Why 2023 Will Be the Year of the Portfolio
The challenges of early 2020 have come full circle in 2023. The boon of originations over the past 30 months combined with rapidly increasing interest rates and a looming recession have made 2023 the Year of the Portfolio. Delinquencies and the cost of funds are both rising and portfolios are swollen with atypical deals and asset concentrations created by pandemic stimulus. Unbalanced portfolios created by government shutdowns and supply chain disruptions are now the primary source of risk for equipment finance companies in meeting their financial expectations.
So, how did we get here – to the Year of the Portfolio – and how should equipment finance leaders respond and manage their portfolios given the challenges created by these market dynamics?
The pandemic made 2020 the Year of Uncertainty. In retrospect, the pandemic itself was not as unpredictable as the government response – total economic shutdown followed by massive stimulus. Borrowers in industries like hospitality and food service were immediately devastated by the shutdowns creating problems for the finance companies that had financially supported them. Then came the stimulus – sent in waves in an effort to reboot the economy. Money flooded into both consumer and business accounts alike. Payment uncertainty was quickly transformed into unexpected opportunity as new norms like work-from-home (WFH) and shop-from-home channeled the stimulus into ecommerce and IT products. The stimulus wave cascaded into domestic transportation services which were struggling to deal with the global supply chain and distribution disruption created by closed borders.
2020 delivered on uncertainty creating some big losses but the stimulus created opportunities for big wins in 2021 – the Year of Originations. Originations grew as much as 30 percent year over year and continued double-digit growth in many markets. Work-from-home enabled employees to work from any location creating domestic migration by lifestyle. This migration collided with an existing residential inventory shortage and resulted in a surge in construction demand. At the same time, supply chain disruptions created both headaches and opportunities as used equipment prices – driven by increased demand and lower inventories – increased by as much as 70 percent in some classes. Lessors serving the transportation and yellow iron markets found themselves awash in deal demand but often faced a lack of available equipment.
2022 became the Year of Reconsideration for many business leaders across the economy as the waves of stimulus brought double-digit inflation and the federal government predictably stepped in with the fastest interest rate increases in more than four decades. With the fast-rising prices and increasing borrowing costs, the specter of a recession took hold almost immediately and put a damper on 2022 economic forecasts. Demand for equipment finance remained high, however, as continued economic uncertainty pushed businesses away from CAPEX towards the OpEx models of leasing. But the damage was already done. Confusion set in and, as a result, business leaders reconsidered both strategy and tactics.
How Should We Respond?
As we enter 2023, many lessors now have significantly expanded portfolios packed with new partners, programs, customer relationships, and new asset types. With equipment prices crashing in some markets as supply chains try to catch up and delinquencies rising, portfolios are full of new risks as well as new responsibilities for those managing risk.
So how should portfolio managers respond to the current economic environment? As is often the case, data and analysis tools can be brought to bear to streamline processes and provide business intelligence to help evaluate and make portfolio decisions. Portfolio managers can leverage data in three different ways to ensure that they do not lose the momentum of recent growth to the erosion of portfolio profitability.
Identify and address concentrations to hedge recession risks.
The first step is to identify and address concentrations that may have resulted from unbalanced organizational activities during the stimulus period. Heavy concentrations in certain classes of equipment, for example, can present new risks if the market values of those classes decrease faster than originally expected. Industry concentrations can present portfolio risks if those concentrations are in less recession-proof industries.
If an organization has responded to higher interest rates with more True Leases, the values of assets could compound payment risk with collateral risk. FMV data streams, data streams like Sandhills Value Insight Portal, provide real time market values for used equipment moving through dealer channels and auctions that can be used to analyze existing portfolios as well as help reduce asset value risk on new originations.
