Better Credit Opportunities Ahead
June 9, 2011
California Apparel News
Better Credit Opportunities Ahead
By Deborah Belgum
Retailers and manufacturers who pulled through the economic downturn should pat themselves on the back. It was no easy feat to weather sluggish consumer demand, tight credit and tricky inventory levels.
Retail sales have been chugging along at a healthy clip for more than a year. In May, discount stores were the leaders in same-store sales, up 7.8 percent compared with last year, while overall same-store sales hovered around 4.9 percent, according to Thomson Reuters.
However, financial analysts expect consumers to pull back from spending with an uncertain economic future ahead, anemic employment figures, and higher gas and food prices shifting consumers’ spending patterns.
To get a better idea of how the credit situation is playing out in this economic climate, the California Apparel News talked with several finance sources about the apparel and retail industry.
How is the credit scene shaping up these days compared with last year? Is it harder or easier for manufacturers to get accounts-receivable financing to sell to retailers?
Sydnee Breuer: From a factoring perspective, the competitive landscape has changed, which in turn should make it easier to get financing—or at least have more offers on the table. In the past year, we have not only seen new competitors come into the local marketplace and rumors of more entering, but others that have stabilized their own financing issues and are now back and active in the market. There are deals to be done at all spectrums of the financing continuum, so it’s a matter of finding the right fit for the deal and at the right pricing—for both the manufacturer and lender.
Mitch Cohen: Lenders have a number of questions they need answered before making loans. What is the financial condition of the borrower? Is there sufficient collateral to warrant the loan? Does the borrower have adequate cash flow? Does the borrower have a strong and stable customer base? Does the borrower have a competitive position in the marketplace, and does it have staying power? Does it have a reliable and proven sourcing model? Does it have a strong and experienced management team, and does it have a strong stable of outside professionals advising it?
When aggregated, these variables affect whether the borrower will be able to get a loan and at what price. That said, strong borrowers might say that it is easier to get financing today than a few years ago because lenders have increased their level of competition among themselves. Weaker borrowers might say that it is harder to get financing.
Ron Garber: There is less concern this year than last on the retail front. Several retailers that we considered possible bankruptcies in 2009 and 2010 have survived and are showing improvement in their numbers. This is not to say certain major accounts are out of the woods, but so far, both the manufacturer and their factors have not experienced any significant write-offs in the apparel sector over the last 12 months.
This has given those of us who lend funds against accounts receivable more confidence in our collateral positions, especially when concentrations in any one or two customers are so prevalent in our industry. However, I am not very optimistic that this trend will continue based on recent economic forecasts and surveys taken by industry experts. My concern about the recent rise in unemployment, housing foreclosures, fewer hours worked and lower consumer confidence levels could result in a slowdown in economic growth leading to declining activity at retail. Couple this with rising anxiety for lenders, whatever slight uptick in GNP [gross national product] we’ve experienced during the last 12 months could be quickly snuffed out.
Rob Greenspan: From what I have seen and from my discussions with my clients, it seems the credit of their customers (retailers) has stabilized since last year. The retailers that were having trouble have either become financially stronger, so they are no longer a problem, or they are no longer in business.
From what I have seen, it appears the list of “surcharged” retailers (the ones who are getting credit but the manufacturer has to pay more to obtain that credit) is not getting any larger. In fact, in some cases, the surcharges are actually being lowered or removed.
Nick Hart: There has been some easing in the availability of credit compared with last year. There has been a big buildup of funds looking for investment-grade returns. These monies are beginning to find homes, and some acquisition and merger activity has been seen. These investments have been at a high dollar volume level, which are not yielding huge returns for the investors. But the money has to work even whilst underlying LIBOR rates are close to zero. These funds are typically not available to manufacturers in our market. However, there is a trickle-down effect, which is easing credit.
