2022 Commercial Factor Outlook

Robyn Barrett of FSW Funding, Sydnee Breuer of Rosenthal & Rosenthal, Sue Duckett of Franklin Capital Network and Rob Myers of Republic Business Credit provide the factoring industry perspective on all the developments of the last year and what it all means for 2022.

It seems like 2021 started an eon ago. In January, COVID-19 vaccines were slowly rolling out, providing some measure of hope that the pandemic would subside by the end of the year. Although that optimism rose throughout the spring and into the summer, new variants of the virus and a resurgence of cases has stalled the progress we may have envisioned 12 months ago.

Amidst the continuing ebbs and flows of the pandemic, the supply chain has been shattered, inflation is on the rise and labor challenges continue to persist. To take stock of how all of these factors (and many more) have impacted and will continue to impact the factoring sector in the new year, Commercial Factor spoke with several leaders from the industry.

How would you describe the state of the factoring industry entering 2022?

Robyn Barrett, FSW Funding: Optimistic. Banks will start to kick out underperforming deals in the second and third quarters and factoring firms are gearing up to take on new business.

Sydnee Breuer, Rosenthal & Rosenthal: By far the biggest competitor the industry saw in 2021 was the U.S. government. With economic injury disaster loans (EIDL), Paycheck Protection Program loan forgiveness and other government stimulus programs created in response to the pandemic last year, the markets have been flush with liquidity. As a result, lenders’ loans are generally down. In some cases, the stimulus funding gave consumers and businesses the shot in the arm (no pun intended) that they needed; but in other cases, the cash infusion masked bigger problems. For those companies, when you finally rip off the Band-Aid, it will be bad news.

If companies are reflecting losses or had a difficult year despite the extra boost (pun intended) from stimulus funding, institutional lenders may start kicking clients out or altering their lending practices, all of which now creates opportunities for factors and other non-bank lenders.

Sue Duckett, Franklin Capital Network: I would say optimistic. I think everyone can agree that a recession will come, but we still have a while before factors can reap the benefits of the situation. I believe SBA loans will be called in and banks will pull back from some of the loans that we have seen them provide, leaving the pathway open to factors again. The majority of small/medium-sized businesses that require our services are now using up the government cash they obtained through the crisis, so I expect our pipeline of new prospects to increase.

Rob Meyers, Republic Business Credit: I see three factoring industries: transportation factoring industry, traditional factoring and recourse factoring.  

When I think of transportation, they're the happiest people in the entire world. There is a demand for transportation and logistics services that far exceeds the number of trucks on the road. So, I think if you look at it in the terms of transportation factoring, they're set up to have another pretty killer year, particularly in the first half.

In the traditional factoring space, you're going to continue to see less credit worthy retailers. You've had a 10-year decline, as more people prefer t e-commerce instead of going to Nordstrom's. It doesn't mean there are not good businesses, but I think that space continues to contract a little bit.

The recourse factoring people are probably set to have a decent run because some of the industries they typically fund are doing better, but I think its struggle is that a lot of banks that aren't necessarily willing to part with distressed credits just yet.

What is the greatest challenge you foresee for your company and the industry in the next 12 months and where do you see the greatest opportunities?

Barrett: The greatest opportunity is picking up deals from banks and asset-based lenders. The Federal Reserve is set to start raising rates in the first quarter of 2022 and this will cause distress for companies that loaded up on cheap debt. Also, there is quite a bit of M&A activity and we have helped buyers leverage assets for acquisitions. The greatest threat is rate compression. There is a lot of liquidity in the market, which is driving yield down for factors. Also, a threat is the ability to find and retain staff. We have found we need to be more flexible with benefits such as working remotely to retain and find quality employees.

Breuer: Navigating the shifting regulatory environment will be one of the biggest hurdles our industry will face in the coming year. There is so much inconsistency from state to state, both in terms of what’s required of lenders as well as how the regulations will be implemented. I worry that some of the small lenders won’t have the resources or ability to figure out how to comply with these new regulations. It’s also likely that implementation of these regulations across individual states will be a slow and laborious process. This has certainly been the case in California.

Duckett: Retail continues to be a concern. Any lender who has positioned themselves to lend to e-commerce businesses will undoubtedly continue to gain traction, which in turn will be an excellent opportunity for inventory lenders.

