The collapse of the sub-prime mortgage market in the US has sent shockwaves throughout the international banking community and has had a devastating effect on the domestic and international credit markets.
Business volumes are now degenerating at their fastest rate since 1991, due to the tightening of lending criteria and sparse liquidity, to the extent that economic growth has been forecast to reduce by up to 1% in 2008.
In particular, inter-bank lending has also become more difficult, in light of the US crisis. As a result, commercial confidence has almost been reduced to the levels of the early 1990s, epitomised by the sudden cooling of the UK housing market.
The global economy has become fuelled by readily available, affordable, covenant-lite debt finance that has underpinned the hysterical M&A activity over the past decade. However, banks have been forced to become urgently risk-averse, as substantial global institutions such as HSBC have recorded losses of up to $17 billion.
Factoring as an alternative
Such a sharp and unanticipated cash drought has made financial directors look to more tangible sources of financing for their businesses.
Current market conditions have and are expected to continue to increase opportunities for factoring companies, especially among small and mid-size firms (SMEs).
By way of example, Platinum Funding Group, a leading factoring company in the US, has reported 2007 as its strongest year to date with new financing deals surpassing the $200 million mark.
London Scottish Bank Invoice Finance Limited recently declared its capital was enhanced and strengthened in its balance sheet and has an impressive 7% forecast yield.
In the last quarter of 2007, Gresham Computing plc, the real-time financial solutions specialist, announced a landmark deal with Credit-IQ Limited, Europe's leading provider of accounting data extraction technology, to meet the dynamic growth in demand for supply chain financing.
The advantages the industry can offer
Such a trend can be explained by reference to various advantages that the industry offers. At a general level, factors make funds available when banks would not do so, because factors focus on the credit worthiness of the debtor. In contrast, the fundamental emphasis in a bank lending relationship is on the creditworthiness of the client company, as opposed to that of its customers. While bank lending offers funds to small companies at a 'lower cost' than factoring, the key terms and conditions under which the small firm must operate differ significantly.
It is this quality that businesses may find particularly attractive in the current climate. There is a danger that all SMEs will be painted with the same brush and those with genuine prospects of commercial triumph may miss out on requisite finance due to banks' blazé lending to others.
Indeed, factoring can provide relief for businesses in the most desperate of circumstances. The client may not have any equity, assets, or even credit record. In the aftermath of the US sub-prime debacle, the analysis has focused on the overexuberance of banks to lend without regard to the creditworthiness of the borrower. While more meticulous lending will inevitably impact most on SMEs, factoring offers a refreshing alternative for such businesses to grow in spite of the decline in widely available financing.
Further, factors are not subject to the supervisory and regulatory scrutiny that banks are - a factor can therefore work closely with a client in order to overcome its problems. In a sensitive economic atmosphere, such client-specific financing is particularly attractive to SMEs. Factors can enhance the balance sheet of a company in a way that a commercial bank simply cannot do.
Conclusion
Commercial banks have inevitably become far more weary of extending multiples of credit that they were prepared to deliver before summer 2007.
Factors can offer advances of up to 85% of funds without a track record, providing a solution to companies who need cash-flow in the current credit crunch. Both factoring and invoice finance have become mainstream alternatives to overdraft facilities, term loans, letters of credit and private equity, giving the option of credit control.
At the same time, factors have had to recognise the downturn in the market themselves and safeguard against suffering from the significant decline in the retail industry in particular. Such safeguards, however, have so far only extended to more dialogue with clients rather than more scrutiny in taking clients on.
The latter would seemingly be too much of an opportunity missed...
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