Opportunity Amidst Risk: Delinquency Management in a Volatile Market

by Quentin Cote Monitor 100 2024
After a prolonged economic upswing, delinquencies and defaults are on the rise. Quentin Cote explores how we got here, outlines the essentials of proactive delinquency management and argues that returning to fundamentals today can set the stage for tomorrow’s growth.

Quentin Cote,
Orion First

Delinquencies and defaults are on the rise and the effects are widespread and multi-pronged. We all know their impact — diminished net yield, accelerated provisioning, reduced eligibility for funding, resulting in strained borrower relationships, reduced access to credit and a constant struggle to stay competitive. It’s a cascading effect: eroding confidence from funding partners leads to lower advance rates, more restrictions and higher interest on credit lines.

This restricts your ability to offer competitive terms, leaving you further behind. Lender relationships begin to demand more attention, and your priorities shift from growth to survival. All downturns inevitably drive up delinquencies, but what effects are at play currently?

We’re still feeling the COVID aftershock following big and hard to predict swings in the market, while supply chain disruptions, inflation and higher Fed rates squeeze already struggling businesses.

First, we experienced dramatic shortages of equipment. COVID instantly changed the way consumers shopped, creating huge demand for trucks. Simultaneously, widespread shutdowns disrupted supply chains, severely reducing the number of trucks available. The result was unusually strong performance from borrowers, overpayment for used trucks and extremely strong recoveries. Supply chain challenges rippled throughout the equipment classes, creating dramatic backlogs and slower industry growth. This generally prevented borrowers from over-extending themselves in reaction to rebounding demand. Additionally, the cash from government programs bolstered company profits and health, hiding any underlying flaws in business strength.

We are now seeing all of this unravel. Supply chains are full. Borrowers no longer have extra government cash and are stuck with used equipment that no longer functions or meets their needs. Additionally, tools once used for distressed borrowers have now become commonplace. Modifications have become a business’ tool for managing cash flow, not a lender’s tool to prevent default. This expectation of accommodation complicates servicing, muddies performance analysis and impacts eventual recovery rates down the road.

Underwriting has become complicated by the “good years” following COVID. Is a borrower a good risk, or did the benign pandemic period mask their poor management? Tried-and-true underwriting tests hold less sway than at any time in recent memory.

We also face an unanticipated factor: the pullback in both equipment financing and lender finance caused by liquidity concerns among banks as depositors demand more for their money. Factors not at all related to the health of our industry are causing us to rethink our funding strategies and revisit how we make profit as an industry. Funding is no longer a matter of cost and leverage. Availability, stability and flexibility are now big factors to consider when solving the puzzle of how to fund originations. These lessons, learned during the Global Financial Crisis of 2008, are being relearned by the next generation of leadership.

The strain on investor and financing partner relations is a double whammy, which impacts your bottom line and sends a negative signal to financing providers who can be quick to assume losses. And they can be quick and harsh in their reactions if they don’t have confidence in your ability to manage the situation.

Lower advance rates, higher interest and more restrictions tie your hands when you want flexibility. With your ability to stay competitive hamstringed, your priorities are reassigned. Your job is now loss mitigation, and your lender is your boss.

But it doesn’t have to reach that crisis point. The sooner you recognize problems, the better. Close monitoring of existing accounts and broader market awareness are equally important.

To fulfill our core functions, proactive delinquency management is essential and operational efficiency is critical. Systems and networks make the difference when borrower resources are tight and the market is changing fast.

Analytics software can help. Designed to make sense of vast amounts of data and reveal patterns and risk factors you might otherwise miss, the best ones help you see trouble coming. Look for software that analyzes your whole portfolio, spotting patterns and hidden risks in the data. What should be on your checklist?

1. Predictive analytics to flag high-risk accounts early.

2. Segmentation to rank and analyze risk by industry, asset class and vendor or originator, so you know where to focus your time.

3. Clear reporting so you can track if your strategies are making a difference.

Solutions like Orion’s Delinquency Manager are built exactly for this purpose, serving as a tool to not only report what’s already gone wrong, but to help you get ahead of the problem.