One of the most significant challenges for us right now is the supply chain issue. Orders are arriving late and therefore being canceled. The cost of freight is hitting our clients’ margins and their ability to get inventory in at all is a hurdle. Although there is some headway being made at the ports, staffing and transportation availability will still be a concern for some time.

Meyers: We keep eroding at the margins to try to get cheaper and cheaper cost of funds. At the same time, our clients can use brokers and investment bankers and shop 10 of us against each other. There are more lenders than there have been, so the biggest challenge is being careful in this race for a bottom of pricing.

The opportunities are expanding in geography, expanding in industries and expanding in products. Diversification increases your ability to help the same number of prospective borrowers and referral partners while maintaining the credit and risk disciplines that have built your business, even if that causes you not to grow. I think the biggest mistake is trying to grow too fast or in new areas outside of your leadership team’s expertise.

In September, the Consumer Financial Protection Bureau (CFPB) announced that its proposed regulation implementing Section 1071 of the Dodd-Frank Act would not be imposed on the factoring industry, pending final regulation. What was your reaction to this development and what is your view on the current regulatory framework in factoring overall?

Barrett: This is a huge win for the factoring community and saves independent factors from overreaching disclosure requirements, which are costly to implement and slow down the sales process. Factors don’t have the time or staff to meet all the reporting requirements of Section 1071, so this was a big relief to be excluded. While the exclusion under Section 1071 is a win, factors still have a lot more state and national disclosure battles to worry about.

Breuer: It is a positive that factors were excluded from this burdensome collection of demographic information for our small business borrowers/prospects. One of the main problems for the factoring industry is that many factors are small businesses or branch offices themselves and shielding the underwriting side (as required in the regulation) from the demographic info is virtually impossible.

With regard to the current regulatory framework overall, it’s likely that lenders will struggle as they work to manage the regulations that will vary from state to state. With each state now responsible for creating its own regulations for small loans to protect small businesses, it will be nothing short of a patchwork approach. Each state law will have a different format and set of standards that will complicate the lending process. As a result, borrowers will be limited by which lenders they can work with if certain lenders decide not to loan in certain states. This will create a major challenge for the industry across the board. The lenders that can quickly pivot to comply with the new regulations will ultimately come out on top.

Duckett: Relief! Factors are not consumer lenders, and for years we have ensured that we do not cross any of those boundaries. If this were imposed, the cost of obtaining the information, maintaining records and reporting would be almost impossible for some smaller factors. Many factors sell their service on speed and flexibility, and there is no doubt that this would have had an impact on both. The cost of regulatory frameworks would affect the smaller independents who do not have the staff or systems to cope.  

This does not mean that I am against regulation. I believe that the IFA or the AFA could play a part in this. Using an association that understands the industry is a positive approach. In the UK, we had a similar organization, with all factors that belonged to it answering to the organization should any complaints be made, while the organization also provided a set of standards that all members abided by.

Meyers: It’s a huge win and  I think getting left out of any government regulation is a good thing generally. Where I would pivot is you've got California, New Jersey, North Carolina, Ohio, Connecticut and I'm sure Illinois will follow, all doing different disclosure stuff. Either stop it all or make it all the same. The upcoming years where we go through separate disclosure laws are going to be exhausting for our industry. I understand what they were trying to do, but it does not work in a revolving line of credit, particularly in the factoring space. I think eventually you're going to have to just do it everywhere or just stop it all together because if it gets into too many states, you may find people don't really want to work in some states anymore. So I’m excited about the Dodd-Frank exemption but anxious over the other different state disclosure laws.

The supply chain has continued to be hampered in 2021. How has that affected the factoring world and do you expect it to continue to have an impact in 2022?

Barrett: The supply chain issues are a big issue for our clients. It has quickly increased costs and clients have not been able to raise prices in a timely manner. This has led to margin erosion and further financial distress for clients. Factors are still funding, but portfolios will be depressed since clients can’t deliver product and create new invoices. Transportation factors will continue to do well, as the increase in fuel and demand for shipping will increase their portfolios. 

Breuer: The supply chain continues to be one of the biggest challenges facing the industry as we look ahead to 2022. We’re witnessing many of the same patterns we saw in the beginning of the pandemic, back when it was difficult to get your hands on personal protective equipment and paper towels. Consumers and retailers are placing more orders than what’s actually needed, which is putting tremendous strain on the supply chain and the economy overall. In fact, the supply chain is so bottlenecked right now that most people are just trying to figure out when the music will stop.