Concentrations can be assessed and then balanced through syndication, customer contacts, account early-exit-strategies, and adjusted sales-by-market strategies. Indeed, in this period, portfolio managers will play a key role in helping the organization define its sales strategies for both deal profitability and risk management across the portfolio through hedging. Equifax’s recent Market Pulse illustrated how different industries perform during recessions and unprecedented trends in labor and housing will exacerbate the unevenness of recession impacts. Portfolio managers need to augment their historical recession experiences with live data from this recession to both avoid new risks and find new opportunities.
Identify and get ahead of stressed accounts.
Those accounts stressed by the recession, inflation and higher rates will need near-constant attention. Portfolio managers should expect to contact borrowers earlier in the delinquency process and with more frequent attention. Teams should be trained to recognize material financial challenges from those that are administrative in nature. Predictive tools can help determine which accounts require the most immediate and intense management.
At the start of the year, delinquencies had already risen in some parts of the economy – as inflation impacts the ability of consumers to pay living expenses. Again, economic data sources like Equifax provide insights for analysis within the portfolio. Portfolio data will show changes in payment days as well as delinquency within the existing customer base. Finance companies with DIY borrower portals will get insights from the data of their customers – who is checking future payments, looking at a buyout, or reviewing contracts for potential opportunities.
Customer teams can work with asset managers to secure additional collateral and/or guarantees, adjust terms to the benefit of both lender and borrower, or begin collection to avoid recovery costs.
Focus asset management on interest rate spreads, residuals, and renewals
Asset management will also play a key role in 2023. Smaller lessors often have funding lines with short-term interest rates that are reducing the spread on deals. Combine spread-risk with the rapid ups and downs of used equipment prices and supply chain disruption, and asset managers have a lot to do. They will need to work with portfolio managers to identify their over- exposure in certain asset classes as well as the underperforming assets that require attention at the customer level to extend payment streams, renewals, or syndication to balance overall portfolio performance. And long-term customers can be challenged during recessions, so determining the right approach is the key to maintaining the long-term earning strength of the portfolio.
Where Do We Go Now?
So what comes after a Year of the Portfolio? The surge in originations followed by the economic impact of high inflation and interest rates will stress borrowers, leading to 2024 becoming the Year of the Customer. As portfolio managers funnel lists of stressed accounts and pending contract collections to customer service teams, the volume and intensity of the effort will require help from automation. Customer-centric systems like borrower self-service applications as well as both monitoring and prediction of new delinquency risks will become essential tools for enabling a high volume of transactions and also for facilitating transparency for customers.
Depending upon the depth of the recession and further geopolitical disruption, the following year – 2025 - will likely evolve into the Year of Remarketing as lessors with leases of 36-to-42-month terms will see the surge of equipment returns from 2021 and 2022 deals coming to term. Renewals, recoveries, and end of lease remarketing will be on the mind of executives – particularly if the organization made strong inroads back into True Leasing where residuals often determine the final value of the deal.
Now is the time to evaluate your portfolio management tools and make sure that you can both determine and manage your risk exposure. Business intelligence tools can help you analyze your current portfolios and leverage data to make better, more strategic decisions that maintain financial expectations. The last few years have been unprecedented in both their economic volatility and uncertainty, but now the die has been cast and portfolio managers are front and center. How they respond, adapt, and innovate will define the next group of winners.
Wells Fargo Releases Its 2023 Construction Industry Forecast
Wells Fargo released its 2023 Construction Industry Forecast, a survey designed to gather insights on sentiment and current business conditions in the construction industry. This year’s survey indicates a level of cautious optimism prevailing among nonresidential contractors and distributors. Most notably, respondents shared several top concerns, including the availability of skilled workers, rising interest rates, economic uncertainty, and supply chain disruptions. Despite the economic challenges of 2022, however, the non-residential construction industry largely maintains a hopeful long-term outlook for 2023.
