“We’re cautious right now because things could change quickly,” says Sarah Palmer, Underwriting and Asset Management Executive, Key Equipment Finance and Chair of ELFA’s Credit & Collections Planning Committee. 

Her words, spoken a few weeks before the Silicon Valley Bank collapse and its fallout, underline the economic uncertainty that credit and collections professionals face going into the second quarter of 2023.

Right now, it’s unclear whether the SVB wake will result in minor ripples, strong currents or a flood of course corrections, including new banking regulations.

“SVB was caused by multiple factors,” says Tom Ware, President, Tom Ware Advisory Services, “but the root cause was funding long-term fixed rate assets with shorter term essentially floating rate liabilities. SVB made a huge bet that rates would never rise, and they lost the bet.”

But it’s not as though the credit and collections landscape lacked uncertainty before SVB. Experts note a slowdown in business investment—in part because of higher interest rates—and a subsequent slowing of originations of loans and leases in the equipment finance industry. 

All of this has many believing a recession is coming. “Many anticipate that we will see a recession in the next 12 months and the questions are around timing and impact,” says Teuni Breg, Head of Risk, DLL. “The recent banking turmoil is expected to put further pressure on economic growth.”

If that holds true, it presents credit and collection professionals with a puzzle.

“There hasn’t been a recession since 2008,” Ware points out. “There are people with 10-plus years of experience in this industry who haven’t seen a recession yet.”

“One challenge is the experience managing a portfolio through a real recession,” Palmer says. Each recession is unique, with varying lengths and underlying reasons. 

“We’re really in somewhat of an uncharted territory for credit teams across the industry,” adds Christine Holguin, Industry Credit Lead, Fifth Third Bank, National Association. “Now is the time to excel at client selection and relationships.”

Post-Covid Getting into Focus

Professionals agree that the credit and collections landscape has become a bit clearer after the pandemic, especially as the Payroll Protection Program money has run its course.

This gradual “return to normal” is allowing everyone to see how a business is truly doing, says Jim Tobin, Director, Retail Credit with Volvo Financial Services. Credit and collection teams can look at the source and quality of a company’s revenues, and whether they can continue to grow their business in an ever-changing environment. 

“Two years ago, you might have looked at someone rapidly expanding completely differently than you do now,” he says.

However, there are some ways the pandemic’s impact on company financials still lingers, Holguin says. “It’s still difficult right now to predict future performance based on historical financial results because there was a lot of noise due to Covid. You combine that with the economic growth and the decline in the stock market, and it’s making it more difficult to determine a company’s true run rate of EBITDA and what the future looks like.”

Changed expectations

Expectations have certainly changed from last year. “I don’t think that a year ago anyone was expecting a recession,” Ware says. 

Now, credit managers will likely take a closer look at terms, down payments, covenants, pricing and additional collateral, Ware says. “There are a lot of dials that can be turned to make things a little less risky,” he says.

“Even before SVB, people were starting to see delinquencies rise, so that was already starting to slow people down,” Ware adds. “There’s a definite recognition that recession is likely on the horizon, and that recognition is probably the most important thing. Expectations drive behaviors.”

“On the credit side, there’s been some changing liquidity,” Tobin says. “What was once there has now either been used and it’s gone, or in some cases, the owners have taken the money out of the business and are not able to put it back in.”

Customer intimacy

As always, equipment finance companies need to know their customers, Tobin says. What are they doing to drive their business forward? How are they controlling their expenses? How are they preparing for the future?

“The more you can drive the relationship piece of the puzzle, the less you will have to talk about rates,” Tobin says.

Holguin tells her team to put themselves in the shoes of client CFOs. What are the main drivers and input costs of the business? What things could go wrong that are outside of their control that could impact their company? 

“Think through and project what’s going to happen next,” she says. “We’re in a time of more robust underwriting. With the uncertainty, we are digging a little deeper and it’s not a bad thing that we get to know our customers better.”

Rising delinquencies

“We’re seeing delinquencies and charge-offs starting to rise,” says Dan Goderis, Director, Portfolio Management, GreatAmerica Financial Services.

More equipment is being leased as the supply chain starts to loosen, Goderis says, including equipment on back order. “But there’s still the unknown of underlying issues that you might have in your portfolio that you’re not able to unmask yet,” he says. “With the rise in delinquencies and charge-offs, you’re seeing the inability of certain end users in various industries to meet their financial obligations.” 

ELFA’s February Monthly Leasing and Finance Index reflects this inching upwards in delinquencies and charge-offs. Receivables over 30 days were 1.8 percent, up from 1.7 percent in February 2022. Charge-offs were 0.32 percent, up from 0.09 percent a year earlier.

