Factoring on growth
Once a second-tier form of finance, factoring’s new value proposition is meeting the needs of even large multinationals, writes Erika Morphy.
A quick glance around the parking lot at any typical US shopping centre tells Jeroen Kohnstamm almost everything he needs to know about the growth he can expect to see in his industry.
Kohnstamm is secretary-general of Factors Chain International (FCI), a global network of some 232 factoring companies in 63 countries headquartered in the Netherlands. Shopping centre parking lots, he reports, are much emptier than they used to be in the US. So how does that translate into a de facto industry report for global factoring.
“In the retail sector in the US there will be many companies that will fail – there is no doubt about it,” he says. “Exporters in East Asia are waking up to the need for credit risk protection.”
Kohnstamm has just returned from a trip to East Asia, where he found that exporters who last year believed they didn”t need risk protection for US buyers – buyers that they may have been dealing with for the past 20 years – are becoming more concerned about the clients’s and the US economy’s performance. More Asian exporters are trying to increase sales to European markets now as a result.
These trends, he says, represent a tremendous opportunity for the factoring and credit insurance market.
Growth Story
American economic woes, though, are only the latest driver behind the growth of this industry. Over the last few years a number of trends have coalesced to make factoring – once considered an alternative form of finance for under-capitalised small and medium-sized businesses – a solid tool to be used by global corporates. According to industry statistics, the total volume for factoring increased last year by almost 15%, compared to almost 12% in 2006 to reach €1.3bn. For international factoring, the growth record is even more impressive, registering in excess of 40%, with much of the global export factoring business generated in Greater China and in Turkey.
Other metrics are provided by such banks as HSBC, which expects to see growth in this product line ranging from 15% to 20% globally, with some emerging markets registering growth rates in excess of 30%. HSBC first began building out its international capability some 15 years ago. Active today in 18 countries, it began its push to expand in earnest over the past two to three years. For instance, last year it established an operation in Greece and Turkey. Operations in Poland and the Czech Republic have already opened this year with another two to follow.
Another example is Coface’s receivables finance business line, which, out of the four major lines the Natixis subsidiary offers, is the fastest growing, says Mark Chamings, receivables finance director of Coface in the UK and Ireland. In 2007, Coface reported an increase in volumes of 22.4% in that business line.
As for FCI, Kohnstamm says that the international factoring volumes in the first three months of 2008 have been the best in the company’s history – even better than in 2007, which was also a good year. “FCI’s volume for international business was 20 percent higher in 2007, compared to 2006. On the domestic side it was 7.6%.”
Many factors
The reasons behind the growth are myriad and not tied only to economic trends.
Factoring received a boost a few years ago when open account trade began to eclipse letters of credit and other forms of secured finance, says Margrith Lutschg-Emmenegger, president, Fimbank Group in Malta. The US subprime crisis-turned-general financial market malaise has only accelerated that trend.
Over the last several months, bank and secondary market debt has become scarcer and far more expensive – and companies have learned to reserve these traditional forms of finance for larger, strategic goals.
“In the past six months we have noticed an increase in the volume of business we are transacting in both domestic and international trade,” says Noel Quinn, HSBC’s global head of receivables finance and factoring. “More and more companies, which historically have been able to rely solely on traditional senior and bank debt, are looking to leverage the value of their assets.”
At the same time, companies’s financial and physical supply chains are as complex and fiscally demanding as ever. Capital must be injected at virtually each point or processes, starting from when the company receives – or even thinks it might receive – an order, to the procurement of stock and equipment, to maintaining inventory, to the sales ledger.
These larger, macroeconomic developments dovetail the recognition over the last few years by companies, and the banks that service them, that certain assets align well with specific forms of financing, and in some cases also provide a tidy solution to balance sheet considerations.
Indeed, in a growing number of instances, it is for these reasons, and not financial expediency, that companies choose to use factoring.
Sudeb Sarbadhikary, CEO of Menafactors, a joint venture between National Bank of Dubai and Fimbank in Dubai, reports that the credit crunch is not having much of an impact in the GCC region.
What is driving more firms to use factoring, he says, is recognition of its value proposition of injecting more cash into the business, managing receivables and at times helping to improve balance sheet structure. “That is why people are taking on factoring, at least in this part of the world.”
Follow these trends to their logical conclusion and it is easy to see that factoring, in all its various forms, is well on its way to becoming a permanent fixture in most banks’s trade finance product lines.
Quinn, for instance, point outs that there has been a more permanent shift in corporate thinking, brought about by the growing availability of supply chain finance products, such as factoring.
“I think more companies are recognising the benefits of adding structured financing solutions to their trade finance needs rather than just relying on traditional overdraft or working capital facilities,” he says.
“There are so many requirements by exporters now that it already demands a wide range of financial products to service their needs. Factoring is already becoming an increasingly important part of that line-up,” Quinn concludes.
