November|December 2011

State of the Factoring Market — Yin & Yang in 2012

Working Capital Solutions’ Tom Siska provides both the yin and the yang for the factoring industry in 2012. The good news: Things will not be as bad as the Great Recession of 2008 and 2009. The bad news: Things will most likely get worse in 2012 before they get better, and no one knows when that will be.

Government Spending Worldwide Will Decrease

Everyone knows government spending, especially in the U.S. and Europe, has to decline and it will be good news for the long term when it finally does. However, the Yang to this Yin is that a spending decrease is not good in the short term. Pulling trillions of dollars out of an already weak worldwide economy is only going tip it back into the red. At home, the U.S. government spends its money in three main areas: interest on its debt, entitlements (such as Social Security, Medicare, etc.) and defense. It is this third important budget category that will have the most immediate impact on the factoring industry. Those factors that target government receivables will see their market shrink. They will probably also experience the already slow paying A/R actually slow down some more. And finally, as the existing contractors compete to maintain their share of a decreasing pie, margins will slowly dissipate increasing client and debtor default risk.

Turning our focus abroad, I must doff my chapeaux to the European Central Bankers for staving off sovereign debt defaults thus far. However, their magic must be all but used up and reality is sure to reappear in the form of more than one Euro Zone country defaulting on its debt. This will cause further contraction overseas, and possibly in a big way. But unlike Vegas, what happens in Europe will not stay in Europe.

The shock will reverberate across the pond back to the good ol’ U.S. of A. Not only will it hit the largest U.S. banks, which hold some of Europe’s sovereign debt, but the austerity measures will sharply reduce the Europeans’ ability to purchase U.S. products, thereby putting another dent in our already fragile GDP. Factors that specialize in foreign receivables will surely find 2012 to be as challenging as ever. The double whammy of falling demand and more risky debtor credit might make it feel like the Great Recession all over again for this sector.

U.S. Manufacturing Will Increase

For over a couple of decades, Americans have watched company after company close facilities here in order to move to lower cost areas of the world. But according to the Institute for Supply Management, September marked the 26th consecutive monthly rise in U.S. economic activity in the manufacturing sector. Of particular interest to factors, 12 of the 18 manufacturing industries reported growth, including apparel and transportation equipment. This is positive news for most factors that directly target manufacturing as well as those that are niched in the support industries, such as transportation and staffing. Of the six that contracted, two of them are heavily factored: textiles and furniture. The traditional Factors will unfortunately continue to see their market in decline, but at least they are used to it by now.

The two biggest culprits of America’s flight from manufacturing are China and India. These remain the fastest growing economies in the developed world. But as the theme of this article has made clear, too much of anything, even growth, has its downside. Both China and India are desperately trying to put the brakes on what is turning out to be major asset and price inflation. While these efforts should help to cool things off, the long-term trend of higher prices leading to higher wages is sure to march onward for quite some time. This will provide the incentive for manufacturing firms to continue migrating back to the U.S.

Be Prepared to be Shocked

Things have not been great. However, the past year has at least given us a break from the economic carnage of the Great Recession. This “rest period” will not come cheap. We’re already seeing that government support cannot go on forever, as Europe wrestles to keep things together. The same dynamic will play out here. S&P already lowered the U.S. bond rating. Moody’s is threatening to follow suit by year’s end. Harrisburg PA has filed for bankruptcy as have almost a dozen other public entities. Factors with state and municipal debtor exposures will have to be vigilant in their credit monitoring, because now that the Feds have decided to cut their spending, several others will surely follow like dominos. Right now it’s only small towns and municipal projects. Can California be far behind?

The mortgage bond crisis of 2008 could have felled the U.S. banking industry. But the government stepped in to provide the necessary liquidity and become the “lender of last resort.” What happens to the banking industry when the defaults come from the government sector itself? Who’s going to bail them out this time? Certainly not the consumer, who’s been down on the mat for three years and shows no chance of getting up anytime soon. Bond insurers can step in, except that they got wiped out by the CMOs and CDOs and are on life support themselves. Will we experience another round of “which to save, which to let go” a la Lehman, Merrill Lynch and Bear Stearns? Most likely. And this time the name being tossed around is Bank of America. So we’re not just saying that it can happen again. We’re also saying that while there probably won’t be as many failures, when the failures do come, they could happen in a big way. And though most thought these giant collapses were strictly happening to the older companies, such as one-time industry leader Kodak, even the nouveau riche like Netflix are proving that the pain is being spread everywhere.

Deciphering Yin From Yang

Business will go on. But with an economy that is predicted at best to grow only 2% and at worst to slide back into a milder recession, factors will have to be both pioneers, in order to take advantage of new trends and industries, as well as caretakers, to protect themselves from the problems that are sure to come. There will be further product expansion as more factors add PO financing to their repertoire. Some are starting to branch out with advances against inventory while others are dabbling in the leasing space. The traditional factors are increasing their presence abroad in order to offer their skills to the offshore manufacturing base. The one constant continues to be change.

The flood of bank workouts that normally follow a recession have simply not materialized. There does appear to be a slow, welcome trickle finally appearing.

But time has eroded the borrowers and taking advantage of these few transactions finally being asked out by their bank is proving to be quite the challenge. Banks are also remaining aggressive for new C&I loans, stripping the better prospects off the market, and then some. This is happening across all sectors of banking, from community banks through regionals and to a lesser extent the national banks. Even the SBA raised their limit to $5 million, taking another swath of businesses off the market.

Funding is plentiful for “alternative asset classes,” with new ABLs, factors, hybrids, mezzanine lenders, etc. sprouting up everywhere. There have been very few failures in the factoring world as of late. This would normally be viewed as good news. However, factoring supply is greater than factoring demand. What we have here is the classic case where a thinning of the herd, the bad news Yang, might actually be good news (Yin) for the overall factoring industry.

Thomas G. Siska is the president & CEO of Working Capital Solutions, Inc., the small asset-based lending and factoring subsidiary of WebBank. Siska is a 25-year industry veteran, who has built several finance companies from the ground up and orchestrated one of the most successful turnarounds in the small ABL niche. He holds degrees in Finance and Marketing from DePaul University in Chicago, and received his M.B.A. from the University of Chicago. He can be reached at tom [dot] siska [at] webbank [dot] com.