Companies Jump into the Financing Gap

Companies are turning out to be the unsung heroes of the credit crunch. So-called trade credit, essentially company-to-company IOUs for goods and services, has held steady at $2.15 trillion this year. By comparison, bank lending to businesses declined 6.7%, to $1.5 trillion. "You have to sell a product," says William S. Veatch, an attorney at Morrison & Foerster. "If you can do that by extending credit, it's a smart business move."

The strategy isn't new. Many large industrial players such as Paccar (PCAR) and Caterpillar (CAT) established financing arms years ago to make loans to customers. The units apply strict standards and operate like a traditional lender. Amid the recession, other types of companies have begun offering flexible financing options, generally on a case-by-case basis through their sales teams.

The strategy—whether formal or informal—is controversial. By making loans or pushing off payments, a company reduces its cash flow and increases its accounts receivable, the money owed by customers. The fear among some investors, especially in the current environment, is that troubled customers will never pay those bills. And if the buyers go belly-up, the company gets stuck with the losses. More than 11% of high-yield corporate borrowers defaulted in the past 12 months, according to Standard & Poor's (MHP).

Such risks prompted Caterpillar to take a hard look at its 25-year-old financing group earlier this year. After a three-month study by Goldman Sachs (GS), Lazard (LAZ), and JPMorgan Chase (JPM), Caterpillar concluded that, with banks retreating, customer credit was critical. The bankers also said the financing group would be an important part of expanding the business, particularly in developing markets.

Dolan Media (DM) started tweaking its financing terms to expand its business. The Minneapolis publisher of trade journals has been trying to beef up a unit that processes mortgage default paperwork for law firms. To attract clients, Dolan offers them up to 45 days to pay, levying a higher fee for customers that decide up front to put off the bill. "We are continuing to try to gain share in doing these types of services," says Vicki Duncomb, Dolan's chief financial officer.

Other companies are filling the lending void to protect their business. Compellent Technologies (CML), a fast-growing data storage company, has allowed select customers ensnared by the credit contraction to defer payments. Companies such as Compellent aren't advertising their efforts. The worry: If other clients learn of the favorable deals, they'll want the same. "We occasionally use the strength of our balance sheet to bring in some customers we wouldn't have otherwise," says CFO Jack Judd. Revenues at the company surged 31% in the third quarter from the previous year.

Tight lending standards are critical. Paccar, the maker of Kenworth and Peterbilt trucks, regularly plays the role of creditor. In trucking, banks pull back about every six to seven years when the industry goes into a cyclical slump. As that happens, Paccar increases its financing from 25% to 30% of the total sales. Paccar digs into its customers' financials. That's kept bad loans under control: Accounts past due peaked at 4.9% this year, a lower level than the two previous recessions. "[Paccar] is not the lender of last resort," says Robin Easton, the company's treasurer. "Every deal we do needs to stand on its own two feet."

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