Short-Term Business Credit Institutions, Except Agricultural

SIC 6153

Industry report:

This industry includes establishments primarily engaged in extending credit to business enterprises for relatively short periods. Private establishments primarily engaged in extending agricultural credit are classified in SIC 6159: Miscellaneous Business Credit Institutions.

Industry Snapshot

Credit generally refers to a purchase, or the power to make a purchase, of goods for use in the present with payment deferred to a future date. Granting credit typically depends on three factors: character of the borrower, capacity to repay, and capital used as collateral. Each of these factors introduces some risk into the transaction. The risk of lending on character is called "moral risk," the risk of lending on capacity is called "business risk," and the risk of lending on capital is called "property risk." An ideal borrower will combine a minimum of each of these three risks.

Lenders are often not in a position to evaluate a business against these criteria as easily as they could with an individual. Consequently, they may contact either general or special mercantile agencies to find needed information. General agencies, such as Dun & Bradstreet, collect information on a wide range of business enterprises nationwide. Special agencies limit their coverage to one or few business areas and may operate nationally or locally.

General agencies furnish general and special reports. General reports are leased by subscribers on a quarterly basis and contain information on capital (based on financial statements) and credit, denoting the grade of credit ratings. Special reports are limited to specific businesses or companies and are obtained under contract. These reports are more extensive than the general reports and contain background as well as general information. Credit reporting agencies collect their information from several sources, including direct investigation, trade creditor and banking connections, insurance records, and public records. The lenders usually pay an annual fee to these agencies in exchange for an unlimited amount of information.

In the latter part of the first decade of the twenty-first century, lenders found themselves taking a careful look at the information they received. Because of fallout from a depressed housing market and a meltdown in subprime mortgage loans, business owners were having an increasingly difficult time securing funding for their ventures as lenders had become wary and tightened their standards. A quick decline in the combined loans between outstanding commercial and industrial bank loans along with short-term loans known as commercial paper toward the end of 2007 made for a bleak outlook. The Federal Reserve conducted a survey of bank loan officers in October 2007 and found that about 20 percent of lenders had tightened lending requirements for commercial and industrial loans for large and midsize businesses over the previous three months. A smaller percentage reported tightening lending to small companies.

Rather than improving, however, the financial situation worsened, and by 2008 the United States had entered a full-blown recession, a situation that affected every facet of the banking industry in the nation as well as around the world. By late 2010, many industry participants were calling for a long and slow recovery.

Organization and Structure

Business transactions, including credit transactions, are regulated by the Uniform Commercial Code (UCC). The UCC is a standardized commercial law effective in most U.S. jurisdictions whose goal is to simplify interactions between businesses. The numerous entities that constitute this category have varying organizations and structures.

Purchasers of Accounts Receivable and Commercial Paper.
Accounts receivables are promises from customers to pay for goods or services that have already been rendered. Commercial paper is any form of short-term negotiable instrument that arises out of a commercial transaction, to be distinguished from speculative, investment, real estate, personal, or public transactions. Many companies receive financing by using their accounts receivable as collateral, or selling the accounts outright at a discount. According to the Federal Reserve, at the end of 2006, there was $1.98 trillion outstanding in seasonally adjusted and $1.95 trillion in not seasonally adjusted commercial paper.

Factors of Commercial Paper.
Factors provide financing on accounts receivable by discounting accounts receivable on a nonrecourse basis. Upon buying the accounts, the factor assumes the position of the seller--including the risk of default and credit losses--and may not hold the original seller liable in the event of loss. The factor then pays the entity that sold the account, paying upward of 85 percent of the face value of the account receivable. The remaining amount is considered a discount fee, which is the factor's payment. In short, factors buy the accounts on an "as is" basis. Customers then pay factors. Factors often are also engaged in inventory financing, secured loans against fixed assets and other resources, as well as unsecured loans. They may also offer financial advisory services.

Sellers benefit from using factors because they are able to avoid tying up working capital in accounts receivable for the full credit period, which may be several months. Another advantage enjoyed by sellers using factors is that they may eliminate their in-house credit and collection departments.

Financing of Dealers by Motor Vehicle Manufacturers' Organizations.
Automobile manufacturers offer "floor plan" financing to support dealers' sales and leasing programs. Floor plan financing, or trust receipt financing, is a form of inventory financing under which the bank holds title to the automobile inventory. The dealer is loaned money to buy the inventory from the original equipment manufacturer and holds the inventory in trust for the manufacturer. As the borrower sells inventory to consumers, he pays these proceeds to the manufacturer. The dealer keeps the mark-up of the retail price over the payments due the manufacturer. When the sale is made on a credit basis, the dealer often sells the obligation to the manufacturer. This practice is used in other industries as well as the automobile industry.

Mercantile Financing.
Mercantile financing is typically done through the sale of mercantile paper. Mercantile paper is a note, acceptance, or bill of exchange made or endorsed by concerns engaged in jobbing, wholesaling, or retailing of commodities.

Working Capital Financing.
Working capital refers to an entity's net current (or liquid) assets, or current assets minus the current liabilities (those expected to mature within one year). This excess, called free working capital, is the cash available to meet a company's liabilities as they mature over this one-year period. This liquidity is achieved by a number of means including trade credit, bank loans, factoring, and sales of accounts receivable.

Background and Development

As the U.S. economy became more complex and competitive in the 1980s and 1990s, businesses needed increasingly flexible short-term financing to remain competitive. This flexibility was provided by a business credit market that offered a variety of financing options.

