Officially, the recession started at the beginning of 2008 and ended in mid-2009. In the past four years, how has the factoring industry changed in the post-recession environment?
In analyzing this, one must define what comprises the “factoring industry.” Originally “factors” were non-recourse buyers of invoices, whose clients were mainly in the textile and apparel industries. These factors provided credit protection on approved orders, collection and receivable accounting services. Later, factoring moved into other areas such as furniture and toys. In this article this type of factoring will be referred to as “traditional factors.” The concept spread to other industries and many small specialist firms arose, offering recourse financing, very similar to asset-based lending — i.e., the client was not given credit protection and invoices would be charged back to the client after an agreed eligibility period. Traditional factors usually charge a flat factoring commission on invoices (plus surcharges for sub-par credits) and interest on funds borrowed. Non-recourse factors typically purchase invoices at a discount, utilizing bucket-pricing, i.e. the discount is charged monthly or in daily increments, for as long as the invoice is open.
Traditional factors were mainly larger companies, many of which were acquired by banks (which later disposed of them). Due to a slew of mergers over the years, the two largest remaining factors of this type are CIT and Wells Fargo.
Conversely over the past years, the number of recourse invoice discounting factors (hereinafter referred to as “invoice discounters”) grew tremendously. There are many niche industries that lend themselves to this type of financing such as transportation, service companies and temp agencies, to name a few. Most of these invoice discounters are small entrepreneurial companies, with relatively low overhead and the ability to act quickly. Also, as long as a certain minimum volume is achieved the client can pick and choose what to factor.
There are two major elements that affect the factoring industry — the economy and the banking environment. These elements are both deeply influenced by the Federal Reserve monetary policy.
A recent Wall Street Journal front-page story analyzed current economic conditions and stated that “Easy Money to Keep Flowing for Now as Economy Plods Ahead.” Highlights of this story included analysis that, while the economy is growing slightly, the pace of growth remains “sluggish” and “subpar.” GDP, which was negative in 2008 through mid-2009, climbed into positive territory in the third quarter of 2009; growth then hovered around 2%, dipping to 1.7% in the second quarter of 2013. This most recent quarter was up from the first quarter, driven largely by consumer spending — despite higher taxes — and business investment, which ticked up amid government cuts that turned out to be smaller than originally feared. The conclusion of this story is that the big picture remains unchanged. The recession appears to have been less severe than first thought and the recovery has been stronger. However, four years after the recession officially ended, per capita output and income have yet to return to previous highs. Furthermore, “despite the moderate acceleration in the past two quarters, the recovery shows little signs of gaining momentum.”
The factoring industry is affected by the economy in a number of ways. In a strong economy — with lower unemployment and a buoyant stock market — customer spending increases, spurring business. This creates growth opportunities for both traditional factors and invoice discounters. If the banking community becomes aggressive, this can create more competition. Conversely this also assists smaller factors and invoice discounters that rely on bank loans for financing.
In this current post-recession environment, business for factors has been a mixed bag. The improvement in the economy since the recession in the past two to three years has brought some stability to the market. Traditional factors, which provide credit protection, have seen fewer bad debts in the retail market. However, there have been some large credit situations causing concern, for example Sears/Kmart and, more recently, J.C. Penney. These accounts are being viewed cautiously, with some restrictions and the imposition of surcharges.
Larger factors are finding that clients have become very conservative in carrying inventory. While this is a positive from a credit standpoint, it has reduced the amount of borrowing and amount of interest earned on advances. Also, the low interest rates being charged by banks have enticed clients to switch borrowing to banks, and using the factors (who generally charge higher interest rates), for servicing their receivables, i.e. credit protection, collections and accounting. To replace this lost income, factors look to increasing factoring commissions, but fierce competition is keeping rates down and compressing margins.
