Smooth sailing expected, credit and collections professionals say
As credit and collections professionals prepare to convene in New Orleans this June at the ELFA Credit and Collections Management Conference, Equipment Leasing & Finance brings four industry leaders together to discuss issues ranging from their thoughts on the current state of delinquencies to the new processes and procedures they are employing to navigate through both known and unforeseen credit risks.Delinquencies & Losses: Calm Seas, Occasional Whitecaps
Stability. That’s the consensus as to the state of things in today’s credit and collections environment. Eric McGriff, Chief Credit Officer at EverBank Commercial Finance, says, “If you look at performance trends in a historical context, delinquency and losses are very low even though there have been some increases. Overall, things remain stable.”“Along with everyone else in the industry, we’ve seen a slight uptick in delinquencies, but it’s nothing that causes me alarm. It’s the natural ebb and flow of the way the market works. Our default rates and losses are in line with where we expect them to be,” observes Robert Fagan, Vice President of Customer Service and Collections at Eastern Funding LLC.
Ben Carlile, Maxim Commercial Capital, LLC’s Portfolio Risk Officer, agrees. “From our viewpoint, we expect very little change in delinquency levels this year. At the same time, we expect continued improvement in reducing charge-offs. Sure, there may be increased competition or new imbalances in the economy headed our way that might start to influence our delinquency numbers, but we are optimistic about 2018 and 2019 at this point in time.”
But, does that paint the entire picture? McGriff notes, “We’ve seen some increases in specific industries. For example, transportation went through a mid-cycle downturn at the end of 2015 and into 2016, which impacted smaller operators. Today, that industry is looking more favorable.”
“If you look at performance trends in a historical context, delinquency and losses are very low even though there have been some increases. Overall, things remain stable.”
—Eric McGriff, EverBank Commercial Finance
He continues, “The retail sector, and in particular brick and mortar retail, has also caused some concern. A number of very large retailers have announced closings scheduled for 2018. That can cause some stress in some markets, particularly commercial real estate. But again, my outlook right now is stable. I’m not anticipating any vast improvements, nor am I anticipating deterioration as far as credit metrics are concerned. I’m also not anticipating rising interest rates having a material impact on credit quality unless rate hikes are extreme.”
To offer a view from the industry’s captive segment, Cisco Systems Capital Corporation’s Chief Credit Officer Amy Wingate says, “Over the last five years, our loss-given defaults have been fairly stable; and right now looking forward to the macro-environment, we are starting to see some shifts in certain sectors. We see some hiccups in the smaller retail space due to the ‘Amazon effect.’ We’ve seen some bankruptcies in that segment as well as some smaller hospital bankruptcies. We are watching trends in both industries closely.”
“We’re using a new technology that allows us to gather real-time information… It’s been a home run so far, and I suspect it’s going to be beneficial going forward as well.”
—Robert Fagan, Eastern Funding LLC.
Barometric Reading: The Journey Thus Far
Looking back over the last 12 months, did these industry leaders experience any atmospheric pressures, either internally or externally driven?Carlile references internal changes at Maxim Commercial Capital. “As a company, we’ve improved our management, our processes and our training. That’s why our delinquencies and charge-offs have really come down. In addition to real estate and other equipment, we finance Class 8 tractors to owner-operators, and that’s a tough business. There’s a lot of competition in that market. We make sure our customers understand the contract and have enough reserve funds on hand for maintenance and repairs. As of now, things are going well, and every month we get better at managing this business line.”
On the technology side and with a broader view, Wingate says, “We’ve seen a fundamental shift in the way our customers want to consume technology, and that has had an impact on the traditional lease-type structures we’re used to seeing. We’re moving away from financing the hardware and boxes toward subscription service offerings.”
As such, Wingate notes that her firm’s customers are asking for increased flexibility. She adds, “Our credit organization is instrumental in crafting structures that fit their needs. As a credit organization, our challenge is to make sure we can scale those solutions in a cost-effective manner. While these solutions have been several years in the making, we’ve had a lot of success in monetizing managed services. We have some open pay structures that help customers focus on variable usage versus fixed usage, and we’re starting to see an uptick in success there. That’s how we’re maintaining a competitive edge in the current leasing landscape.”
For Fagan, the most significant change has come from the outside. He says the biggest change was the Federal Reserve raising the Fed Funds rate three times in 2017. “We have a number of variable rate loans in our portfolio and, as a consequence, those customers have seen their payments increase. That could be a back-breaker for some people. I think we’ve done a good job from a credit quality standpoint. It starts at the top with our credit committee, and they’ve done an excellent job in sifting through what we like and what we don’t like. All of this shows up in our numbers, and we’ve been under 1% in over 30-day delinquencies the entire year. Today, we’re right in line where we need to be.”
EverBank’s McGriff tempers his largely positive outlook with only a slight hint of caution. He states, “As I look back to 2017 and going into 2018, I’m able to say that for the very first time, things are looking very good.” As for the cautiousness, he adds, “Maybe that should make me a bit nervous … but from today’s perspective, that’s how I see things. That’s the nature of a credit person; when things are looking good, we get a bit nervous.”
