SFNet Annual Factoring Industry Survey Results

It is that time of year where we present the results of the Annual Factoring Industry Survey.  Last year this commentary was written after the pandemic had set in, the country was in lockdown, historical results were completely disconnected from the unfolding reality of 2020.  A year later, we look back and reflect on a surreal year.  The factoring sector experienced unprecedented declines in volume (as did most secured lending), the highest level of write offs in 15 years and yet remained profitable, thus demonstrating the durability of the business model and its suitability as a financing tool for uncertain and turbulent times.  Last year we noted that factoring is an “all-seasons competitor”, and that factoring would likely grow and thrive in the turbulent time to come.  Looking back, we see that though the industry did not grow – in fact, it shrank – it did thrive and provided a valuable source financing to many businesses adversely impacted by the pandemic.

One caveat should be noted before diving into a summary.  The participating companies in SFNet’s study represent a substantial amount of outstanding funds, but skewed to a small number of larger bank and non-bank companies; lacking in the data is a broad representation of medium and smaller industry participants.  As a result, smaller shifts at one company can have an outsized impact on the aggregate data results.

Throughout 2020, the economy was on a seesaw journey, declining 5% in Q1, then declining an additional 31.4% in Q2.  Then in Q3 GDP reversed course and grew 33.4% followed by an additional 4% of growth in Q4.  Measuring from the beginning of 2020, these down and then upswings saw overall GDP off 10% over the year.  The impact, though broadly based, had very different impact on different sectors within the economy – for instance travel and hospitality were perhaps impacted the greatest and have been the slowest to begin recovery.  By comparison, durable goods and investment in equipment declined less in the early part of the year and grew strongly in the second half of the year. 

Adding to the difficulties of analyzing the year, was the impact of the multiple government stimulus programs, most notably the Paycheck Protection Program (PPP).  This program and others have served as a critical lifeline to thousands of businesses and millions of jobs and had a twofold impact on the factoring industry.  On the one hand, the liquidity created further reduced the already reduced demand for working capital finance.  On the other hand, this liquidity support meant that many businesses had an ability to pay their receivables when they otherwise would have been hard pressed to do so.

All of this makes cogent analysis of 2020 in factoring a challenging task.

For 2020 overall factoring volume declined 25% following the sharp reduction in broad economic activity related to the pandemic, as well as the impact of broad government stimulus programs. While overall volumes were down significantly, international factoring showed some increased activity, though from a slightly lower number of clients, suggesting that global credit insurance coverage may have pulled back in response to the changed economic conditions. Further and though not broken out in the data factoring volume related to the acquisition of personal protection equipment (PPE), much of which was sourced internationally, most certainly increased in the period offsetting some of the general decrease observed.  

The regional volume data showed some sharp differences between regions. The percentage of overall volume in the Midwest showed the biggest change with a percentage of reduction with a decline from 11.1% of overall volume in 2019 to 7.8% of in 2020.  There was a smaller decrease in the Southeast region. While it cannot be pinpointed, the slowdown in automobile manufacturing output in the related supply chain early in the pandemic could account for this change, as these industries are concentrated in the Midwest and Southwest.

Reviewing client industries by volume showed textiles remaining the top user of factoring with a consistent percentage. However, there was a significant shift in overall percentage volume upwards from business services and a very significant decrease in factoring attributed to the electronics industry. Again, the pandemic’s impact on global trade flows combined with a micro processing chip shortage, which became more pronounced throughout the year, likely contributed to this significant shift in the electronics sector.

Looking at the mix of recourse factoring versus nonrecourse factoring, we see a slight increase in recourse factoring in 2020, while the number of clients using recourse factoring as a percentage overall fell several percentage points. We believe that this is a combination of some recourse clients converting to ABL facilities in a very competitive marketplace, combined with the disparate effects of the government stimulus programs on overall liquidity needs.

We also concluded that there was well-placed increased concern for the credit environment as volume dispersion between non-notification and notification factoring revealed significant tick up in the percentage dollar volume of notification factoring during the period.

An interesting change was observed in the source of referrals to factors as the percentage of referrals coming from nonbank finance companies (ABL and similar) was up just over 11%, absorbing a significant reduction in referrals from bankers of 9%.  Though difficult to pinpoint, we suspect that bankers referred fewer clients due to the accommodative regulatory client as regulators sought to minimize the negative fallout from lockdown and quarantine.

Turning to financial performance metrics in 2020 versus 2019, there was an overall increase in revenue as % of factoring volume, comprised of a significant increase as a percentage of volume in interest charges combined with an uptick in service fee income as a percentage of volume pointing.  Looking at revenue as a percentage of earning assets showed a slight decrease in interest charges with a very significant increase in service fee income as a percentage of assets. The combination of these factors suggests much longer receivable payment cycles in 2020 as assets remained on the books longer, incurring extension and accommodation fees, all of which is consistent with conditions related to the pandemic.

Examining changes in expenses we observed a very slight increase in overall % of direct expense as a percentage of volume and significant increase in the percentage expense of business development as a percentage of volume.  Companies reported overall headcount reductions of approximately 10%, but a threefold increase in other personnel costs combined with a 50% increase in other direct costs as a percentage of average earning assets.  This suggests that factoring companies in 2020 invested more heavily in fewer staff related to the lower volume and heightened credit concern.

Moving on to write-offs, 2020 showed a huge increase in gross write-offs as a percentage of volume though the reduction in overall volume would make this increase seem larger. Looking at write-offs as a percentage of average earning assets still saw a hugely significant threefold increase in gross write-offs for the year consistent with poor economic conditions. Recoveries remained virtually unchanged year over year as a percentage of earning assets. Observing a 15-year trend, we see that as a percentage of earning assets that the 2020, gross write-offs exceeded the Great Recession of 2009.  This was no doubt in great part attributable to the continued store- front retail decline, the effect of which was first observed in 2019, when losses had ticked up significantly from the year before.

All this brings us to an examination of pre-tax profits. The increased write-offs led to a slight reduction in pretax income as a percentage of earning assets, whereas the pretax income as a percentage of volume rose slightly.  This counterintuitive difference can be attributed to the significant volume decrease. Given the significant increase in credit losses, the relatively stable pretax income as a percentage of earning asset the stable pretax income as a percentage of earning assets suggest that factoring companies were successful in making cost adjustments, which we see in a reduction in head count of approximately 10%.

In conclusion, we believe that 2020 demonstrated the overall resilience of the factoring industry as it weathered the most significant economic and health crisis experienced since the great depression.  And the industry and its members came through scarred, but comparatively unscathed…an “all-seasons competitor” in the world of finance.