Larger factors are seeing some increases in volume. Bigger businesses, which were forced to become more efficient, are doing satisfactorily and some are even doing well. But generally growth is coming from signing new business by taking clients from competitors and expanding international portfolios. One bright spot is business being created by acquisitions, which occurs when organic growth is tough. Merger and acquisition activity has started to expand and the second lien market is growing. Also, there has been an increase in trademark lending.
One of the benefits to borrowers is that the current competitive climate has enabled them to negotiate better terms, such as relaxed loan covenants and looser advance rates, in addition to lower commission rates.
For invoice discounters, the environment is different. Undercapitalized companies that are in niches that are growing, usually do not qualify for bank financing. As long as they are earning reasonable margins on incremental sales, they will always be looking for the availability of financing, with cost being a secondary consideration. Industries in which specialty factors have enjoyed increases include transportation, services and government contractors.
A recent International Factoring Association (IFA) survey produced some surprising results. In responding to a question about the anticipated change in 2013 revenues versus 2012, a large majority of respondents (83.5%) stated that they expect to see year-over-year increases, with 38.2% saying “greater than 20%.” Those reporting gross invoices funded (GIF) of less than $5 million said they anticipated revenues to increase by more than 20%. Those reporting GIFs of $5 million to $100 million expect 40% growth; and those with GIFs more than $100 million expect 26.5% year-over-year increases. These numbers seem to project a very rosy picture for the factoring industry. However, the statistics generated from a survey can be misleading. Of the larger factors (GIF volume of more than $100 million), 32% of their volume came from the transportation segment. Also, the IFA reported that the survey was distributed to about 1,500 members in the US and Canada in January 2013. However, in some areas of the survey, only 11% of the recipients of the survey responded. Accordingly, the companies that responded to the survey could be concentrated in those doing well, while the majority that are not in that category, did not respond. Additionally, since the survey was conducted, the economy has been more sluggish than anticipated.
Looking back, how was the factoring industry impacted by the recession? As previously stated:
• Certain niche businesses, such as transportation, have generated more business for factors. Generally, however, business is flat.
• Competition has driven factoring rates down and compressed margins. Also, advance structures have loosened.
• Businesses are borrowing less due to increased efficiency and inventory management, and the ability to borrow cheaper from banks.
One major legal fall-out from the recession, was the bankruptcy filing of the CIT parent company (the largest factor in the U.S.) in October 2009. This bankruptcy was caused by some of CIT’s activities outside its factoring division, such as sub-prime mortgage and student loan lending. Unfortunately, this dragged down the factoring division, which had a major impact on the entire industry. The silver lining was a switch of factoring business from CIT to its major competitors in late 2009 and early 2010. Since then, CIT’s parent has emerged from bankruptcy, and the restructured group is doing well. However, this event caused an analysis of the legal structure of factoring, i.e., the purchase of receivables by the factor and the client being left with an unsecured claim for the credit balance due from the factor. This is particularly severe in the case of collection factoring, where the client utilizes the factoring services, but does not borrow from the factor. This gave rise to the changing of some factoring contracts to “deferred purchasing” or “servicing” arrangements whereby the client retains ownership of the receivable and only sells it to the factor if the credit-approved account goes bad. As CIT has stabilized in recent years, this issue has not been so prevalent.
The main lessons that factors should have learned from the recession are:
• The economy can change very suddenly and credit standards should be maintained at all times. It is one thing to cut rates to get business, but very dangerous to reduce credit requirements which can cause great losses when the bubble bursts.
• Strong marketing efforts must continue at all times. There will always be turnover in clients, and new clients must be obtained to replace those lost.
• Success will come to those factors that stick to their niches and continue to operate efficiently with strong due diligence and customer service in good times and bad.
The factoring industry has weathered a big storm and proved it is a vital part of the economy. The writer believes it has changed for the better. While 2013 may not produce the optimistic growth some factors have predicted, the situation is stable and the economy should improve when employment increases.
Neville Grusd is chief operating officer of Merchant Factors Corp. and president of Merchant Financial Corporation.