Factoring gained popularity at the height of the financial crisis as a means of solving cashflow issues. Factors now hope their newly-expanded client base will stick with the product when recovery sets in, writes Helen Castell.
No link on the financial chain exists in isolation, and factoring has faced its share of troubles since the credit bubble burst in 2008.
Weak economic activity means fewer invoices to factor, and a tightening of credit insurance has made it difficult for factors to manage their risks.
As an industry that has traditionally relied on clients that need to have better control over their cashflow, factoring has seen its potential customer base balloon. Factors, it would seem, have finally entered the mainstream. The challenge for them now is to hold onto that new ground.
Figures from Asset Based Finance Association (ABFA) show the factoring market declining last year “for the first time in living memory” as credit availability tightened across the board, says Lionel Taylor, chief operating officer at China Export Finance (CEF).
And with many western economies expected to face a long, slow road to recovery, the market could get even harder. “The worst type of climate for a factoring company is total stagnation,” he notes. “Factoring comes into its own when you have a growing economy or, dare I say it, a declining economy.”
The reduced availability of credit insurance has also taken its toll, with books pared down, says Steve Walshe, solutions manager for Misys Trade Innovation.
“However, I don’t think the credit insurers’ reduced risk appetite has had a disproportionate effect.”
The UK market shrank by around 10% over the first three quarters of 2009 as companies’ sales and therefore their working capital requirements fell, says Xavier Denecker, managing director – UK and Ireland at Coface. Import and domestic factoring have been worst affected.
Weakness in this market has been exacerbated by the UK government’s HM Revenue and Customs’ ‘time to pay’ programme, which allowed some companies to stagger their tax payments and therefore reduced their immediate funding needs, Denecker notes.
Defaults have been most severe in Eastern Europe, Spain and Ireland, Denecker adds. And although the BRICS – Brazil, Russia, India and China – represent better short-term opportunities, events in Russia highlight the need for cautious underwriting there.
Joao Costa Pereira, first vice-president – head of Mediterranean factors at FIMBank believes that the market outlook is generally much brighter in emerging markets, where less damaged economies plus a low saturation rate should continue to drive double-digit rate growth for factoring.
Factoring in Asia has racked up 22% in annual growth rates over the past six years, and is now taking a greater role in international trade, as more importers demand open account conditions rather than cash or LCs, he adds.
“This is particularly relevant as regards exports from emerging markets to more developed countries.
“It is not surprising to note the explosion of export factoring from China, and other markets like India will certainly follow.”
One company tapping that trend is China Export Finance. Operating on a reverse factoring model, CEF finances Chinese sellers that are exporting to the west, taking its risk on mainly US and European importers.
China’s fast-growing exports combined with the difficulty of obtaining working capital there, especially since the central bank announced a lending curb, supports demand for the company’s products, says China Export’s COO, Taylor.
Chinese exporters are also being squeezed by western buyers, who first pushed them from LC to open account, and are now pressing to extend terms.
Sitting on the bridge between the seller and buyer, “we continue to be able to thrive in that business”, Taylor says. “It’s a very nice model.”
And the slow process of obtaining regulatory clearance in China – not only to operate as a factor but to handle foreign currency – means it should be some time before CEF faces a real competitor.
Broadening client base
China aside, factoring has also won new ground during the downturn, attracting a broader client base that it hopes to be able to retain post-crisis.
Despite last year’s smaller volumes, receivables-based financing has proved itself to be a valuable financing technique for companies that – despite a good business positioning – are still fragile. Coface’s Denecker notes an increasing demand for larger corporate for factoring-type instruments.
The flexibility offered by factoring – under which the amount a company can borrow mirrors almost immediately the growth or contraction of its business – is helping it gain mainstream appeal, says Faisal Khan, director of banking and insurance at 3i Infotech Western Europe.
“People used to think of factoring as a mechanism of last resort – maybe a company was in trouble for it to have to go to factoring,” he says. “That stigma has largely gone.”
