Uncertainty Rises, Opportunity Knocks: Evaluating the Factoring Landscape for 2023

In a wide-ranging roundtable discussion, Robyn Barrett of FSW Funding (a division of Oxford Commercial Finance), Sue Duckett of Franklin Capital Network and Robert Meyers of Republic Business Credit discuss interest rate hikes, rising inflation, the collapse of Silicon Valley Bank, a pending recession and more.

How has the factoring industry performed through the first few months of the year?

ROBYN BARRETT, FSW FUNDING, A DIVISION OF OXFORD COMMERCIAL FINANCE: Various industries have performed in different manners. Transportation factoring grew tremendously during COVID-19, but is now trending down. General factoring is still seeing a good pipeline.

SUE DUCKETT, FRANKLIN CAPITAL NETWORK: For us, it was a quieter January than I would want, and then prospective client activity picked up dramatically in February and March. But, honestly, there was not much difference from previous years.

ROBERT MEYERS, REPUBLIC BUSINESS CREDIT: Busy — and thankfully so far, a good busy. Our new business originations are up more than 50% this year versus the same period last year. We have twice as many inquiries, twice as many letters of intent issued and twice as many deals in underwriting. As you would expect, we have seen significant growth in our portfolios as a result and expect that to continue at least during the first half of the year based on current activity levels. Overall, I think our industry is seeing a significant uptick in activity as a result of credit tightening by the banking industry starting back in Q3/22.

How has the factoring community weathered the storm of rising inflation and interest rate hikes?

BARRETT: It is a yes and no kind of answer. Factors charge a fee, which should allow them to weather the storm in terms of revenue. The issue is the cost of capital (interest expense) to factors, which has increased up to three times for some. The interest rate increases will greatly squeeze factor’s margins and could lead to some factors selling to larger companies or banks.

DUCKETT: It really will depend on the pricing structure of the factor. If they are still hanging onto a single administration price with no link to interest, then this will of course affect their return on funds employed and will have a major impact; however, most of us learned this lesson back in the day of increasing rates and many now link the two equations into pricing.

MEYERS: This falls into an “it depends” category. Republic provides nearly all of its working capital products on floating/variable rate structures that adjust as Prime increases or decreases. In transportation, you often have a lot of fixed invoice-based fee pricing that is tied to the increasing cost of bank borrowing the factoring company will experience. It is a timing mismatch at a minimum between your clients and your bank funding, or a runaway freight train if you have been doing extremely cheap fixed-rate fee pricing where your cost of funds could exceed what you are charging your clients. I am sure most of our members have already solved this, but if not, I would chat with the many great lawyers across the factoring community.

How do you think an impending recession will impact the industry?

BARRETT: Factors will greatly benefit from the recession, as banks typically pull back credit in a recessionary environment. Factors can provide much more liquidity to companies, as we are underwriting the credit quality of debtors, not their historical cash flow performance. Thus, factors will be a safe haven for many companies that will be kicked out of their bank due to covenant or industry issues.

DUCKETT: Positively. Historically we have seen banks pull back during recessions, giving independent factors the ability to jump in and grow their book. I do not anticipate this time being any different. In this environment, the ability of small businesses to obtain loans will be reduced, giving us a larger pond to fish in.

MEYERS: As we have already seen, the economic forecast has increased activity on the new business front while heightening risk profile depending on the industry, niche or segment of the market you tend to service. As many will remember from 2008 and 2009, often the first companies that seek capital can be in the worst shape for our industry to help. During periods of cheap debt and inflated asset values, clients often try to obtain as much as possible. With rising interest rates meeting a recession, I expect the amount of debt-to-refinance will often exceed the eligible receivables of the factoring customer. This would be your classic over-advanced or undercollateralized situation — the difference being, they will also have more debt to service from the rising interest rates. Overall, as our COO Matt Begley often quotes, a robust pipeline can be the best solution to credit discipline, and we should focus on supporting businesses that fit our policies and procedures.

How will your company try to find success and opportunity during a recession?