Multi-currency, multi-jurisdiction
One only has to look as far as the landmark €850mn transaction crafted by GE Commercial Financial and Deutsche Bank for the Italian copper giant KME two years ago to appreciate the benefits a factoring solution, particularly a value-added one, can offer a corporate. This particular deal included a €650mn borrowing base tranche secured on inventory and a €200mn five-year amortising tranche secured on fixed assets. The resulting structure combined two separate products: a receivable non-recourse factoring line and asset-based financing on inventory and fixed assets in several countries.
According to Paul De Domenico, senior managing director for Working Capital Solutions, a division of GE Commercial Finance, the firm has replicated that structure for some 20 other companies. “We have many customers that are looking for two-country solutions and several looking for five-plus country solutions,” he says.
Demand for such facilities will continue as long as liquidity remains scarce in the capital markets, he predicts. “Securitisation as a form of cheap risk and off-balance sheet finance is pretty much dormant right now. A lot of corporates relied on it and so the pressure is on to create new avenues for domestic liquidity.”
Leaving aside the growing demand for multi-country solutions, in general De Domenico says: “Factoring and AR financing solutions are great products, which help corporates gain liquidity both in domestic markets and in those countries where their subsidiaries are.
“In many cases they would have to go to four separate financial providers to underwrite a trade transaction, including local banks at both ends of the trade. Going to a provider like GE Commercial Finance allows the company to develop a factoring strategy at the corporate level.”
Tweaking a straightforward product
GE Commercial Finance, however, is primarily active at the higher end of the user spectrum. In the main, factoring is a large-to-mid-market tool, with each provider adding its own tweak to meet the needs of its particular customer base. And more often than not, the resulting product is then integrated into a larger supply chain finance product line.
For instance, Lutschg-Emmenegger says Fimbank offers factoring without recourse, along with value-add services such as collections, general ledger and credit protection. “Providers are becoming very creative for what is considered a straightforward product,” she says.
HSBC, as another example, positions its proposition as receivables finance rather than just factoring. “Our terminology reflects a broader suite of products we provide to our clients,” Quinn says. By that he means HSBC’s receivables proposition is about more than just finance. It is also about cross-border credit assessment, collections management and payment protection.
In fact, this trend of integrating factoring into a larger product suite has spawned related IT offerings that address some of the risks to banks.
For instance, while banks usually integrate the front end of their financial offerings into complementary product suite for customers, in many cases the back-end IT and risk mitigation operations are still siloed. So a bank that offers inventory financing and factoring to one customer might well have two separate risk profiles – and two separate exposures – to that customer and not realise it. Surecomp’s new product – called allFAC – was developed to give financial service providers a complete view of a customer’s exposure to risk.
“Surecomp didn’t want to develop a solution specifically for factoring, because it is only one part of supply chain finance,” says Lee Kingshott, general manager. allFAC has launched as a factoring solution, with the next releases scheduled to include vendor financing, asset backed lending and inventory financing. “The point is that a financier, using allFAC, can lend under all of those product lines – but still see their risk and exposure on one screen.”
Emerging market growth
Despite the growing sophistication of this form of finance, at its most basic factoring still remains a way for SMEs, namely emerging market corporates, to pay the bills.
A dressed-up balance sheet, one of the main reasons why larger corporates use factoring, is not all that relevant a reason for many small firms, FCI’s Kohnstamm says. “The bulk of factoring still happens with SMEs, not for window dressing, but simply because only factoring gives them the required working capital.”
“Receivables finance meets the needs of many emerging market corporates,” Coface’s Chamings agrees. These firms are not necessarily start-ups, they have enough receivables against which a finance provider such as Coface can lend. They do tend to be small and mid-sized firms though, albeit with large multinational clients, Chamings says. “Their receivables are generally viewed as creditworthy assets.”
While their transactions may not be as impressive as KME’s multi-country, multi-structure solution, emerging market SMEs and their growing trade volumes can be thanked for providing the biggest boost to factoring in recent years.
Consider Menafactors. The company primarily operates in the Gulf Cooperation Council (GCC) countries – economies largely supported by oil. But, notes Sarbadhikary, these same economies have also seen a significant level of new SME growth activity over the last several years. It is this segment at which Menafactors is aimed.
“Over the last two years such companies as fabricators, assembly plants and so have been setting up businesses in this region – businesses that are suitable for factoring.” There is also a lot of cross-border intra-regional trade as well, which is also well supported by factoring, he adds.
Another example is Vietnam, whose factoring market is also poised for strong growth, FCI’s Kohnstamm says. “We are seeing an interesting shift of business operations from China into Vietnam because of the introduction of new labour laws, inflation and a shortage of labour in China.
“Vietnam is becoming more and more a competitor to China – smaller of course, but equally dynamic.”
A description that, if you think about it, happens to apply to factoring as well.