And for increasingly risk-averse banks, invoice discounting and factoring represent a safer form of financing, leading a number of lenders to build and expand operations.
“If other asset classes are losing value and therefore could not be used to raise credit, then a pretty solid asset is an invoice,” 3i Infotech’s Khan notes.
Factoring offers providers an easily “measurable exposure” to their clients, while “almost on a day-to-day basis you can measure the health of the company”, adds Walshe.
Powers of recovery in some countries are also stronger for an invoice than for example an overdraft, he adds.
Under Basel II, less capital is required to provide accounts receivable finance, and this is benefiting bank-owned asset-based lenders. “A lot of the banks are pushing a lot more business towards their asset-based lending arms,” a move that is “providing opportunity” for the market, says China Export’s Taylor.
A wider push towards supply chain finance – and the development of a clear place for factoring within that – is helping the market grow, says Walshe at Misys.
“In the past, factoring existed in a vacuum, but now it is an integral part of the financial supply chain.”
Being better connected to the rest of the financial and business world means that factoring companies are far from immune to the wider credit crunch. The challenge now is how to manage rising risks at a time when credit limits from insurers are scarce.
FIMBank has negotiated a new credit insurance agreement to support its non-recourse business. Also, by supporting the risk on the debtor portfolio and operational structure of each deal, and being more aware of risk alerts and potential fraud, it has “focused on the basics of factoring best practice”, Costa Pereira says.
“Basically, we had to be more conservative when taking risk decisions, even at the cost of accepting less business.”
Misys’s Walshe reiterates this point. “The holy old phrase of ‘know your customer’ was never more true than it is today.
“This is a stock pickers’ market – not a stock market,” he adds, drawing parallels with equity investing. “Where niche players are picking their customers, picking their risk, this is still a good business to be in. But piling it high and selling it cheap has gone.”
Although selective regarding what risks they take on, many factors are keen to expand their global presence.
After a year dedicated to consolidating their portfolio and tightening their underwriting criteria, players are now eager again to acquire new business, with mergers and acquisitions a likely outcome, says Coface’s Denecker.
FIMBank for one is eyeing a move into selected, untapped emerging markets via factoring joint ventures, a strategy it has already employed in Egypt, Dubai and Lebanon.
The company has established a factoring partnership in Romania, and will soon commence operations in India and Russia. Pereira says the company plans to tap both the Latin American and African markets in the near future.
However, he adds that each of these markets present specific challenges that need to be overcome. These include lack of product knowledge and awareness, complex corporate and political environments, and a lack of laws and regulations to enable safe factoring.
The creation of recognised factoring 3associations – such as South Africa’s FELEFAC, introduced last year – would be a “critical step” towards coordinating regulatory systems, says Pereira.
Although the EU Federation – created to represent the factoring and commercial finance industry in the EU – will certainly be a good test of the industry’s strength, “we still lack a single and strong factoring organisation to represent and pursue the interests of the industry with one voice and on a more global scale”, Pereira observes.
Pricing remains an issue for factors, especially as one of its key “raw materials” – credit insurance – has become scarcer, FIMBank’s Costa Pereira notes. Coupled with tight liquidity, this has not only pushed prices up but volumes down.
Pricing has certainly improved, says Coface’s Denecker. After entering the crisis significantly under-priced, “the remuneration for risk has been progressively re-balancing over the past months”, he notes.
Also, a trend towards pricing contracts over market rates, typically Libor, rather than over base rates, has helped factors.
Technological improvements – such as the development of fully automated systems running end-to-end between suppliers and buyers – will bring down transaction costs, meaning factors can ultimately lower their prices but also improve their own margins.
Solutions that help factors detect fraud – an expensive problem for the industry but one that few providers like to talk about – will also reduce costs, comments 3i Infotech’s Khan.
The future for factors hinges on economic recovery, and the hope that new clients will stay converted to the service even after other financing becomes more available again.