Co-branding led business credit institutions to get involved in other services. General Motors (GM), for example, was involved in financing the sale of its cars to consumers and floor plan financing. In the early 1990s, GM got involved in credit card financing in a co-branding arrangement with MasterCard, thus providing automobile and credit card financing to its customers. By 1994, GM had earned $9.4 billion from financing. Ford Motor Credit was also involved in this type of co-branding financing, earning $21.3 billion in 1994.

Throughout the 1990s, most business credit institutions broadened the range of services offered. In the late 1990s, the major credit card companies began to offer purchasing or procurement cards in addition to typical business credit cards. These cards were designed to make the purchase of small items cheaper and more efficient. The average company conducted 90,000 transactions--typically individual purchases of $10,000 or less--annually.

All three major credit card providers--MasterCard International Incorporated, American Express, and Visa USA--adapted their services in the late 1990s to facilitate electronic commerce conducted business-to-business. In late 1999, MasterCard and American Express expanded their alliances with e-commerce businesses: MasterCard allied itself with Commerce One, which tailored its BuySite and MarketSite to accept online payment with the MasterCard Corporate Purchasing Card; American Express increased the number of affiliations with e-commerce companies in its portfolio, adding Clarus, Extensity, Sun-Netscape Alliance, and Trilogy to its affiliations with Ariba, Commerce One, Concur Technologies, Intelisys, Remedy, and tradex Technologies.

At the same time, Visa USA focused its efforts on tailoring its procurement cards toward the newly defined global commodity code standards merging the United Nations' Common Coding System (UNCCS) and Dun and Bradstreet's Standard Products and Services Codes (SPSC) to create UN/SPSC Codes specifically for electronic commerce. SAP ag, Visa's ally in e-commerce, adopted this coding system to streamline its purchasing systems, paving the way for other affiliates such as Ariba.

All of the major international credit card companies--American Express, MasterCard International and its affiliates Europay and Mondex, Visa International, and JCB of Japan--joined forces in the Smart Card Security Users Group (SCSUG) to create a standardized system, called Common Criteria, for evaluating the security of smart cards. The astronomical increase in online credit card use brought with it the inherent fraud enabled by transactions conducted in such a public forum. Credit card security thus became a key issue, not only in terms of real protection but also in terms of consumer perceptions of security.

The credit industry prospered after historically low interest rates spurred a sluggish economy during the early 2000s, but interest rates rose in the mid-2000s. Trouble with the cost of adjusting rates in subprime mortgages triggered delinquencies and foreclosures at record rates later in the decade, prompting lenders to take drastic measures.

After the combination of outstanding commercial and industrial bank loans and short-term loans known as commercial paper peaked at about $3.3 trillion in August 2007, such credit dropped nearly 9 percent by mid-November. According to The New York Times, the decline was the most dramatic drop since the Fed began tracking those numbers in 1973. Fed vice chairman Donald L. Kohn acknowledged in November that the trouble in the mortgage and housing industries appeared to be reducing credit to businesses as well as individual consumers. "Since the resale market went away, major banks have had much less availability to make loans. Absolutely, credit is much less available," said Mark A. Sunshine, president of First Capital, a private commercial lender.

The financial situation worsened as the end of the decade neared, and the U.S. government stepped in to try to provide relief when it passed the Emergency Economic Stabilization Act of 2008, which the Insurance Information Institute called "a $700 billion rescue plan for the U.S. financial services industry." Bail-out receivers included former auto industry giants GM and Chrysler. Another attempt to promote economic recovery came in 2009 from the U.S. Treasury Department with the implementation of the Financial Stability Plan. Despite these efforts, the United States entered a recession that many compared to that of the 1930s. FDIC reported 25 bank failures in 2008 and 140 in 2009. One hundred thirty-two more banks had closed by October 2010. By comparison, two and three banks failed in 2003 and 2004, respectively.

Current Conditions

Conditions seemed to have improved by late 2010, although the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law by President Obama on July 21, increased government control over the financial sector. The act called for a massive overhaul of financial services regulation. The legislation was "expected to result in at least 243 new formal rulemakings by at least 11 federal agencies, including some new entities," according to Iowa Banking Law. Some of the changes included the creation of a Financial Stability Oversight Council and an Office of Financial Research, meant to oversee large BHCs; the establishment of a Consumer Financial Protection Bureau, to enhance and oversee consumer rights issues; the reduction of total TARP spending from $700 billion to $475 billion; and new record-keeping requirements for hedge funds, among many other provisions.

The industry was also affcted by the Credit Card Accountability Responsibility and Disclosure Act of 2009 (Credit CARD Act of 2009), a federal law passed in May 2009. The legislation aimed to "to establish fair and transparent practices relating to the extension of credit under an open end consumer credit plan." Although the act included several provisions regarding how credit card companies can charge consumers, it did not address price controls, rate caps, or fee setting. Opinions differed on whether the bill would actually help the industry.

Industry Leaders

The top 10 financers of small businesses with the largest loan balances in 2009, according to Entrepreneur magazine, were American Express Bank, Capital One Bank, First Citizens Bank and Trust, Wells Fargo Bank, People's United Bank, First National Bank, Hamni Bank, Wright Express Financial Services Corp., Renasant Bank, and Advanta Bank.

Workforce

The short-term business credit industry includes many diverse companies, employing anywhere from 2 to 50,000 employees. These occupations include bankers, tellers, loan officers, secretaries, and security personnel.

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