How Does the Sub-Prime Mortgage Crisis Impact Your Staffing Company?

By: Andy Allaire and Tanya Boczek
Date: 2/1/2008

First of all, what is the sub-prime mortgage crisis? Over the last six years, the American dream of owning a home came true for millions of people - many of whom had less-thanstellar credit (i.e. the "sub-prime" market). The mortgage lenders, whether driven by greed or otherwise, lent money to these subprime borrowers utilizing adjustable rate mortgages ("ARMs"). These ARMs had very low initial rates (commonly referred to as "teaser rates") that would be fixed for a period of time - usually 3- 7 years - and would increase and "float" thereafter. To make matters worse, the banks frequently required little or no money down for these mortgages.

Now, as these teaser rates are maturing, interest rates are considerably higher than they were a few years ago. As a result, the mortgages are resetting to much higher floating interest rates. This is increasing monthly mortgage payments by as much as 300% in some instances. Many homeowners can not afford the higher mortgage payments and are defaulting on their loans in unprecedented numbers. This has caused a credit crunch at the banks -- i.e. it's tougher to get a loan now! This further exacerbates the problem, as there are fewer opportunities for these borrowers to refinance their mortgages. The default rate on these mortgages is already staggering, with many banks reporting losses in excess of $1 billion!

Still, your business seems pretty stable, sales are holding up well, your local and regional economy is still growing and the businessto- business market remains vibrant. So why should you worry that the credit crunch may impact negatively on your business?

The Trickle-Down Effect

For the most part, banks have very thin profit margins - a typical bank has a return on assets ("ROA") of 1.5 to 2.0 percent. This means if just 2 out of every 100 loans goes bad, it wipes out the bank's profits for the entire year! Banks experiencing losses in the mortgage market can't afford losses anywhere else in the bank - this leads to a tightening of the bank's credit policy across all lines of business.

In addition, in recent years, banks have been willing to take on additional risk because they could sell-off problem loan portfolios to hedge funds and other cash-rich buyers. But the market is now flooded with "bad" paper from all the banks. The buyers are no longer interested, and the market for a bank's "bad" paper has dried up virtually overnight.

And with the trend towards bank employee layoffs, fewer loan officers results in fewer new business loans and more time spent working out existing problem loans.

In sum, when bank credit tightens, the entire economy is affected. A recent survey of CFO optimism reports that one-third of responding companies have been hurt through decreased availability of credit.

So what does all this mean for your staffing company?

First of all, if your customers are not strong financially (and how many of them really are?), they may run into problems with their bank financing. And you could end up with a problem collecting your accounts receivable.

Secondly, if you're funded by a bank line of credit, tightening credit policy means your bank may have less tolerance for any hiccups in your business. Even banks with Asset-Based Lending and Factoring divisions are tightening their credit policies. Your borrowing availability may be reduced, or you may even be asked to leave the bank.

And if you're funded by a small factoring company, you could be at risk as well. Remember the trickle-down effect? Factoring companies have their own bank lines of credit. And the smaller, undercapitalized factoring companies are likely experiencing difficulty with their bank's changing appetite for risk. And if your factor's money runs out, so does yours!

Protecting yourself from the trickle-down effect

There are two keys to minimizing the impact this crisis can have on your company.

Key #1: Monitor Your Customers!

Reassess the creditworthiness and payment trends of all your customers. They may be suffering from the trickle-down effect themselves! If you utilize a factoring company to fund your business, they'll usually provide this credit function for free. The factor will conduct ongoing credit monitoring, payment trend analysis and overall accounts receivable management (including collection assistance on past due accounts). If your funding source does not provide these services, you can subscribe to a provider of business credit information for an additional fee (of course, then you'll need someone on staff who can review and analyze the credit reports). This is not a time to be Mr. Nice Guy! To protect your company (and stop the trickle-down effect!), customers who are paying slower or appear to be struggling financially should be placed on credit-hold or cut off.

Key #2: Monitor Your Lender!

Protect your access to working capital and cash flow! If you are funded by a bank that has a significant mortgage portfolio, you can plan on a tightening of credit. Don't wait until it's too late - begin reaching out to other banks or funding sources now! Access to continuous working capital financing (cash flow) is the lifeblood of every staffing company.

Likewise, if you're funded by a smaller factoring company, find out who their bank is. If their bank has a mortgage portfolio, your factoring company may very well run into its own funding problems - which trickles down to you!

The most stable sources of financing in these times are the wellcapitalized independent (non-bank) factors and lenders with little or no exposure to bad mortgage loans. Consider moving your line of credit to a large independent factor with a long-standing history.

Here are a few good questions to ask a potential factor: How long have you been in business? Have you survived various economic cycles? How financially sound and stable is the ownership? Who provides your financing? Do you have any non-bank sources of capital? How quickly can you respond if I need to move my line of credit to your institution?

In sum, the current attention paid to the sub-prime mortgage market and resulting credit crunch may seem like it is of no concern to you and your staffing company. But nobody is completely safe from the trickle-down effect! To improve your chances of survival, you need to take proactive steps to protect your business.

Andy Allaire and Tanya Boczek are business development officers for the nationwide firm Amerisource Staff Funding. They may be reached at aallaire@amerisourcefunding.com / (716) 662-0301 and tboczek@amerisourcefunding.com / (440) 365-2006.