BARRETT: I sold FSW Funding to Oxford Commercial Finance (OCF) in April 2022 and the timing was perfect. Over the last year, OCF has invested in people and technology. We are primed and ready to grow OCF exponentially.

DUCKETT: We will continue to provide facilities to those small businesses that do not fit bank risk criteria or cannot secure adequate amounts of working capital from banks. We are augmenting our product mix so that we can provide a broader spectrum of financing solutions for our clients.

MEYERS: Republic has focused on diversifying our referral base and channel partners since 2017, including our focus on the turnaround management community. So, our mission is to educate our partners on our client successes, reinforce our suite of ABL and factoring solutions, and execute quickly when the opportunities present. A recession should increase the number of opportunities we receive, but it is our challenge to stay disciplined, decisive and be a strong partner for their referrals.

Commercial bankruptcies have been on the rise early on in 2023. How is this trend affecting the factoring world, if at all?

BARRETT: Debtor-in-possession lending is a perfect niche for factors. Factors can provide liquidity based on the credit quality of the debtors, which allows companies in bankruptcy to exit successfully. Factors also play a vital role in providing liquidity when companies emerge from bankruptcy and are not bankable.

DUCKETT: We are seeing more debtor-in-possession funding requests; these are opportunities for us. We rarely have a client in our portfolio file for bankruptcy, for numerous reasons, and therefore, only see positive aspects of these statistics.

MEYERS: So far we have really only seen a handful of debtor-in-possession opportunities, given the increased costs of bankruptcy and Subchapter V’s debt limit of $7.5 million. I don’t expect it to be a large part of our new business strategy, unfortunately. We did a lot of DIP deals following 2008 and 2009, so hopefully I am wrong about my expectation. On the portfolio side, it is why client visits and regular communication are so important, no matter the economic environment.

What is the greatest challenge your company is facing this year and where do you see your greatest opportunity?

BARRETT: Our biggest challenge will be finding high quality team members to keep up with our growth. Our greatest opportunity is to help companies that are cash flow challenged due to growth, inflation and rising interest.

DUCKETT: A huge concern is state disclosure legislation, which continues to be promulgated throughout the country. Until uniform national disclosure legislation is enacted, we shall continue to spend a lot of time and effort ensuring that we adhere to the rules and regulations that are state specific.

MEYERS: As I said earlier, I think the greatest challenge will be having enough liquidity and availability. With so much cheap debt, I worry companies tend to take more than their working capital assets might support. Our greatest opportunity continues to be our partnership with private equity, as more than 40% of our clients are now owned by private equity sponsors.

What is your outlook for the industry for the rest of the year?

BARRETT: I think factors will be a vitally important as the Federal Reserve continues to raise rates and inflation remains high. Companies that leveraged up with debt during the period of low interest rates will have problems meeting bank debt service coverage covenants. Factoring will be able to offer facilities that are account-receivable based and not cash flow, which will help over-leveraged companies work through issues and right the ship. Also, the failure of Silicon Valley Bank will cause companies to consider factoring as a safe haven until other bank fallout concerns are tempered.

DUCKETT: I am very optimistic. From my conversations with other factors, we are all getting busier, seeing larger deals and, in some cases, deals that we previously considered bankable.

Many small businesses faced existential risk during the 2008 collapse of the banking system; many small business owners have not forgotten. While it has taken a long time for small business owners to start trusting the banking world, the failure of Signature Bank and SVB likely will rekindle small business owners’ concerns about access to working capital. It is for this reason that we have retained some clients that are bankable. Recent events may impact clients’ decisions to stay on board with independents, improving attrition rates for us and the industry.

MEYERS: I am very bullish for the first half of the year for the factoring and asset-based lending industries, but it’s too early to see if this momentum is a Q1 surge or an entire year. Compared to last year at this same time, I feel more confident in the outlook but am always cautiously optimistic, as there is a lot going on in the world that could significantly impact performance in a variety of ways.

As a wholly-owned subsidiary of Renasant Bank, we are excited to provide more small and medium sized businesses across the United States with access to working capital facilities. The transition has gone incredibly well, better than I would have ever expected, and we are excited to see what we can do together with our new partners at Renasant Bank. •