Collections Professionals See Rise in Delinquencies, But Stop Short of Crying Recession

by Amanda L. Gutshall January/February 2008
With the current uncertainty about the economy and where it’s going in the near future, we look to collection companies to see if there is an obvious rise in defaults and repossessions. And although in some cases there are, participants in the Monitor’s Collections Roundtable are still playing a game of “wait and see.”

The first indicator that things aren’t running so smoothly? An increase in equipment finance companies seeking help with delinquencies spurred by current credit quality deterioration. Ed Castagna, president of Nassau Asset Management, noticed the increase two weeks before the subprime news hit the streets. “Since February 2007, it started to up-tick immediately when all the subprime mortgage news broke … ever since then we have seen a considerable increase in account placements for both repossession and collection.”

Equipment lessors and financiers, he adds, began calling for advice almost immediately. “It started with a few more than usual account placements … there were a number of calls for advice,” he says. Nassau Asset Management provides full-service asset management to the equipment leasing and finance industry, including one-stop services for asset recovery, collections, global remarketing, plant and fleet liquidations, appraisals and legal activities.

“Our knock and demand program has been in demand. Nassau places a diplomatic collector and a repossessor in the field at the same time. If the lessee can’t pay, we pick up the asset usually on the spot. We’ve saved an untold number of charge-offs by positioning ourselves in exactly the right place and time to either collect or repossess. Once repossessed, we conduct a commercially reasonable sale then proceed to collect the deficiency. Our motto is, ‘Recoveries rather than write downs,’ and in this market, there’s no time to waste,” Castagna explains.

Mark Arvin, principal of Cash Recovery, agrees, although he doubts that the additional advice to equipment financiers will be much help. Why? Because of the uncertainty toward and within the market. “I don’t think anyone is sure, as of right now, the extent of the problems with credit… Things are changing so rapidly. We thought we had a credit crunch in August, then in September we thought we were over it. Then in October, we thought we had a credit crunch again.

“But I do think the economy is slowing, and I think that will have some effect on delinquencies and will cause collection managers within companies and credit collection companies to have more work to do in the future.” Cash Recovery is a provider of complete commercial debt recovery services to the industry. The company collects the debt, recovers the collateral and then works to remarket it.

Ken Schivone President, United Portfolio Management

However, Ken Schivone, president of United Portfolio Management, happens to disagree, noting that a downturn has a negative effect on his company’s profits, something he knows from experience. When the company began in 1989, Schivone says he wondered what would happen if a recession were to occur, and then in 2000, it did. And the effect was the opposite of what one might imagine.

“There may have been more accounts going delinquent, but the number of people who were able to pay for those accounts decreased. I also noticed that the leasing companies that we were doing business with were holding onto accounts longer, working them harder in-house and were not really sending them our way.”

He thinks the same is happening, at least with placements coming from equipment financiers, this time around as well. And he doesn’t see a downturn boosting his business from those placements. Schivone’s company’s clients are small- to mid-ticket leasing companies, placing accounts under $100,000. United Portfolio provides a range of services, including liquidating an entire portfolio, servicing underperforming accounts, collecting accounts that were charged-off or considered uncollectible, and remarketing of assets.

Another aspect Schivone has noticed since the last downturn is, “Competition has been tighter in the commercial realm, and there’s been a lot of pressure on commissions so it’s tighter from that perspective as well.”

Real Estate, Trucking Taking the First Hit
Schivone, however, does see increasing activity with anything having to do with real estate and home construction, and Castagna and Arvin agree. All even go so far as to say that smaller companies are currently and will continue to be the hardest hit. According to Schivone, “The companies that are in distress today are small businesses that have anything at all to do with real estate… it’s really hit real estate hard; mortgage brokers, small agents are suffering. I think that’s where a lot of activity is going to come from.”

