Reprinted from April 2011 issue of The Commercial Factor

The automotive market is heading toward a growth spurt, giving factors enormous opportunity to help fuel the growth of this country’s single largest manufacturing employer.

Pent up demand, consumer confidence and a shift towards fuel-efficient vehicles will spearhead this automotive Renaissance.  Industry analyst Lindsay Chappell predicts, “The U.S. market is now fully capable of selling 15 million or more new autos a year. A year or two at 10 million sales suggests there are millions more of unrealized sales out there just waiting to happen.”

This behemoth of an industry has come a long way in a short time. The Recession caused it to come to a screeching halt in 2008 and 2009.  But now, Toyota, Volkswagen, Kia and Audi are all opening plants, or expanding existing plants, in the Southeastern U.S. along with several new plants in California. The Big Three American auto makers — General Motors, Ford and Chrysler — are also all showing signs of a promising turnaround:

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  • •    GM reported after tax profits of $4.7 billion in 2010, making it its best year since 2004;
  • •    Ford surpassed GM, with after tax net profit of $6.56 billion,
  • •    And, Chrysler, the smallest of the Big Three, announced that even though it saw a net loss in 2010, it expects to see net profits of $200-500 million in 2011.

They all are betting that consumers will trade in a sizeable portion of the 250 million cars on the road today for more fuel efficient, technologically savvy models.

All of these indicators show this is a promising market for factoring, but not one without risk issues. It’s important that we as financers support this industry that is vital to the health of our economy. Here’s how the factoring industry can effectively capitalize on this trend:

Help suppliers meet demand

With growth on the horizon, the suppliers to the automotive industry are ramping up production to keep up with the demand for new products and the increased interest in current models. According to Autotrends.org, the industry has begun to recover the hundreds of thousands of jobs lost over the past five years. The automotive industry now directly employs over 685k Americans – and is hiring again. It generates an additional 3 million jobs through the suppliers that support them.

Although suppliers are expected to benefit from this resurgence, they’re now experiencing the growing pains that come from a spike in demand without increased liquidity. According to the Automotive Supplier Barometer of the Original Equipment Suppliers Association (OESA), an increasing number of suppliers are seeing increased operational costs across the board:  Production labor premiums, material cost premiums, set-up and change over costs, expedited freight, and inventory carrying costs. More than 90% of suppliers say their predominate concern is an increase in material costs. It has already forced some companies into bankruptcy.

Step in while banks remain reluctant lenders

With the cost of materials on the rise, supplier pain is exacerbated by the difficulty maintaining and obtaining bank loans. According to Automotive News industry analyst James B. Treece, despite parts suppliers’ healthy stock prices, banks are holding back from supporting this important sector. This could be due to the losses banks took from this sector during the Recession.

Suppliers are fighting back with mixed results. They have lobbied to get access to the low-interest government loan offered to automakers. But even after they were able to influence Congress to redraft the U.S. Department of Energy’s Advanced Technology Vehicles Manufacturing Loan Program to include suppliers, their ability to get the loans remains tentative at best. Even one of the industry’s largest suppliers, BorgWarner, was eventually denied a loan.

With government loans difficult to come by, factoring is an ideal cash flow solution for the automotive supplier market.

According to Marcus Ferrari, National Sales Director of Bibby Financial Services, “Currently, traditional bank lending is generally not available to automotive companies in the middle market so they must rely on asset based financing for working capital. But, as clients are pushing ABL lenders to generate more availability, ABL lenders are reaching out to factors that have international capabilities and purchase order finance companies to fill in the cash flow gaps.”

Bibby Financial Services had the opportunity to help an automotive manufacturing client that was forced into bankruptcy. Its sales fell due to the poor economic conditions in early 2009; they were in the unfortunate position of having Chrysler as their main customer at that time. Their bank called up their note on an otherwise performing loan before Chrysler declared bankruptcy, forcing the client into bankruptcy themselves. Bibby Financial Services received the client through DIP funding.

Understand industry tiers

It’s important to understand the automotive supply chain when entering this market.  There are three tiers of automotive manufacturing companies that will fuel this rebirth of the American auto industry. Each is defined by the end user of that company’s product.

Generally, Tier One suppliers provide full design, assembly and engineering support. They sell finished components, such as transmissions, seats and instrument panels, directly to car companies, known in the industry as Original Equipment Manufacturers (OEMs). Tier one is comprised mostly of large companies such as Delphi or Johnson Controls.

Tier Two companies mostly sell products to Tier One. An example of a typical Tier Two company would be one that supplies component parts, such as transmission gears, electronics, speedometers and seat covers, to the Tier One suppliers.

Tier Three suppliers generally provide smaller components and some tooling and dies to Tier Two companies. In practice, they sell to both Tier One and Tier Two.

“We consider all three tiers factorable,” says Robert Meyers, VP of Sales at Bibby Financial Service. “Tier Two is usually the most factorable tier with the lowest risk issues due to their size and position in the supply chain. Tier Three companies are factorable, but will have risk issues that need to be mitigated.

“We find that Tier Three companies typically will have the slowest paying customers because they sell to the second tier, which is waiting for cash from the first tier,” said Meyers. 

Tier Three companies that do tooling create special concerns for factors, according to Meyers. Tooling is usually billed in progress payments and it may take twelve months or longer to complete.

“There is always a chance the OEMs may change their product or not pay until it’s complete which creates liquidity problems for suppliers and risk issues for factors,” he warns.

Pursue credit insurance; beware contra accounts

Even with the Recession in the rear view mirror, pursuing credit insurance is a great way to mitigate risk in this sector and it is becoming easier to obtain again.

“Many Factors use credit insurance,” according to Scott Ettien, Senior Vice President of Trade Credit and Political Risks at Willis Financial Solutions. “It becomes a nice form of opening new credits and expanding existing lines, however, the availability of credit insurance will ebb and flow with the market sector and economic conditions. During the Recession, most credit insurers pulled away from automotive manufacturing companies but that is fading as individual financials and economic conditions improve. Because credit insurers monitor the market so carefully, they can supply an important third party expert opinion to bolster a factor’s own credit decisions which instills further disciplines during difficult times.”

Every tier may or may not also have contra accounts. For example, a Tier One company might supply materials to a Tier Two, which will then manufacture the product and sell it back to the same Tier One company.

“This can happen in any of the tiers,” according to Meyers, “but we tend to see it occur mostly in the top tiers where larger companies are involved.”

Review vendor agreements and purchase orders

With any tier of the automotive manufacturing industry, pay special attention to the vendor agreements and purchase orders. Some may have liquidated damages. The company may also have a performance guarantee that states if it doesn’t fulfill an entire order and the customer has to find an alternative supplier, they can charge the client for production costs as well as the costs associated with finding that additional supplier.

Facilitate flexible solutions

Finally, an important way to help companies in this sector is to bring together multiple lenders such as equipment, inventory and real estate financiers. You can then provide the maximum cash flow possible so these suppliers in every tier can help the US take its leadership position in the global automotive industry again.

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