“Adapting to ongoing economic uncertainty and impacts of increasing interest rates are two of the primary concerns for construction executives,” said James Heron, National Sales Manager for the Wells Fargo Equipment Finance Construction Group which sponsored the report for its 47th year. “Despite a number of market variables, the level of optimism reflected in the 2023 forecast survey confirms industry leaders maintain a deep-seated belief in economic recovery.”
Key findings in the 2023 Construction Industry Forecast include:
Cautious optimism remains the dominant sentiment within non-residential construction
The economic environment has caused a divide in perspective and expectation among executives. Those who continue to feel that non-residential construction will remain at current levels also expect activity will begin to increase in 2024 or later.
However, those who do not believe non-residential construction will remain at current levels foresee that the industry will see a decrease in 2023.
Top risks, financial concerns, and opportunities
Executives have four areas of concern: availability of skilled workers, economic uncertainty, rising interest rates and supply chain disruptions.
Inflation has impacted more than 82 percent of surveyed businesses, while increased material cost has impacted profitability for more than 59 percent of businesses surveyed.
Equipment acquisition
Over 50 percent of contractors expect to rent the same amount of heavy construction equipment in 2023; however, equipment purchases will be contingent on a stronger backlog of jobs and lower costs.
Distributors report continuing to rent the same or more equipment now than a year ago and continue to utilize 70 percent of their fleet.
To learn more, download the complete Construction Forecast Survey.
Equipment Finance Industry Confidence Improves in February
The Equipment Leasing & Finance Foundation has released its February 2023 Monthly Confidence Index for the Equipment Finance Industry, which shows an increase in confidence in the equipment finance market to 51.8, up from 48.5 in January. The report indicates that pent-up demand in the light and medium-duty transportation segment is expected to decline by the third or fourth quarter of this year. Survey results show that 16.1% of executives expect business conditions to improve over the next four months, while 9.7% believe demand for leases and loans to fund capital expenditures will increase. 38.7% of respondents expect to hire more employees over the next four months, and 51.6% believe their companies will increase spending on business development activities over the next six months.
NFIB Jobs Report: Small Business Job Openings Back Up in January
According to NFIB’s monthly jobs report, 57 percent of owners reported hiring or trying to hire in January, up two points. Of those hiring or trying to hire, 91 percent of owners reported few or no qualified applicants for the positions they were trying to fill. Twenty-seven percent of owners reported few qualified applicants for their open positions and 25 percent reported none.
“The labor shortage continues to be a major concern for small businesses in the New Year as nearly all owners trying to hire are reporting no or few qualified applicants,” said NFIB Chief Economist Bill Dunkelberg. “Small businesses’ sales opportunities are limited because of the staffing shortage but owners continue to make changes in business operations to compensate.”
Forty-five percent (seasonally adjusted) of all owners reported job openings they could not fill in the current period, up four points from December.
Small business owners’ plans to fill open positions remain elevated, with a seasonally adjusted net 19 percent planning to create new jobs in the next three months, up two points from December but 13 points below its record-high reading of 32 reached in August 2021.
The percent of owners reporting labor quality as their top business operating problem remains elevated at 24 percent. Labor costs reported as the single most important problem to business owners increased two points to 10 percent, historically among the highest readings in over 49 years.
Seasonally adjusted, a net 46 percent of owners reported raising compensation, up two points from December and just four points below the 49-year average record high set in January last year. A net 22 percent of owners plan to raise compensation in the next three months, down five points from December. This is a major concern of the Federal Reserve, as these increased costs are likely to be passed on in higher selling prices.
Thirty-six percent of owners have job openings for skilled workers and 17 percent have openings for unskilled labor.
Click here to view the full report.
Check These Steps to Make Sure Your Small Business is Ready to Grow
You may be ready to take your small business to the next level, but is your small business ready to grow? Expanding a small business can take many forms, like hiring more employees, adding products or services, opening a new location, purchasing your commercial space, entering a new geographic market, or buying another business out.
Before you take any of these leaps for your small business, check off the items below to make sure you’re growing on a stable foundation.