For small banks and asset-based lending companies obtaining funds from venture capitalists and investor groups, the availability of finance has increased. These are the companies that are now able to start lending again into the apparel sector. As with all lenders and borrowers, you have to look after your lender to avoid unforeseen shocks. This applies to lenders managing their venture-capital funds as well as apparel companies managing their factor. Open communication is the key, particularly of problems so you can work it out together. Some of the credit insurance limits on some of the major retailers are starting to tighten again as the market reviews the last quarter’s sales figures.
Sunnie Kim: Credit is much more available this year than it was a year ago. The ability to obtain credit is results-driven. Over the last year and a half, manufacturers have improved their positions by tightening expenses, shoring up their balance sheets and closely monitoring inventory levels. The companies that adhered to these practices are much stronger today than they were a year or two ago, while, conversely, those that did not follow these steps are suffering now—if still in business.
It should also be noted that manufacturers have a greater opportunity to do business than they did during the last few years because retailers are busier as the economy—although nowhere near as robust—is slowly improving.
Donald Nunnari: Manufacturers have a number of very good options in Los Angeles today to find excellent non-recourse factoring. Most apparel companies in town are astute to the cash-flow benefits of factoring along with the flexibility it provides. Apparel companies also seek the cost effectiveness and “peace of mind” that a non-recourse factor provides by guaranteeing and collecting the account receivables. Because of the uncertainty of the apparel business, having a factor with a full-service office in Los Angeles provides the manufacturer with a local lender to meet with long after the factoring salesperson has moved on to their next prospect.
Dave Reza: Both the retail and wholesale credit markets appear to be strengthening. With limited exception, major discount-, department- and specialty-store results demonstrate improved year-over-year and same-store sales gains. Domestic wholesale suppliers have enjoyed stronger demand as commodity prices have grown. To some extent, these same vendors will still enjoy strong sales as customers buy on shorter lead times as raw-material prices start to fall.
Manufacturers who practice good asset management and have a strong order book, a solid capital base and favorable operating results will find it easier to find financing. More capital availability is flowing into the local market as some new players are expanding into the West Coast.
Tri Sciarra: While the economy is slowly improving, high unemployment and a depressed housing market are limiting substantial growth. Consequently, the current credit environment is similar to last year. Over the last three years, banks have been less inclined to provide asset-based credit and are not granting unsecured credit to borrowers. This remains true today. Banks are also being very restrictive when it comes to secured credit, taking an even closer look at manufacturers’ past and present performance.
For commercial finance companies such as CBC, this credit environment has provided us with even more opportunity, as we look beyond a company’s balance sheet. CBC evaluates collateral performance, the management team and the organization’s business plan when determining whether or not to lend to a potential borrower. A manufacturer’s past problems are an opportunity to find a solution, not a reason to decline access to credit.
Ken Wengrod: There is money available for good people and good companies. The issue isn’t the availability of money in the credit scene but the strength of the manufacturer. We don’t want to be lending money for companies that are losing money. That has to be replaced by equity financing. But for those companies that are growing and need working capital, there is money out there to support them.
We see a lot of growth in companies that have $3 million to $10 million in annual volume, have a certain market niche and are using U.S. manufacturers to produce goods with a short lead time. We are seeing more people trying to manufacture here and over the border in Mexico to reduce lead times, which is the key thing right now.
What kind of criteria should manufacturers take into consideration if they want to accept orders from new retail clients?
Sydnee Breuer: Getting paid on the receivable should be priority No. 1. Why ship the merchandise if the prospects of getting paid are doubtful? And just because a retailer has been in business for years and has always paid its bills doesn’t necessarily mean the next bills will get paid. The underlying financials are key—and continuing to get updates is important. That’s the benefit to non-recourse factoring, where the factoring company stays on top of the credit quality of the retailers and can assist the manufacturer in making that decision. If the factor is not approving the retailer, there are still options to get the sale. Perhaps cash on delivery, some deposit up front (hopefully enough to cover cost of goods sold), shorter terms, etc.
A second criterion should be understanding how the retailer handles markdowns, allowances, damages and other deductions to the payment. Any reduction eats into the manufacturer’s profitability, and excessive ones cause the manufacturer to lose money on the order—or even cause the manufacturer to go out of business. Once again, knowledge is key here. Once the manufacturer understands how much of the receivable they can expect to get paid, they can work their pricing to the retailer backwards from there.