For the most part, Fagan expresses the views of these credit collections professionals as he contemplates the future. “I see things being business as normal.”
Keeping an Even Keel: New Processes and Procedures
While the seascape remains relatively calm, we asked about any new processes and procedures implemented in their operations to ensure continued steadiness as they chart their courses.
“We’ve seen a fundamental shift in the way our customers want to consume technology, and that has had an impact on the traditional lease-type structures we’re used to seeing.”
—Amy Wingate, Cisco Systems Capital Corporation
Wingate notes changes on both the product offerings side as well as on the operations side of the house. She says, “One of the most innovative things we’ve done is developed the ability to meter usage and comingle that usage with the lease product. Our partners are looking to us to help match their cash flows in instances where a traditional lease structure doesn’t do that. Another offering is our open pay structure, which allows our customers to consume the technology without the complete cost of ownership. It’s taking the traditional fair market lease structure and forming a product that fits their needs, but where we take the residual risk on the asset.”
Operationally, Wingate explains, systems are becoming more complex. “We’ve implemented some new technology impacting the way we invoice, the way we collect and the way we approve credit. As with most integration, these things should pay off in the long term. In the shorter term, you simply have to work through the pain points.”
McGriff offers, “Achieving greater utilization through technology has always been an industry-wide concern. Today, I think the issue is more about refinement and improvement as opposed to any radical changes. One thing I hear a lot about these days is machine learning. There’s a great deal of focus on the ways machine learning can be incorporated into credit scoring and the credit process to enhance credit results.”
In essence, McGriff explains, machine learning introduces other parameters that go beyond an institution’s credit scoring model and, in theory, combines those correlations with a given score to improve results. Yet, he notes, there could be implicit problems in taking advantage of these enhancements.
“I’m at the early stage of exploring machine learning, but one area I see where this can run afoul is with the regulators. You might wind up pulling in factors that build certain biases that aren’t suitable in a banking environment.”
Fagan shares the biggest change that has occurred in Eastern Funding’s collections and legal operations. “We’re using a new technology that allows us to gather real-time information. As we all know in collections, you wind up with people who don’t want to speak with you. This technology has enabled us to locate these people through secondary numbers and other businesses they own. It’s been a home run so far, and I suspect it’s going to be beneficial going forward as well.”
In summation, and as Carlile notes, “Every company has to look for ways to continually improve their processes. Our company is not different in that regard. We are always looking for better ways to do things and new practices that can be integrated into our business lines. But we need to be disciplined in this approach so that what we have remains organized and efficient overall.
Credit and Collections By the Numbers
As delinquency and default rates hover at record lows, Thomas Ware, Senior Vice President, Analytics and Product Development at PayNet, Inc., points to four key factors.“We have seen the weaker borrowers wiped away, the lenders being very conservative, the borrowers being conservative as well and a better economic environment than anyone expected. We saw these four factors come together, and that set the stage for record absolute lows.”
While delinquencies and defaults are slightly elevated from those lows, Ware notes, they have flattened out as of late. “It’s a nice place to be, but I don’t think it’s sustainable forever.”
The PayNet Small Business Default Index hit a new post-recession peak default rate of 1.89% in April 2017, up 0.25% from a year before, but has since moderated slightly to 1.83%. “At the industry level, agricultural default rates have almost tripled from a low of 0.78% in February 2014 up to 2.12% today, which puts it in the very unusual situation of being higher than the construction industry default rate of 2.07%,” notes Ware.
Other findings from the Index? Transportation default rates had a similar run-up, going from 2.18% in August 2014 to 4.67% in May 2017, but have since improved to 4%. Mining, meanwhile, went from 0.99% in April 2014 to 4.88% a year ago, down to 2.7% today. Conversely, information services including telecom, internet and the media are showing the greatest increase in defaults, increasing from 2.23% a year ago to 3.14% today. And defaults in accommodations and food services increased by 0.38% during the year.
As for new business, Ware states that originations in the fourth quarter were up 7% compared to the year before, the largest year-over-year increase in two years, which resulted in the highest level of originations seen in two years, “a good sign for the year to come.”
And what about CECL? With implementation dates looming on the not-too-distant horizon, Ware says that the Current Expected Credit Loss FASB standard has moved from a future concern to a top priority. “We’re definitely in a ramp-up stage, and I think it’s very important to remember that CECL applies to all lenders. It’s an accounting standard, and if your institution uses accounting and makes loans, CECL applies to you.”
Of course, implementation brings about a new level of compliance. At the same time, Ware sees CECL as a move in the right direction. “Net-net, I think a lot of good things will come out of it. For one, CECL will shift the focus more on loss as opposed to default. Historically, we have focused on defaults because that’s what we could measure and yet, it’s the losses that we care about,” notes Ware.
Ware further explains that total-loss defaults only amount to 12% of all defaults in general. “Total-loss defaults depend on a number of variables, and when you drill down into the specifics, total losses among seven-figure deals are extremely rare whereas total losses among deals $10,000 and under occur in one out of six defaults.”
