The last six years have been most eventful for the entire banking and financial community. As the Chief Operating Officer of an independent factoring company and President of its asset-based lending affiliate; our firm specializes in financing growing companies. The group was formed in 1985 and has increased in size every year since, including during the financial meltdown period.

In this article, I offer my perspective on the items that have had major impacts on our environment since 2008. These impacts include banks tightening up on credit; the government’s low interest policy; and the emergence of Deferred Purchase Agreements.

Banks Credit Tightening

When the crisis hit, banks essentially stopped lending. This was particularly apparent in the case of finance companies. Three banks with whom we were having discussions about credit lines broke them off and suggested we call them in three months. Fortunately we had adequate lines in place with our existing bank group, which continued to support us throughout the period.

One positive aspect of the banks tightening up on credit was the fact that many smaller companies, which may have been bankable in normal times, had to seek financing from independent finance companies and factors.

Also, the financial crisis caused businesses to focus their attention on reducing cash needs. This involved improving efficiency and reducing inventory. Many found they were able to cut out fat that had accumulated over the years. As a result, balance sheets improved and many lenders found that clients’ working capital borrowings declined. This led to the lowest utilization of credit lines in many years.

Low Interest Rates

There is no doubt that low interest rates have had a material effect in assisting the economy. After five years of stimulus there is much liquidity around and banks have opened up for lending. In addition, some new players have emerged. We have now been approached by a number of banks that had shut their doors on lending, about participating in our bank group.

We also noticed an upturn in new prospects inquiries in the second half of 2013 and had calls from referral sources and prospects we had not heard from in years. This indicates that the economy is stirring and that bodes well for 2014.

Deferred Purchase Agreements

The onslaught of the financial crisis brought about, among other things, concerns over the creditworthiness of certain large factors at the level of the parent companies. This in turn, brought into question the issue of clients’ rights over their factor credit balance and their ability to collect the funds that were due to them. As a result, larger companies required a change in the legal structure of their factoring arrangement to a Deferred Purchase Agreement. Under this agreement and unlike regular factoring arrangements, the client does not sell its receivables to the factor. The latter still provides all the usual services (i.e. credit protection, collections and receivable accounting) but they only purchase the receivables when they become bad debts. Hence the terms “Deferred Purchase” or “Servicing” Agreements. The factor can still provide loans against the receivables subject to taking a lien against them. In the clients’ financial statements, instead of reflecting an asset of “Due from Factor;” the receivables are shown as assets, and loans from factors are shown as liabilities.

Operational Issues Affected by Growth

A major item which is critical to factors, especially those that are growing, is their IT system. Computerization has enabled the factoring industry to grow because of the vast number of transactions that need to be tracked. More and more companies are moving to electronic data interchange (EDI) transmission of invoices and payments. It is now possible to do verifications of invoices due by major retailers online. While these are all very positive developments and factors today would not survive without them, it also creates certain challenges. Factors need to be hiring skilled IT personnel; systems need to be consistently upgraded; and disaster plans have to be put in place. On the latter subject, Hurricane Sandy and the recent snow storms in the North East, proved that traditional disaster recovery plans may not work. Having a backup facility is a good idea, but does not help if the employees can’t get there.

It is vital for companies to ensure employees can access systems, communicate and continue to service clients from home, or a number of remote locations. Also, cloud computing is being used, which obviates the need for backup servers.

Training the Next Generation

As the factoring industry grows, the need for trained and experienced personnel becomes a necessity. There are no college courses on factoring or asset-based lending, so growing companies need to set up training programs. It is pleasing to note that the Commercial Finance Association and the International Factoring Association do offer educational programs, which are being greatly expanded. These programs should assist the industry.

The Future

Reviews of the industry from various sources indicate that 2013 was a year of few surprises, with modest increases in loans outstanding, factoring volume and credit utilization. More of the same is predicated for 2014. It appears that low interest rates will continue for a while, although the latest Fed report indicates there may be a modest increase in 2015.

While banks costs are increasing because of regulatory issues, competition is keeping rates down. This is causing a trickle-down effect to independent factors and finance companies. There are numerous bidders for new business and rates are being compressed. No financier wants to give up a good client, so rates and terms are being constantly renegotiated when renewals come up. Also, because of the liquidity in the market, many banks -- particularly community banks -- are moving down-market and looking for business outside their traditional real estate and SBA spaces. This also leads to “covenant-lite” contracts and prospects and clients looking to avoid giving personal guarantees.

While it is understandable that competition will drive rates down, it is dangerous for credit standards to be cut too far. We have stressed in our company that we will not chase business to the point we will be exposed to undue credit risk. I like to quote an old mentor of mine from the industry who used to say: “I would rather lose money paying my own overhead and not doing bad business, than pay a client’s overhead.” In order to expand opportunities, factors are diversifying outside the textile and apparel industries and are looking for business from companies selling to retailers, such as electronic accessories, toys, hardware, and the like. Also, smaller lenders are looking at larger deals, often with participants. This offers an interesting opportunity for growth.

Conclusion

With all the issues the factoring industry has faced in the past six years, it has come out stronger and more efficient. It is continuing to make a major contribution to the growth in the economy and in particular, in assisting developing companies to expand.