Financial Readiness
Growing small businesses need capital. Whether you are looking for investors, applying for a small business loan or SBA loan, or applying for a business grant or SSBCI opportunity in your state, you will need to know your financials inside and out and have them in a presentable, dynamic form.
Are your financial documents up-to-date? You must be able to show your business’s financial health, and to do that you need these documents on-hand. If you are not able to prepare them internally, consider investing in a certified public accountant (CPA).
Personal and Business Tax Returns
Income Statement (or “Profit & Loss”)
Balance Sheet
Personal and Business Credit Reports
Business Bank Statements
Is your business plan pitch-ready? If you present a possible lender or investor with a business plan that you’ve invested time and care into preparing, you will be more likely to succeed. Financial statements are part of your business plan, but it also shows your history, your plans, and the data your plans are based on.
Are your expenses under control? It’s important to know what your expenses are and eliminate any unnecessary bills. This is essential because, as we have learned in recent years, disruptions can come from nowhere. If your expenses are kept under scrutiny, you’ll increase your profits and be ahead of the game if circumstances outside your control affect your revenue.
Operational Readiness
Growing small businesses rely on quality employees to get the job done. Whether you’re a sole proprietor, or a team of ten or fewer employees, you must be ready to be a responsible, attractive employer before your team increases.
Do your current and future employees have the tools they need to succeed? Even small teams need to be able to communicate with each other and complete their tasks efficiently. These days, this means investing in technology to support their tasks, and provide you with the reporting you need to optimize their roles. Take the time to review the tools you use to process payments from customers, respond to their needs, organize data, and perform internal tasks.
Is your operational infrastructure ready to support a growing team? Hiring employees means taking responsibility for their well-being at while at work, and providing competitive compensation that make them glad to stay. Millennials have high expectations from their employers to provide transparent communication from leadership, diversity & inclusion policies, quality benefits, and more money than they could make on their own as Uber drivers.
What is your hiring strategy, and what roles do you need to fill right away? Before you and your current team burn out, identify the tasks that could be built into new roles, including your own, by asking yourself these questions:
What are you bad at?
What tasks do you hate doing?
What tasks are going undone due to time constraints, by you or your team?
What goals do you have for your business?
Market Readiness
Growing businesses need to be easy to find, and easily recognized in their community or industry. Marketing plans help customers discover your business, engage with it in a positive way, and associate it with the need it fulfills.
Is your small business website and social media up to today’s customer expectations? Over 80% of consumers navigate websites on their phones. Millennials and Gen Z, who have lived their whole lives online, expect websites to be easy to read, pleasant to look at, and convenient and quick to navigate. If they’re not (1) interested (2) looking at what they’re looking for in 8 seconds, they’ll close it and go elsewhere. They also expect to engage with you on social media, so consider this when making your staffing plan.
Have you defined your brand? Your brand is an external expression of your business’s core values. Before making any choices about colors, graphics, and voice, you have to be able to express what your core values are, and what tone best serves those values. It’s hard to make big changes once you’ve gained momentum, so be true to your business, and define your brand before you grow.
Do you have a marketing plan? Marketing is more than a website and social media, it answers the questions (1) What you do, and (2) Why others should care. Most importantly, it answers these questions before someone else answers them for you. With a marketing plan you identify your target market, research who else is getting their attention, including your competitors, and strategize how you will get in front of them and get them to care about your business.
Disaster Readiness
Growing businesses must be ready to weather a storm. The whole world learned in 2020 that anything can happen at any time. It won’t always be the scope of a pandemic, but even localized disruptions and disasters can cause setbacks for your business.
Do you have a data security and back-up strategy? In the age of data, customers expect the businesses they share their information with to keep it safe. Internally, you also must consider how you store and back up the data your business relies on.
What’s your Disaster Recovery Plan? Ready.gov provides information and resources to help businesses prepare for disasters that come from technology, weather, and other types of risk.