Exploring Challenges and Opportunity in the Transportation Factoring Space

With the supply chain inching toward some level of normalcy, shippers, carriers and factors are still facing plenty of challenges in 2023. In the first piece of a two-part interview, Tim Valdez, president of the factoring division at Triumph, discusses where the supply chain stands today, how the U.S. trucking industry fared in 2022 and how all parties in the transportation factoring space should be navigating 2023.

Generally speaking, how did the U.S. trucking industry fare in 2022?

Tim Valdez: The interesting thing with transportation and trucking in 2022 is it started off fairly hot coming in from 2021. We had major tailwinds, and the business did really well. But by about the end of the first quarter, the industry started to fall off very rapidly. We saw weakening demand in the market. Spot rates dropped off at a very high percentage all the way through Labor Day.

The tailwinds we had at the beginning stalled to somewhat of a crosswind for the rest of the year. That means we saw a shift from very aggressive spot rates to spot rates softening and contract rates playing catch up. The first half was very dynamic. The second half of the year, average invoice amounts dropped, but seemed to flatten out. I believe we've gotten to the point now where the average invoice amount has dropped to the level where we're almost back to a new baseline or at the low point of where the actual average load or spot rate price will be going the first half of 2023.

There was a shift. If you go back and look at what happened in 2020 and 2021, there was a huge number of new entrants into the marketplace and those were the companies chasing very high spot rates and doing extremely well.

In 2022, and even the tail end of 2021, we saw equipment prices go up. The overall cost structure for a lot of these smaller guys changed dramatically. They were paying considerably higher for used trucks; they were paying higher wages to drivers and fuel prices were starting to spike. A variety of things were coming out of a robust economy that drove the cost structure to a whole different level than it had been previously. So when things started to soften, we started to see contraction on the small carrier side, and a number of carriers either failed or migrated back to becoming drivers for larger fleets.

To put it simply: record rates drove a lot of new entrants to the trucking business. At the same time, the cost to run a trucking business significantly increased. Now that the market has corrected, businesses have struggled to meet higher operational expenses at significantly lower rates, causing them to park their trucks or transition to driving for a larger carrier.

How did the broken supply chain impact the industry and how did factors help such clients navigate such a challenge?

Valdez: Let’s talk about the most popular headline items. The U.S. had a lot the congestion in the ports, for instance in Los Angeles and Long Beach, and many ships were delayed. At the same time, China’s economy was turning on and off. Those were the two obvious things from the supply chain breakdown in the U.S.

Let’s say I’m in manufacturing. I have 100 containers that come in every single month. Normally, when the supply chain is operating as it should, those containers would come into a port and they would be taken by an intermodal carrier from the port to a warehouse where they get broken out into specific product types. I’d then go out to the contract market, which are your large carriers, to say I've got 100 loads going from Los Angeles to Chicago that I need covered. They bid the rate, and everything works really well.

The challenge that we saw is there were multiple factors disrupting the supply chain. In my example, you have containers. Normally, it's consistent that three or four weeks after they leave the port, they're going to show up in the U.S. Those timelines extended for a variety of reasons, and with shutdowns, you weren't getting 100 containers, you might get 50 and then the next month you might get 200. These disruptions created a situation where manufacturers, distributors and importers were having to step away from their contract capacity because they typically only had an expected number of loads being hauled by contract carriers and then they had to move to a variable model. This drove the spot rates up and created weird dynamics in the delivery of needed products.

Importers that normally use 90% to 100% contract freight were forced to move to a more variable model where they might be using a 50% contract rate and 50% spot rate capacity to meet their obligations to their customers. On top of that, consumer demand went through the roof, ultimately disrupting inventory.

You see how that played out in the transportation space because contract rates stayed fairly flat and spot rates went up significantly because the spot rate is a variable component and ultimately drives accelerated demand. Against this backdrop, factoring companies thrived and were able to provide liquidity to those carriers in the spot market space.

Contract carriers typically don't factor. Those are the big guys. The spot rate carriers are the ones that factor and have the opportunity to grow, and we saw that play out over the last two years. Without a factoring facility in place, growth is difficult just because the working capital needs are so great when you're running at full capacity, which is what a lot of the small carriers were doing in late 2020 and throughout 2021 and early 2022.

During this time, companies needed immediate financing to meet the demand for services. Sometimes this was the funding needed for fuel to accept the next load, but other times it was to actually grow their business and purchase new equipment to take advantage of what was happening in the market. The benefit, in many cases, of a factoring relationship is avoiding a debt commitment — trucking businesses receiving increased financing simply as a function of their business growing. You're moving more loads at higher rates, so you get the benefit of that cash flow boost now.

The elasticity of the factoring solution coupled with a lower barrier to entry than a traditional lending product really helped propel growth among those running largely spot freight. It can quickly expand to meet the moment versus the opportunity cost of seeking out traditional lending solutions that come with debt, covenants and potentially limiting how that capital is used.