Nassau, Castagna says, is seeing an increase in trucks being repossessed, particularly from owner-operators and construction equipment from smaller construction companies, subcontractors, etc. “These are people that may have been overextended, they have been consolidating debt, using the equity on their homes, which they can’t do that anymore. It could be more of a credit risk in general. In that respect, with the credit quality deterioration, there will always be a need to finance companies in that demographic. Certain leasing companies have an appetite for that and others do not.” The ones that do play in that space, he adds, will feel it as delinquency starts to increase.

“The easiest target right now is trucking and transportation because if you think about it, how many different segments of that industry work within the homebuilding industry … there’s a lot of commerce that goes through the trucking industry tied to homebuilding. When that slows to a halt, the companies that were put in business because of the increased activity are being put out of business because of the lack of activity.” Castagna is sure the larger companies in this segment are feeling the crunch as well but are more prepared to “weather a downturn.”

This ties right in with Arvin’s response. He comments, “At the moment, the problem is somewhat confined to companies either affected by rising fuel prices or significantly affected by the subprime mess.”

If the current crisis does indeed turn into a recession, all three agree that it will eventually — as all recessions do — hit everyone. The current theory is, Arvin says, that those problems will extend into the broader economy, and he says it will have some effect.

The Effect on the Secondary Market?
As for the secondary market for off-lease equipment and repos, Arvin says the declining economy has “always been a double-edged sword for a collection, workout or a repossession company,” because the slow economy means there is more equipment coming off-lease due to end-of-lease situations as well as more foreclosures. This means, of course, more equipment sitting around, depreciating, which results in even more lost capital. The increase in equipment, he adds, is good news for the third-party sellers but not necessarily for lenders.

On the other hand, he explains, in a declining economy there is less demand for product, so it’s “more difficult to move and prices aren’t as good.” In that case, companies have to look for other outlets to move the equipment, and many are turning to the global marketplace to do it. This works for two reasons, he says: because many developing nations have a need for the equipment, and even equipment that is obsolete is in demand as many nations are not technologically advanced enough to buy newer models. Also, as the dollar weakens, equipment in the U.S. looks less expensive to other nations, so demand will increase.

For United Portfolio Management, most of its clients repossess the equipment before the account reaches the company’s hands. If the equipment has not been repossessed, generally the company can make a better deal. He notes he has spoken with remarketing centers and they say they don’t see an effect on their ability to resell equipment.

Castagna sees this as well, and doesn’t feel that it will cause problems in the secondary market because there are buyers for the equipment coming in. That is one of the biggest differences since the last downturn and one that he feels will keep the increased levels of delinquency and repo activity over the next year at bay.

Ed Castagna President, Nassau Asset Management

In 2001-2002 when there was increased activity, Castagna says, “things came to a screeching halt. People were afraid to travel. We were picking up equipment and had nowhere to sell it. When we were busy, we had no buyers. Now, as we repossess assets, we have no problem selling them.”

What’s the difference from the last downturn to this one? “The underlying economy is still there, it’s still strong… commerce has not come to a halt. We are not in a recession.” Castagna notes that the world economy, which is stronger at the moment, is driving demand for our repossessed assets. Foreign contractors are coming here and scooping up equipment.

“This is like a candy store for them. They come here and there’s a variety of equipment that they can’t find in their own country and it’s all at a discount once they convert their currency to dollars.” What’s also interesting for the company, he says, it that since the downturn began in February it takes Nassau less time to recover the assets once an account is placed. “Our efficiency is not driving this trend as much as the fact that delinquent lessees are giving up rather than hiding the equipment or skipping town.”

The Future: A Cloud of Uncertainty Remains
Even with this positive outlook for unloading repossessed equipment, the future remains uncertain in these collections professionals’ minds.

Schivone, for his part, expects to see certain aspects of the industry change and evolve. Over the past five years, he says, there’s been a movement toward creditors selling accounts. The company was not interested in consumer debt but Schivone told them if they have commercial portfolio to call ASAP.

“Now we are starting to see that… I think there’s going to be a trend toward that sort of thing where creditors are going to look for immediate money and sell off those accounts and let someone else go through the entire process of collecting them. I’m not sure if that’s an indicator or precursor of a recession, but it is, I think, a precursor to an evolving collections industry,” Schivone explains.

