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Interview with Rich Gumbrecht, CEO of Secured Finance Network, formerly Commercial Finance Association
By Susan Carol
Signs of Financial Stress, Recession, Tariffs & Sources of Capital
On indicators of stress in secured finance:
In the first half of 2019 we saw modest quarter-over-quarter growth and strong year-over-year comparisons with perhaps the first indications of stress per our recently released Confidence Index. It shows that our regulated members’ outlook fell below the midpoint (six-month period) after being consistently above the mid-point before this. They are somewhat less confident in the economy and performance of their own portfolios. Bank members saw a modest uptick in stressed loans.
What about non-banks?
The non-banks are consistently positive. Growth of independents continued unabated with commitments and outstandings both reaching a new high in 2Q 2019, with utilization rates swelling to pre-recession levels. They remain bullish on the economy and prospects for their continued growth.
On the impact of a downturn:
A mild downturn would be a boon for asset-based lenders. As unsecured lenders become more cautious, businesses turn to secured finance companies for capital.
It’s too early to tell if a downturn is on the horizon. If the increased utilization rates start to roll through into weaker portfolio performance then we will have a clearer signal.
How members describe the market:
There’s a good volume of business being written, but it’s an intensely competitive environment. Financing providers are pressed to move on terms as it has been a borrower’s market.
Some of our members are international and those heavily dependent on the European economy are beginning to see some weakening in portfolio performance.
Concerns about recession:
Borrowers need working capital and these forms of financing hold up well in an expanding or mildly contracting economy, whether we’re talking about factoring, ABL or other forms of supply chain finance.
On trade wars and tariffs:
Our members typically lend against a range of asset categories, but primarily, receivables and inventory. Commodity pricing is directly impacted by tariffs, which can reduce customer’s available borrowing base and create financial pressure. It can also create supply chain interruptions if shipments get held up in ports.
Larger borrowers feel greater impacts from tariffs and trade policy uncertainty while small businesses are generally more dependent on U.S. consumers for sales growth.
How is the data SFNet captures valuable to economists or journalists?
The data we compile quarterly is a harbinger of shifts in the broader economy. Higher asset-based lending utilization rates and increased factoring activity can reflect either a strengthening economy or rising financial stress on borrowers depending on other considerations we monitor. Unlike many forms of commercial lending, secured finance products are structured to withstand economic cycles and provide critical financing to mid-market companies during a downturn.
Recent Bureau of Economic data noted a drop in corporate profits at the end of 2018 and beginning of 2019 and the WSJ reported Aug. 21 that big retailers are seeing lower profits or forecasting lower due to the China tariffs. How much of a concern is this to the secured finance industry right now?
Our most recent SFNet Market Pulse report flagged the drop in corporate profits as one indicator of a potential slowdown along with a rise in C&I loan delinquencies. But the ratio of consumer confidence to unemployment rate is still quite positive, which has a strong mitigating effect. Retail is the largest sector of the asset-based finance industry, representing 25% of large syndicated loan activity over the past few years. This segment is under significant stress, but consumer confidence continues to buoy the sector. Our members have begun to see the impact of tariffs, particularly on importers of commodities and certain finished goods that have been held up in shipping and where pricing has affected COGS. This does create some stress on client profitability, which has both negative and positive consequences. The nature of our products is such that financial stress increases the need for working capital and in the event of default we are fully secured primarily by receivables and inventory.
Balboa Capital does an annual survey in the equipment leasing and finance industry and this year reports on Aug. 21 that 60 percent of small businesses use unsecured loans for expansion, new capital inventory and unexpected business expenses. Does that surprise you?
There has always been a place for unsecured lending and in recent years the supply of such loans beyond traditional bank sources has increased significantly through new online cash advance providers. These are generally viewed as supplemental loans. For sustainable operating capital, secured finance remains the core funding engine of small and mid-sized businesses.
Are secured lending companies mostly serving larger companies and what makes it an attractive source of capital?
Secured lenders fund all kinds of companies from large multinationals to small entrepreneurs. Large syndicated loans make up close to 40% of industry outstandings. The average syndicated loan is $100MM-$250MM, but there were 10 deals of >$1B in 2018 (like $2B for Nike – also to Energy, Infrastructure, Mfg.). Smaller companies are also significant consumers of factoring and asset-based loans as well as other forms of supply chain finance.
These sources of funds are typically used for working capital and the structures can be very flexible. They are also used for recaps and M&A. Generally, these forms of financing are most attractive for sub-investment grade companies or as a complement to investment-grade companies’ bond offerings and unsecured bank lines.
What are the top five types of customers your members serve and what ABL products and services are most in demand?
Retail trade, wholesale trade, general manufacturing, oil and gas, business services, healthcare, technology are all heavy consumers of secured revolvers, term loans and factored receivables.
How does your industry differ from the equipment leasing and finance industry which also provides funding for commercial expansion?
ABL and factoring primarily leverage borrowers’ receivables and inventory to provide working capital. These finance companies will also lend against equipment, real estate and even intellectual property, however, these assets are typically less liquid and require different expertise that equipment lessors can provide. Often asset-based lenders will complement equipment lessors to fund their clients.
Your organization recently produced a ground-breaking industry sizing and impact study to look at the size and nature of your network of companies. What was the most important learning from that study? Do you think your industry is well known and understood? If not, what should the business community know about your sector?
What is striking is the interconnectedness of alternative forms of secured finance. ABL complements leveraged lending and cash flow loans and waxes and wanes based on cycles in those markets. Factoring is an integral form of supply chain finance with multiple derivatives that extend into inventory finance and leasing. It is all these products in combination and the service providers who enable them that underpin nearly 20% of GDP.
I would say ABL in particular is the most prevalent half-trillion-dollar form of secured finance that most people have never heard of. Factoring and asset-based lending are often viewed as expensive and more targeted toward weaker credits. In reality they tap into the power of borrowers’ tangible and intangible assets to fuel operations across industries and company size and stage of development to drive our engines of commerce.
Is any of the growth you are seeing record setting?
We’re at all-time highs in loans outstanding. Our industry is up 6 percent this year and growing faster than the economy. We’re only about 10% of all C&I lending so we feel there is still a lot of room to grow. The countercyclical nature of the industry is such that it has the runway to become a more predominant form of finance even if the economy slows.