Mark Duncan,
Executive Vice President and Chief Operating Officer,
Mitsubishi HC Capital America

How have your customers been impacted by the current state of the economy? Can you share some stories or case studies that demonstrate what it’s like to do business right now?

Mark Duncan: As a general matter, the economic slowdown is having an impact on our clients; higher inflation and increased cost of capital are presenting them with a much more challenging environment to do business. From an overall perspective, delinquencies have been drifting up a bit, but the losses haven’t really followed along, so for now it’s more of a cautionary situation for our business.

The one exception is the freight sector, which has been in a recession for a while. Reduced shipping activity due to the economic slowdown is hitting their bottom line, and we are seeing an increasing number of situations where our customers are struggling. We have taken action to support their businesses and the industry as best we can.

Jim Freund: Yes, some of our customers have been negatively impacted by the current state of the economy. We are in touch with our customers daily, and we have been

hearing a consistent theme that this high inflation over the last 24 months is taking a toll on revenue and shaking their confidence in the U.S. economy. This is creating a cautionary environment, and when there is caution in the market, businesses and customers curtail their spending. We are seeing some business segments defer their equipment purchasing to later this year or 2024, waiting to see if the inflation recedes and their sales pick up before making heavy equipment purchases.

In your opinion, what can equipment finance companies do to navigate through economic uncertainty?

Duncan: I look at preparing for a potential recession with a two-pronged approach. First, you have to look at your practices and your business. Typically, during periods of growth, people start to extend beyond where their core competencies are. They might experiment, or they might do some different things in their business. So, you have to look at the direction you’re going in, and make sure you’re not getting ahead of yourself. Generally, in a recession there are going to be problems in your portfolio and in collateral values, and there are going to be problems you will to have to address. If you don’t have a really strong capability in whichever sector you’re focusing on, generally that’s where your outsized problems are going to be. Look at the business, stay focused and stay effective inside of the space where you’re playing.

The other thing to do is to take stock of the key counterparties you rely on to do business. While you might be fine, in some cases your counterparties might be having challenges. To extent, there are parties that you rely on for critical parts of your process, such as origination, funding, collection or recovery. You need to make yourself aware if they’re under stress and take necessary precautions.

Freund: Regarding front end originations, you often see lenders take one of these paths in front of a looming recession: they pack up the tent and run, or they stay committed and show their support for your markets and customers by staying active and continuing to lend. We choose the latter. We have been in our markets a very long time and are committed to them. We understand cycles and recessions and how they affect our markets and our portfolio performance. We have a very well diversified book of business and an extremely strong and respected parent in Mitsubishi HC Capital. All these things enable us to weather a recession better than most others. The key for us is to remain in front of our customers, remain consistent and continue to provide financial solutions to our customers to help them grow their businesses.

Uncertainty is typically viewed in a negative light. Can there be opportunities found in an uncertain environment? If so, what are the best ways to find these opportunities?

Duncan: It’s true that recessions are usually viewed in a negative light, and if you are in areas that aren’t core competencies, that’s generally how you get hurt. However, if you play to your strengths, typically what happens in recessions for a specialty finance company like us – where we focus on industry know how, structure, account management and rigor – is that you can win business by reliably generating value for your clients. Banks historically have not been experts in their chosen areas and operate more as generalists with several products arise and credit costs go up, banks generally pull back dramatically and retrench. They leave markets and come in and out based on the situation. But, as a specialized lender with deeper understanding of industry dynamics and collateral value, companies like ours have the capability to ride through the cycle with our clients and customers.

So where do you go to look for these opportunities? In a lot of cases, you should turn to the same channel partners you are already talking to. Let them know you’re active and particularly interested in areas that historically may not have been available to you. You could also talk to banks since many are realigning their business models and starting to shed assets. By virtue of staying in touch with these parties and hearing how their businesses are changing, you can find those opportunities. Historically, specialty finance companies like us tend to be countercyclical and, during periods like this, the strong will capitalize and capable players will gain share.

Freund: Absolutely, opportunities exist in recessions. Opportunities always open up with new vendors, customers, portfolios and game-changing talent, but only those with a deep balance sheet and a strong business platform can execute on these opportunities. At Mitsubishi HC Capital America, we are fortunate to have both. We expect to be active in pursuing these opportunities.

How can equipment finance companies balance the risks associated with a downturn with the potential rewards?

Duncan: Many businesses immediately raise their prices in response to credit costs and delinquencies going up. That’s only part of the equation because you can raise your price, but you’ll get self-selected, worse-quality credits in some instances. You have to look at what your value proposition is, why you’re winning, how to continue driving forward by taking advantage of your core competencies and differentiating yourself to win. In the cases where you find that you are providing pockets of value to the market, you can justify charging a higher rate. It doesn’t mean you’re just automatically taking more risk; you’re actually delivering more value and you’re being compensated for that value. Banks, for example, aren’t structured to have the high level of monitoring and specialized risk rigor that Mitsubishi HC Capital America has with our product suite. So, when the economy turns and they move away, we can move in to demonstrate and differentiate our value, and thereby earn the business. So, one part of balancing the risks is just knowing where you win, go there and convert.

The other part is understanding your own business economics so that you have a good financial model when you price to the market. In an environment like the current one where inflation is up, costs of funds are up and credit costs are changing, it’s all very dynamic. If your pricing model isn’t dynamic, you will not be able to understand the impact that these changes could be having on your profitability and be putting your business in a position of risk.

Freund: We originate business in many market segments. Recessions tend to hit some segments harder than others. The key is to have a diversified book of business so you can lean in on the segments that are not affected, while being cautious but relevant to the segments that are affected. The other consideration is pricing the appropriate risk and reward. A recession brings greater risk in the form of higher delinquency, defaults and losses. A prudent lender takes this into account and frequently raises pricing leading up to and into a recession to cover this additional risk.

Any final thoughts or topics that we missed in the questions above?

Duncan: Although the situation with bank failures we had earlier in the year seems to have stabilized, it has led to additional proposed regulation that could likely change bank capital requirements. So that could, again, change where the banks put their focus. Although regulatory changes would not likely be implemented for a while, I would recommend people pay attention to these regulatory shifts as they could result in new market opportunities for non-bank finance companies like us.