How would you rate where the supply chain stands today? Why?

Valdez: It is getting closer to normal for two reasons: First, there’s hope that countries like China will reduce some of their restrictive policies and get back to business in more of a normal fashion. Second, we've also seen demand fall off. With interest rate increases, the Fed is having some impact on slowing the economy, demand has slowed down, and it's giving the supply chain time to heal.

It's starting to come back to normal. It's not there yet, but the pendulum is swinging back more to the center than it was previously. I think we'll see the supply chain normalize more as we get toward the tail end of Q1/23 and the beginning of Q2/23.

What are the greatest challenges facing brokers, factors, shippers and/or carriers in 2023 and how can these challenges be overcome?

Valdez: For those of us in the factoring space, our cost of capital has gone up. After 10 years of virtually free money, we've seen a reverse, and with the Fed increasing rates, the cost of capital has gone up dramatically. If you look at a year ago, a factor might be paying somewhere around 2% to 2.5%, but that cost has gone north of 6% now.

The other challenge with factors is that the average invoice. Most of our clients are doing spot loads or spot rate loads, and those have dropped by 30% to 40%. As a result, factors are seeing margin compression. When you combine the two challenges, — costs going up and fee income going down — it puts stress on a factoring company.

Most factors borrow money, so when they are highly leveraged, they get squeezed. Now, part of that is because we've lost creativity on serving our clients effectively, while maintaining focus on long-term profitability. It was a race to the bottom on who could do a deal with the lowest discount at the highest advance rate. A lot of the deal structures that we saw in the last decade are flat rate-based deal structures that didn’t take into consideration that the cost of capital might go up and/or the average invoice might drop.

It's also during these times that we see increased instances of fraud. Sometimes it’s really just an issue of owners trying to make payroll. Sometimes it’s inflating invoice amounts by 10-15%. Worse, you may see fraudulent invoices designed to prop up working capital shortfalls.

The justification is they need to make payroll or pay fuel and insurance. We saw an uptick in fraudulent behavior significantly on the factoring side about a year ago, almost simultaneously with the invasion of Ukraine. I think it's just coincidental timing in most cases that it happened about the same time, but we also saw an increase in the cost of fuel during that time, which typically puts stress on those carriers as well.

If you look at stress on the carriers, it's been to their cost structures. The cost to buy and operate a truck or trailer is increasing because insurance rates go up when there's an influx of new carriers into the space like we saw in the last few years.

In addition, fuels costs are a concern. Smaller carriers that were getting paid a lot of money to run spot loads typically don't have the best fuel discounts. It might be a discount of 10 or 15 cents, but it's nothing in comparison to what the large carriers can get. Large carriers can save significantly greater discounts because their size and potential gallons allow them to negotiate directly with suppliers.

Carriers are also facing higher costs for labor, equipment and insurance all while revenue has dropped, leading to the same margin compression we’re seeing on the factor side.

During these times of increased uncertainty, carriers have changed or even increased their expectations of what they are looking for in a financial partner. This shift has required factors to be more proactive in their approach and look for meaningful ways to increase value without a significant increase in cost to the client. If we don’t want to participate in the “race to the bottom,” we need to justify and demonstrate what clients are getting for their investment.

Over the years, you’ve seen factoring companies do this by offering added value programs like fuel discount cards. More recently, you’re seeing factoring companies play an increased role in identifying partnerships or integrations that can enhance value to the carrier. On the Triumph side, you saw that we recently consolidated our transportation-focused divisions under one brand – Triumph – to strengthen our value proposition to the trucking space by offering factoring, insurance, equipment finance and asset-based lending, as well as access to other banking and treasury management solutions.

Our CEO has said that we want to be the best at banking small truckers, and that means taking a more holistic view of their business. I predict you’ll see similar innovations across the factoring space, albeit with a disciplined approach given where we are at today versus the previous two years. 

Looking at shippers, they are in the best position out of all the constituents in this equation because they are not having to go into the spot market as much. As the supply chain normalizes, they can stay with their contract rates and not deal with as much variable capacity. So, the pendulum has shifted for them.

The big challenge I see for shippers and brokers is that there has been a significant uptick in double brokering, which is when someone takes a load from a load board and/or from a shipper and doesn't haul the load. Instead, they send it to someone else. We saw a huge uptick in that practice in the second half of 2022, and that's a challenge. If a shipper books with carrier A based on carrier A's ability and safety record to haul the load, and carrier A doesn't haul the load for whatever reason, they’ll give it to carrier B, which may not have the same safety record. It puts the shipper at risk because they don't know who's ultimately hauling their freight. If there's an accident or any issue with that load, getting the load through a cargo or potential liability claim creates problems for the shipper.