Construction Factoring Industry Remains in Uncertain Position
Brent Chambers of CapitalPlus Construction Services returns a year after examining the status of the construction factoring industry in the immediate wake of the COVID-19 pandemic to provide an update on the market in the current environment. Once again, uncertainty reigns, especially with a slowed supply chain, meaning construction factors need to be creative and patient.
BY: BRENT CHAMBERS, EXECUTIVE VICE PRESIDENT, CAPITALPLUS CONSTRUCTION SERVICES
Exactly one year ago, I wrote an article on the status of the construction factoring space and more specifically how the COVID-19 pandemic was impacting the industry. Now, writing on the status of the industry a year later has compelled me to reflect back on the 2020 article. I walked away realizing many impacts of the pandemic we were experiencing a year ago continue to this day, with some things having improved, while others but have not. To top it off, there are potential new concerns on the horizon.
A year ago, the primary concern in the construction industry was the abrupt slowdown in business caused by the howling winds of uncertainty from the pandemic. This uncertainty a forced many traditional lenders, investors and developers to put their money on the sidelines, causing projects to be shelved or terminated, which all directly impacted the backlog and top line of contractors and, subsequently, the pipeline or deal flow to the construction factoring industry. The good news today is the construction industry has rebounded nicely and has positive outlook for the near future; however, deal flow continues to be slow relative to pre-pandemic times for a variety of other reasons.
The Slowdown Continues
Out of the gate, in April of 2020, the federal government passed the Paycheck Protection Program to provide financial support for all industries, including construction. But it didn’t stop there, with a second round of PPP money coming through in August 2020 and a third round delivered this past March. More recently, the federal government, in conjunction with the Small Business Administration, instituted the Economic Injury Disaster Loans (EIDL) program, providing financial assistance to small businesses impacted by disasters, including the pandemic. The low interest (3.75%) EIDL loans have a 30-year payback and are guaranteed by the federal government. As you would expect, most firms, including construction firms, have taken advantage of one or more of these programs and have had limited or little need for additional financing. In short, the slowdown to the construction factor space today is not due to a slowdown in construction work but due to the low interest — if not free — money from Uncle Sam. It is anyone’s guess when firms will work through these funds or if more cheap money is to come.
Another aspect of the EIDL loans that have contributed to the slowdown for construction factors is the fact that the SBA filed UCC-1 financial statements on most of the borrowers. There have been numerous circumstances where EIDL loans were insufficient to handle a prospects’ longer term cash flow needs, forcing it to reach out for a supplemental factoring facility. In most cases, factors can often work with another lender through an intercreditor agreement in which the other lender subordinates the purchased receivables to the factor. However, this can be a easier said than done. To date, CapitalPlus Construction Services has yet to get the SBA to agree to subordinate, leaving prospects in a bind and preventing factors from offering financial assistance.
The Supply Chain is Broken
A relatively new wrinkle in the new world created by the COVID-19 pandemic is a devastated, if not completely broken, supply chain. A year of shutdowns with little or no production of supplies and materials and a rebounding economy which is driving demand has created a real mess.
On the construction side, firms are wrestling with higher prices for all their materials. Some have estimated that the cost of construction materials is 50% higher than pre-pandemic levels. Even worse, many contractors cannot get the supplies they need, causing huge delays to their projects. This means contractors are either faced with eating the overages or negotiating higher prices on jobs that are already bid and awarded as lump sum pricing. These negotiations rarely turn out well for the subcontractors no matter how they are settled. This has put a burden on the construction space and many lenders in the sector.
To top it off, the human supply chain is broken as well. Too many folks are opting to remain on the government payroll while jobs go unfilled. This is a monster impact to construction firms because success in construction is all about managing scope, schedule and budget. To effectively manage project costs and stay on schedule requires firms to maintain a highly skilled staff that can effectively drive productivity and all-around performance. On the other hand, poorly managed projects lead to poor performance. For a construction factor, poor client performance means substantial risk and potential disaster! Mitigating this risk in the current environment means a lot more client monitoring and hand-holding.
Getting Innovative
Having a diverse client mix in terms of industries served can be a double-edged sword. On one hand, when one market or service is down, it is good to have diversity of clients and services to fall back on. On the other hand, when things are good, you might ask yourself why you’re not focusing your core service. The pandemic has added some clarity to the subject over the last 18 months, leading many entrepreneurs to diversify their businesses.
For factors like CapitalPlus Construction Services, industry diversification isn’t an option. One does not dabble in construction factoring and succeed. However, soon after the pandemic’s impact on the construction industry became clear, innovation became necessary for factors focused solely on the construction industry. For example, at CapitalPlus Construction Services, we started a new service offering construction firms the ability to bundle their purchasing power, purchase their needed supplies upfront and gain extra time to pay. For subcontractors, this new service not only assists customers in getting the supplies they so badly need but it also helps with cash flow concerns. This service also allows owners of construction projects and general contractors the opportunity to control lien risk, maintain material quality and reduce multiple markups down the supply chain.
New Concerns
Just when you thought you could shed the mask for good and literally breath fresh air, variants of COVID-19 have begun to spread. Mask mandates have returned in select states and communities and many more are considering the same path forward. The overall concern here is simply renewed uncertainty at a time when the U.S. was becoming more optimistic. Increasing uncertainty will mean additional impacts to the supply chain, and lenders and developers may again hedge their bets and start pulling back capital or putting projects on hold. It’s also possible Uncle Sam may feel the need to throw out additional life buoys. If so, the rebound we have been seeing will stall, creating more issues for the construction industry and its factors.
Light at the End of the Tunnel?
Every week, I read an article or two about the reckoning or adjustments to come in the financial lending markets due to the lending practices during the pandemic. Many articles claim that cheap and/or free money is simply masking or covering up real operating and financial issues in businesses. If this is true (and I believe it is), what will balance sheets look like when the free money is used up?
Furthermore, it appears that many lenders have hung on to clients for a variety of reasons when, in times past, they might have worked clients out of their portfolio. At some time in the near future, the Band Aid will have to be ripped off. This will ultimately lead to workouts and/or bankruptcy for many businesses. When the time comes, it will be unfortunate for all involved; however, the factoring community, including the construction factors, will be ready to work hard to bridge the working capital gaps where possible.