If you borrow working capital from a factor or a commercial finance company, sooner or later you can expect to hear from a commercial banker eager to compete for your business.
When you do, clap and cheer--even if you don't qualify for bank lending.
Why? Bank of America, Wells Fargo, Sanwa, Comerica and a host of other big commercial banks compete for asset-based loans these days, and the competition puts pressure on all lenders in this arena, even factors, to cut prices--good news for any business owner who borrows against inventory or receivables, because this kind of capital doesn't come cheaply.
To understand why this is true, it helps to think of the market for debt capital as a continuum of risk, with safe bets at one end and dicey ones at the other. As a general rule, as capital flows from the safe to the less-safe end of the continuum, it pushes interest rates down.
Put another way, as more dollars chase higher lending risks, the cost of borrowing goes down. Conversely, as dollars flow toward safer bets, or disappear from the market altogether, the cost of borrowing goes up.
At the safe end of the continuum you find creditors of major corporations, among them commercial banks lending directly to big corporations, plus the buyers of bonds and other corporate obligations. Because the best of these obligations carry little risk, they earn interest at or just above the prime rate, the borrowers being "prime" customers.
As you move toward the middle of the spectrum, you find secured lenders holding liens against specific assets of a business. In the event of a bankruptcy, these lenders enjoy the right to claim and sell these assets--for example, equipment or real estate.
Toward the far end of the continuum, you find lenders who take bigger risks for bigger returns. These include institutional lenders--banks, pension funds and life insurers--and investors who lend to middle-market businesses in mezzanine financing deals described in this space in recent weeks. Bankers call these investors unsecured creditors for the good reason that, in a bankruptcy, they enjoy no right to seize and sell specific corporate assets.
Even farther down the continuum you find asset-based lenders and factors. An asset-based lender holds a lien against your receivables or inventory or both, and may seize and sell them if you go belly up. A factor buys your receivables at a discount and stands to collect on them in full no matter what happens to you.
As this description shows, when lenders move from the safe to the dicey end of the continuum, they give up security and take on risk. They also earn more interest.
But no matter what kind of loans they make, these days lenders want to get their capital out at interest, and any change in the competition affects a wide part of the continuum.
"In good economic times, money becomes available and the banks get aggressive in our market," said Bron Hafner, CEO of Celtic Capital Corp. of Santa Monica, a commercial finance company specializing in asset-based lending to small and middle-market manufacturers, distributors, printers, job shops and service organizations posting $1 million to $10 million in sales.
"Banks make more credit available at cheaper rates than we can offer. This economic upturn has been so extended that it has affected our business significantly," Hafner said.
"When banks do the kind of lending we do, they generally don't monitor things as closely as we do. We do hands-on monitoring of inventory or receivables. And where banks look to a company's financial ratios, we look at the collateral," he said.
"So if a bank wants to do a particular deal, they're going to get the business because they can do it cheaper."
The pricing differential is nothing to sneeze at, Hafner said. Banks offer asset-based loans at prime plus three to five points; commercial finance companies typically charge six points over prime, plus fees for certain services.
John Danis, a partner at Redondo Beach-based Riviera Finance, which does factoring against receivables for small businesses, also has seen commercial banks come and go as asset-based lenders. Danis said that commercial banks, laboring to get loans on the books, will burn their fingers and pull back at some point.
Danis agrees that competition from banks has pushed prices down at his end of the continuum, even though, as a factor, he doesn't compete directly with either banks or commercial finance companies.
"Although factors and asset-based lenders look similar, on the inside they're different," he said.
"Asset-based lenders lend money against the invoice. We purchase the invoice from the client. And the clients we do business with generally don't qualify for bank lending of any kind--because they don't have a credit history or any of the other things a bank wants."
But they do have receivables. Factors "advance" against the value of the invoice by buying it at a discount and then collecting directly from the debtor. They don't lend money, but from the standpoint of the business owner, they might as well--since it costs money to turn an invoice into cash whether you sell it to a factor or borrow against it from an asset-based lender.
"Commercial banks dominate the competition for asset-based lending at the upper end of the market," Danis said, "and they're moving into the upper-middle end because they're under pressure to lend money."
At present, banks chase only the most credit-worthy customers needing asset-based loans. They leave commercial finance companies and even factors to fight over the leftovers--businesses presenting greater risks, most of them small and struggling--but the competition means good things for the owners of these businesses.
They need capital, and the more eagerly everybody competes to supply it, the better.
Freelance writer Juan Hovey can be reached at (805) 492-7909 or by e-mail at email@example.com