While PayNet is currently rolling out a whole suite of CECL Expected Loss models for equipment finance, Ware notes that CECL rules don’t specifically dictate the way a lender calculates expected losses. Some lenders will approach the CECL rules on an overall portfolio basis, or what Ware calls a top-down approach. He says, “Using that approach doesn’t give the lender the benefit of understanding the details at the level of the borrower type, asset and transaction size, and other specifics. In my estimation, a bottom-up approach implemented on a deal by deal basis will be more beneficial. My sense is that this will become the preferred approach.”
Regulatory Matters: Red Sky at Night, Lessor’s Delight?
There’s an old sailing adage, “Red sky at night, sailor’s delight. Red sky in morning, sailors take warning.” Paraphrased, this could apply handily to the current state of regulatory and compliance matters. McGriff points out the following: “As far as the regulatory environment is concerned, I’m unaware of anything on the horizon. In fact, I was recently at a session with the ELFA Credit and Collections Planning Committee. In years past, the conversation has been focused heavily on regulatory issues, and that wasn’t quite the case this year.”He adds, “Of course, that could change by mid-year, but nothing new is showing up at this point.”
Carlile, on the other hand, eyes some potential billows on the horizon. “We’re not a bank, so we’re not on the front lines of regulatory battles. But there are things that concern us. For example, the regulations are becoming more complex, and that is trickling down to the independents as well. There is also the encroachment of consumer protection laws into the small business finance segment. That’s something we don’t like. We want to comply, but we don’t want these things to hamper our ability to compete.”
For her part, Wingate states, “Regulatory and compliance are a challenge for us even though we’re not a bank. In my group, we work with our external accounting firm and our controllers who monitor new regulations, laws and accounting changes. With our new product offerings, we have to find ways for our teams to collaborate to get these products to market, while making sure we stay compliant and above board with all of our financial reporting.”
One thing is for certain: Compliance and all that comes with it is here to stay. Therefore, all concur that a high degree of internal and external collaboration is key when it comes to dealing effectively with such matters.
On a related topic, we asked these professionals to comment on their level of involvement regarding the implementation of the Current Expected Credit Loss (CECL) standard scheduled in early 2019. Here again, the responses were consistent.
For the bank-affiliated equipment leasing and finance companies—Eastern Funding and EverBank Commercial Finance—both note that CECL implementation is being addressed at the highest levels of their respective institutions. In short, both Fagan and McGriff are awaiting their marching orders. Still, both expect to become involved in the not-so-far-off future. Similarly, Wingate says, “That one hasn’t come across my desk yet.”
Carlile has a bit more to offer on the topic. He explains, “As a privately held small financial entity, we maintain and improve our own forecasts for expected credit losses, and they are reviewed and audited. We are looking at the FASB CECL regulation, but our compliance deadline is not imminent. However, even though compliance is not on the front burner for 2018, we are always striving to improve our own risk analysis, and bring in new ideas and analytical tools.”
Challenges and Opportunities: Westward Ho!
To wrap up the discussion, we asked these professionals to weigh in on the key challenges and opportunities as they see them. Fagan notes, “Overall we’ve experienced unbelievable growth, and we’ve set a record this year as far as originations go. We’ve also set a record regarding the collection of fees on our end. That, of course, goes to the bottom line. At Eastern Funding, we’re in the process of exploring other markets to bring greater diversity to our portfolio. The question before us is, ‘What’s next?’”Carlile senses things similarly. “As an opportunistic firm, we see many opportunities available to us. Of course, we can’t take them all on at once, and we are sometimes challenged to find the right people to fit the right roles in our business lines. We have to keep this in mind as we chart our growth plans.”
From where she sits, Wingate explains that her focus lies as follows: “I think the biggest challenge is to stay in front of the problems before they become problems. Any risk manager is going to tell you that. We’ve been able to automate some metrics within our portfolio, and we’re very focused on yellow-flag reviews and red-flag reviews to make sure these periodic reviews are automated for our credit managers. With our portfolio management function, we’re trying to be as proactive as possible. If we do detect areas of softness, we can respond quickly.”
For McGriff, such challenges and opportunities are more likely to be realized at the organizational level rather than at the level of the industry as a whole. “Issues like effectively delivering your products to your clients or using technology to enhance your ties to your customers all continue to be important, but they aren’t new. My sense is that everyone in the industry will continue working on these goals.
“However,” McGriff adds, “When it comes to staffing, it seems the heat has been turned up a bit. It’s a more competitive marketplace and we’re starting to see movement there. Perhaps it’s a sign that the marketplace for talent is getting more intense. We’ve been fortunate in terms of our credit people, and we’ve had a very stable environment in that regard.”
As current conditions point to stability in the marketplace, these credit and collections leaders expect relatively safe and uneventful passages, at least for now.
Don’t miss the 2018 Credit & Collections Management Conference, June 4–6 at the Omni Royal Orleans in New Orleans. For details visit www.elfaonline.org/events