Mark Arvin Principal, Cash Recovery

For Arvin, the future of a down cycle in unclear. “What does ‘down’ mean? How far down?” Although he admits there is a lot of concern that the economy is headed down, maybe even into a recession, he explains, “The consensus, at the moment, is that we won’t actually reach a recession but the consensus is also that the economy will slow appreciably…

“I think we will have a significant downshifting in the economy. Clear enough to label it a recession or not, I don’t know. But I think it will cause collection activity to increase over the next 12 months, but I just don’t know how significant of an increase it will be because I don’t think anyone really knows what the impact on the economy is going to be yet.”

“In the capital markets, we went from too much money in the market to not enough virtually overnight,” says Castagna. “And it’s going to take a while for people — that invest and fund our industry — to have the type of confidence it takes to bring the market back to levels we were seeing a year ago… Once all these subprime issues clear out … it will be business as usual with the exception of the addition of some new government regulations.”

As far as farther down the road, throughout 2008, “I think it’s going to be up and down. It’s going to depend on interest rates and the general economy.” However, Castagna adds, “I’m not seeing a disaster out there. It’s definitely a correction caused by subprime lending in the mortgage industry.”

The current market will, he says, “shake out the weak ones, that’s what we’re seeing right now. Anyone that can weather a 12-month storm … until the end of 2008, if people can sustain the business they are doing right now, the economy will eventually bounce back. I’m seeing it as a cycle.”

“Because credit is harder to get,” Arvin says, “that’s going to have various impacts on leasing companies and third-party collection companies… Lenders are tightening their lending standards. At the same time, interest rates and rates on leases presumably, have gone up or at least should go up… Lenders are more adverse to risk, they’re going to charge a higher risk premium than they had in the past, and also there’s just less money available to lend because people have curtailed their lending, and with less money to lend, the rates are going to be higher for the money that’s available.”

Either way, he adds, “I’ll be curious to see what happens with leasing companies. They have an opportunity to step in and fill a bit of a void with less money being available for businesses to operate. [They have to] provide more lease financing and provide it at higher rates than they might have been able to get previously.” But, he warns, these leasing companies need to “not get too over eager about lending money to people that the banks will no longer lend money to, and pick their spots… don’t go overboard.”

Staying Ahead of the Cycle
So what can we, and more particularly collection managers, do to keep ahead of the game in the months ahead? Schivone says that a company’s decision makers “need to think ahead… You’re not going to be able to get security, but you can get personal guarantees, and the more personal guarantees you get, the better.”

Because we are going to continue to be in a period of uncertainty, Arvin explains that collection managers need to be more “vigilant in their portfolio, and look for any signs of stress in their portfolio… They need to be alert to the potential for the [current] problems becoming more widespread and affecting a broader range in their portfolio… They need to be attune to what industries seem to be affected by our current problems and address those, and focus on those and be proactive in trying to head off problems in those elements of their portfolio.”

Castagna advises, “I would prepare for the worst and hope for the best.” The lenders who were disciplined in the past few years, will come out okay. The ones who weren’t and who were involved in subprime lending, “that’s a recipe for a problem… Equipment and credit quality are two key factors that need to be evaluated. Having a good process in place to deal with those quickly, that’s going to be important in the next 12 months. Whether it be insourcing, outsourcing, whatever they do, they should have a well-oiled process in place. If it’s not already in place, playing catch up in this market is not going to be fun.”

In the future, he adds, to minimize costly repos, “underwriting decisions are going to be key going forward… I’ll be tuned into what’s going on in the capital markets… It would be positive for all of us if investors decide that commercial equipment is less of a risk than real estate. I think for 2008, we will see most people waiting on the sideline. They want to see what’s going to happen. They may jump in and out to test the waters, but we won’t see a real commitment from the big, conservative players until the coast is clear.”

In any case, “Time will tell, I guess. I would hope that and think that these problems are relatively short-lived and manageable,” Arvin concludes.


Amanda L. Gutshall is the assistant editor of the Monitor.

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