“Because of high interest rates, you’re going to have rate compression, and I don’t see interest rates coming down for quite some time,” Goderis says. “That’s going to put pressure on your revenue as a financer.” 

But many equipment finance companies learned many lessons during the Great Recession. “We’re prepared because we know we maintained discipline with credit standards even during the good times,” Palmer says. “I don’t think people are as worried because they are confident the underwriting and credit over the past 13 years has been solid.”

“We need to be very disciplined in our portfolio and collection management,” Holguin says. “The minute we see anything of concern, we should be on the phone with a client talking through it.”

Going green

ELFA’s Top 10 Equipment Acquisition Trends for 2023 press release estimates that climate financing will generate $18 trillion in equipment financing opportunities over the next eight years. That has the attention of the equipment finance industry. 

Plus, the Inflation Reduction Act of 2022 in part directed monies toward green equipment. “It needs to be deployed,” Ware says, “and the credit is available now.” ELFA’s Climate Finance Interest Group will present a session on climate financing at the upcoming ELFA Credit & Collections Conference (see “Hot Topics & Cool Solutions” sidebar).

“This equipment is new and different and tends to be more expensive,” Ware says, “so there’s a need to push terms out longer than usual.” The broad range of equipment involved—from charging stations in the thousands to multi-million-dollar projects—means that there will be a variety of ways to participate, he says. 

“There’s the question of how we approach this equipment from a risk perspective,” Breg says. “How do we structure the transactions appropriately? Do we understand the quality and longevity of the asset? Will it hold up in value and how quickly will it become obsolete?”

It’s worth paying attention to, Ware says. “It’s the biggest growth opportunity in our industry,” he notes. 

Automated customer experience

“There’s been a dramatic shift to online channels,” Palmer says. “We’ve all become more digital.”

Such things as postal service delays can be mitigated as the industry and its customers convert to e-invoicing, online payments and direct debits. 

“Digital capabilities create opportunity for a better customer experience,” Breg says. “Customers have more control in how they interact with us, and they can manage their information, preferences and payments. It also allows for interaction through various channels, providing more support to the customer.” 

 DLL has been working on making use of AI in its processes and decision making, Breg says. “For instance, we use AI in our underwriting process. With AI, we can use more data elements and different types of data in credit decisioning, allowing us to better segment our customers for improved decision making.”

AI models can also be used to prioritize collection calls and focus on customers that need attention, Breg says. “The data collected will help tailor our approach, which leads to better outcomes and a better customer experience.”

It’s critical that equipment finance companies know which experience works best for their end users and customers, Goderis says. This includes providing multiple notification/payment channels, including emails, texting, online portals, etc. 

Combating fraud

This automation will also help combat fraud. For example, there are currently systems that use facial recognition that compare images to driver’s license photos. 

In addition, asset snapshots and trackers give lenders the ability to confirm, in real time, the equipment involved. “It helps in terms of fraud prevention, but also in conducting field audits,” Breg says. “Do our customers have the equipment that they say they have, or have they sold it? You could also use it in asset recovery.”

There are also tools that help assess the likelihood of fraudulent financial statements, Breg says.

“These technologies weren’t invented for leasing, but they’re out there and they can be leveraged,” Ware says. Fraud is another hot topic addressed at the Credit & Collections Conference in June (see sidebar above).

Distributed workforce

“I firmly believe that the workplace will not return to pre-pandemic norms of five days a week in the office,” Palmer says. 

The transition to hybrid work from fully remote is a journey, Breg says. 

“I absolutely believe that there is value in spending time together,” she says. “For instance, it’s beneficial to be able to sit next to other credit analysts, have and listen to conversations, and conduct in-person onboarding and training or workshops. In-person interactions help teams to connect beyond their own team, maintain a sense of community and a sound company and risk culture. But there’s also certainly value in working from home. Offering flexibility and finding the right balance will be key.”

Post-pandemic hybrid teams have been well received, Goderis says. “It gives team members flexibility, but time working in the office is important as you learn by sitting next to team members. This also helps preserve the company culture, which is critical to continued success,” he says. 

A time to shine

In whatever form it takes, the expected downturn will be an opportunity for younger analysts, Holguin says. “They’re going to be able to really deepen their skills,” she says. “This is when they learn to see around corners because it will be real time.”

“This type of environment is the time we shine the best,” Holguin says. “This is when you really demonstrate your credit and collection skills. And this is when we partner with our customers the best.”