Successful delinquency and default management in this environment doesn’t rest on the guile and genius of individual collectors. We all can share stories about the collector who was able to maximize a specific recovery through creative genius. While skills and creativity are important, it is systems that generate consistent, predictable and positive results.

Collections is a competition. We compete with other creditors to be the first in line while structuring solutions. We compete for attention and focus from attorneys, repo agents and resellers. Building and cultivating that network is what enables our collectors to generate consistently strong outcomes, regardless of the assets being recovered. We can create positive outcomes with delinquency management, consistent, constructive attention on identifying borrower issues, demanding borrowers to address their challenges, and being constructive in finding solutions. This consistent focus is difficult to maintain in a rising delinquency environment. The focus then must turn to hiring and training systems. Can you hire, train and deploy quickly enough to maintain that focus at the very time it is most needed?

Delinquency management requires all the operational basics. Counting promises to pay, calls per day and call duration are just a starting point. It’s also important to look from the borrower’s perspective. How many contacts per month are you making to each delinquent obligor? Are they getting consistent, persistent attention that increases as contracts age? It is all too common to see your call frequency drop as delinquencies rise, since it is challenging to keep up with rapid changes. If you are not contacting your 61- to 90-day delinquent contracts daily, you are likely falling short. But here’s the kicker: call quality matters as much, if not more than, quantity.

What makes an effective collection call? How can you train your entire team to replicate the winning strategies of your high performers? Do you have the systems to monitor quality and ensure effectiveness? New phone technologies offer a wealth of data to differentiate between effective and ineffective calls. But capturing these insights and converting them into actionable training is another challenge.

The challenge of rising delinquencies is very real. And managing them is demanding and urgent. But savvy lenders know within these challenges lies opportunity. History tells us that the market rewards those who see beyond immediate chaos, as some of the strongest portfolios are written during periods of market turmoil.

The cohorts originated following the 2008 crisis, particularly 2010 to 2011, stand out as a notable example. Following a significant increase in delinquencies as businesses struggled with liquidity and low demand, this period presented unique opportunities for independent lessors. Where larger institutions pulled back, some of the most agile independents capitalized on gaps left in the market. They embraced less impacted sectors, adapted their products and offered more flexible terms to originate some of the best performing portfolios of that decade.

We are looking, somewhat, at a return to the fundamentals. Our industry has three primary purposes: to provide businesses the funding to buy essential equipment, to help equipment dealers maximize sales and to provide diverse, high-quality assets for investors to generate attractive returns.

With higher rates, better spreads and uncertain credit risk coming to the fore, the changes that create value for customers, vendors and funders take center stage and present opportunities that we haven’t seen in a decade. Entrepreneurship flourishes when credit spreads are sufficient to encourage new entrants and business models. Changing risks spawn new, creative solutions to quantify and optimize risk-adjusted returns.

Post-COVID, strong portfolio performance and anemic transaction volume encouraged a rate race, rather than a solutions race, squeezing independents and smaller players. That situation has reversed, but just when independents regain the upper hand, they might get handcuffed by reduced liquidity and flexibility provided by funders.

To seize opportunities today, focus on these five fundamental goals:

1. Help borrowers access funding quickly for equipment purchases.

2. Support vendors in providing their customers with easy access to capital to purchase equipment and get back to business.

3. Build processes and tools to optimize portfolio performance.

4. Collect and use data to better serve your markets.

5. Invest in the customer experience to make it easy to secure funding and build a lasting relationship.

For lenders willing to adapt, today’s challenges could be tomorrow’s growth engine. •

Quentin Cote is the President of Orion First, leading business development, client relationships, operational, and financial strategies. With 31 years in finance, Cote has held roles at State Street Bank, Sherman Financial Group, Babson Capital Management, and Cambridge Place Investment Management. A Dartmouth College and MIT Sloan School of Management alum, he resides in Boston with his wife and enjoys golf and travel.

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