At some point, the supply chain will normalize and companies will have significant excess inventory that will have to be unloaded if they want to remain profitable. Factors like Rosenthal have a unique opportunity right now to help companies right-size their inventory and find the perfect balance between too much inventory and not enough, both of which can be problematic. Factors can also help clients with purchase order financing, trade financing and putting inventory controls into place, all of which ultimately enable companies to keep less inventory on hand when there is so much disruption in the supply chain.

Duckett: As per the previous question, this is one of my biggest concerns right now. Factors will have to maintain a higher level of verification, as late deliveries may increase dilution and nonpayment of invoices.

Our clients continually drive down the margins to the extent that they may not afford the finance facility. Many cannot pass on these costs and hope things will soon revert to normal, which I believe is not the case. China has an energy crisis and may impose further restrictions by placing restrictions on manufacturers to reduce their output by 40%, reducing supplies further. To compensate, clients are hoarding inventory, which uses up their working capital, floor space and has a risk of having obsolete stock in the future. All of these issues can eventually be the downfall of a business. 

The government is spending billions to improve U.S. manufacturing, and the Port Authority is taking action to boost throughput. Still, I believe this is not enough to overcome the issues before the end of 2022.

Meyers: The need for freight to get moved, whether it's via rail or via truck, is going to reverberate through 2022, so you might argue supply chain is almost a favorable tailwind or headwind for the transportation factoring side. And from the rest of the industry, you just have lost receivables if the goods don’t arrive in time. That's what worries me because you're going to have a lot of receivables that don't come through, and as a result, you're going to have inventory coming back into clients' warehouses. So I think it's going to reverberate in a lot of areas and it will put some pressure on some credits because I don't expect another round of PPP or EDIL loans in 2022. Businesses are going to have to stand on their own two feet, and supply chain issues, inflation and labor shortages are really going to cause them problems.

Congress recently passed the Infrastructure Investment and Jobs Act. How do you think the bill’s investment in the United States’ infrastructure may impact the factoring industry, specifically clients in construction and energy?

Barrett: There are so many moving parts of the bill, but, overall, factors that fund government contracts should see an uptick in business. The increase in government spending should also create demand in shipping, manufacturing and staffing. Thus, I hope all factors would benefit.

Duckett: We do not fund construction or energy, so I am not the most qualified to comment; however, any investment in infrastructure usually creates jobs and, therefore, opportunities.

Meyers: I'm not sure it'll have much impact at all for the majority of us. Maybe there's a little bit of a surge on the materials side, but I'm not expecting any pickup whatsoever in a large chunk of it. On the energy side, I think there'll be some impact, but I don't think you'll see a massive uplift.

What are your overall expectations for the factoring industry in 2022?

Barrett: Again, still generally optimistic. As the economy continues to recover, more opportunities will be created. Existing portfolios will grow and startups will thrive. One item to keep on the radar is the Fed raising interest rates, which will mean factors interest expenses will go up. While factors charge a fee and are generally interest rate agnostic, aggressively priced deals will cause margin erosion. Thus, increasing interest expense and rising employment costs will hurt the bottom line of many factors.

Breuer: I expect there will be some significant headwinds in 2022 between the supply chain, inflation and interest rates rising toward the end of the year. The real question will be what the economy will do and what direction it will take. The businesses that seize opportunities where they see them, similar to how many companies pivoted to manufacture personal protective equipment in 2020, will continue to thrive in this environment. Factors will also need to continue to evolve to meet the needs and demands of the market and changing client needs and expectations.

Duckett: I expect to see more acquisitions of independents, and factors will start to diversify their product offerings more. Although the bank workouts will provide more factoring deals, I believe many of these clients may be too far “gone” even for the factors. I hate to be a pessimist, but I certainly do not see an easy year ahead for anyone right now.

Meyers: In the next couple years, as you continue to see price compression, real margin challenges and a wave of growth in certain industries, it will put pressure on businesses to re-look at capital options, so I think you'll see some consolidation in 2022.

Overall I think it'll be a good year. Generally, factoring does great in periods of growth. It does really well in periods of distress, when cashflow covenants and things like that don't work. Where factoring struggled is during periods of stagnation, and I don't think 2022 is going to be a year of stagnation. You're going to have industries that are growing and you're going to have some industries that are declining, and I think that will present some good opportunities in factoring in 2022.