work here for factors and lenders. I will not touch the high-end, given the liquidations, unstable price points, fraud and related distress. The low-end costume jewelry sector has more steady, dependable transactions with a better quality of retailers (i.e., J.C. Penny’s, Macy’s, Target, HSN, etc.). This area is relatively free from the need for guarantees, mark-downs, allowances or return provisions.

Linens & Bedding: I really like this sector at this time. It is a consistent business with decent retailers driving it.

Printing: This sector has become “the terminal patient of the finance industry.” At one time, this was a robust, bountiful source of deals for factors and asset-based lenders. Online technology has overtaken a lot of traditional printing. The continuing Web innovation and application advances are aggressively marching on while the economics of printing have dramatically diminished. Some of this scenario is being fueled by the “green movement” where paper and printing ink now have a negative perception. There is some graphics service work again, especially as it relates to the Web. But this is a fraction of what the printing industry once was. Finance opportunities here are meager when you take into account the following dynamics: major depreciation and obsolescence on equipment (a growing source of auctions and liquidations), much less reliance on products like ink or paper, binding and more. If any aspect of printing is still possible for financing, it is those printers that do the packaging.

Computer Consulting: This is a sector that has come to mean a lot for factors and asset-based lenders, especially since 9-11. There have been some excellent opportunities for financing receivables and related products since many service providers are procuring and accessing finished hardware/software products as part of their process. While computer systems consulting has slowed in the past two years, proportionate to the rest of the economy it appears to be coming back, some pent-up demand. I see a level of maturity in this sector, where there is a whole lot more approval among lenders about product valuations, business models, quality of invoices and the like. Given the product/tech modernization needs of so many businesses (i.e., merging company platforms, integration, converting to upgrade capabilities) I am optimistic that computer consulting will continue offering a lot of potential for factors and asset-based lenders.

Outsourcing & Staffing: This sector is another once decent finance area that has turned quiet during the past two years. I am seeing some comeback signs, especially where companies have additional manpower needs but are still reluctant to permanently hire workers. Contracts for temporary help, employee leasing and project management personnel have come into play once more. So the staffing and outsourcing firms need factoring to fulfill their opportunities. (This segment usually sees good quality receivables which are supported by documented, detailed time sheets and sign-offs as part of their billing cycle.) Still, this is hardly the boom that this sector enjoyed three or four years back.

Survivor has been an enormously popular television show in recent years where its human subjects are thrust into all sorts of cruel, adverse and bizarre situations. Certainly, the factors, asset-based lenders and many traditional banks that are now left standing have been severely tested and put through the mill the past two years. To this degree, there should be a gratification among us that our strength and buoyancy has been demonstrated once again.

Adam Winters is the president and chief executive officer of Merchant Factors Corp., with offices in New York City and Los Angeles. For more information, visit: www.merchantfactors.com.