Mitch Cohen: Many manufacturers do not have the credit expertise or systems to adequately evaluate retail credit risk. This is a primary reason why apparel companies come to CIT. We have proprietary financial information and valuable insight into retailers’ credit history, based on our first-hand experience with them. This allows us to make informed customer credit decisions.
Here are a few suggestions of items to consider before accepting orders from new retail customers. First and foremost is the retailer’s pay history. Does the retailer have a history of paying on time? Other criteria are the retailer’s financial condition and its ability to pay future invoices. Manufacturers and vendors need to evaluate whether the retailer’s order enables them to achieve their desired profit margins. Lastly, are the terms of sale reasonable? These are all criteria manufacturers should take into consideration before accepting orders from new retail customers.
Ron Garber: Taking orders from new retail accounts must be done in a very disciplined manner. Checking their credit history as well as their penchant for making unjustified claims are paramount steps to take before commencing any major commitment with a first-time retail channel. In today’s world of technology, there are ample resources that will provide reliable information quickly to assist the manufacturer in being a wise seller.
A quick sale without proper due diligence can ultimately result in hours, if not weeks, of unproductive time spent in collecting or settling a bill—and that doesn’t even take into consideration the possible costs to recover your investment. The best piece of advice I can give is to check the customer out with a factor from a credit perspective and a manufacturer you know well who has past experience with the account from a merchandising/claims standpoint.
Rob Greenspan: As I have always said, the manufacturer should not be in the credit business. That is their factor’s job or the job of the credit insurance carrier to cover any losses.
Manufacturers have a tough enough business in doing what they do best, which is to design, merchandise, produce and ship their garments. Taking credit risks should not be their main interest. If their factor or insurance does not cover the retailer, then the manufacturer should think about taking a deposit using a credit card or cash payment to cover their cost of the goods to be produced or to cover the entire order.
Quite frankly, I am seeing more credit-card business than ever before. Once produced, and before shipment is made, the manufacturer should then get the balance paid by either credit card or cash. At this point, if the manufacturer wants to take some risk, although I do not recommend it, they can ship the balance (their gross-profit portion) at their own risk.
Nick Hart: Definitely speak to your factor to understand what financing is available and, if not, what options are available if you still want to proceed with the order. That particular customer could be carved out of an existing facility. Listen to your competitors for market intelligence. Of course, you have the best product line but do a sense check on why your product is going into a particular retailer. Do the doors make sense for your target market? Depending on which segment of the market you are attacking, chains or boutiques, negotiate as hard as you can on the vendor agreement over markdowns and other things.
We are seeing a rise in discounting. The economy has been on the slow rise but feels like it is stagnating a bit, which is leading to a wobble in consumer confidence. Ultimately, it will be your sell-through that determines how successful you will be with a particular retailer. So the huge order that is setting your business on the right path may not be the answer to your dreams if it is followed by 40 percent markdowns and returns at the end of the season. It will also give your factor a real headache. So choose your doors carefully and don’t get too carried away with an excited buyer. Know your end customer.
Sunnie Kim: Manufacturers should continue to use the same due diligence and best practices as always. They should look to do business with those retailers that are stable and have a good track record, solid financial position and proven management. Manufacturers have to understand that these precepts need to be paramount in order to attract potential customers to purchase their products.
Don Nunnari: Because non-recourse factors are specialists in credit evaluation and collecting accounts receivables, our primary guidance to our apparel clients is, foremost, the credit worthiness of the debtor, being here the retailer. Therefore, the primary criteria of the manufacturer should be the credit worthiness of the debtor and how they pay their bills. We can share with our apparel clients how these retailers not only pay their bills but also their history for disputing bills and taking deductions. This is a very important consideration for the manufacturer when evaluating their gross-profit margin. The manufacturer will make other determinations, including whether to sell a new customer based on how the product or brand fits into that retailer.