As Congress battles over the debt ceiling, budget deficits and mandated spending cuts, equipment finance managers maintain their optimism. Replacement still drives harder than capital expansion, but both are on the rise. The economy may not grow as fast as the 2.3% experienced in 2012, but a modest anticipated growth of 2% should continue to inch the economy forward.

As part of the Monitor’s annual round table discussion with capital markets professionals, we solicited the opinions of Scott Kiley, vice president, territory manager of Indirect Originations at Fifth Third Equipment Finance Company; Theresa Provencher, managing director, PNC Equipment Finance; and Joe F. Thompson, senior vice president of Capital Markets at AIG Commercial Asset Finance (AIGCAF).

With ELFA data suggesting year-over-year volume up 14% from 2011, we asked our panelists to rate the economic momentum going into 2013. Thompson said that AIGCAF volume is up substantially year over year; he sees positive signs that businesses are investing in fixed assets. “Energy-related and transportation assets seem most plentiful,” notes Thompson. “I attribute our increase to tailoring our marketing efforts to the investment appetite. Insurance companies have a need for long duration investments to match the duration of their liabilities, so we have become attuned to sourcing those transactions.”

Fifth Third’s Kiley chimed in, “On the buy side, our activity was about 7% higher than 2011, which I attribute to the overall level of equipment acquisition activity. As we came out of the recession, more and more transactions were completed, allowing more to go to the syndications market. In 2012 we’ve seen an uptick in added capacity for manufacturing, and there’s growth in the vessel and marine areas. Replacement has been huge in the transportation industry, especially tractor-trailers.”

“From a volume perspective, we were flat to our expectations in 2012 but had a better year than 2011,” conveys PNC’s Provencher. “While there was overall growth in the market we serve, there was not as much growth in the investment grade/near investment grade market that we look to play in. On the buy side, we had about 10% growth and came in on top of plan. We are seeing some growth in the healthcare space with its technology expansion and modest growth in transportation.“

“There are still too many dollars chasing too few deals, plus there are a few new players that didn’t exist a few years ago,” reports Kiley. “Because there are companies with strong cash balances, our competition is often cash.”

“The longer the transaction, the more competitive we become,” declares Thompson. “We do not exclude shorter transactions if the economics make sense, but there seems to be a lot of sources of shorter term funding. I think competition will intensify in 2013.”

Pricing continues to be competitive, too. “Banks were more willing to stretch on structure but have otherwise been consistent on equipment valuations,” says Provencher. “This may change as the market recovers. Just as we’ve seen a slight improvement in valuations in the transportation and aircraft space, I anticipate similarly modest growth for 2013, perhaps 10% on the buy side.”

“The risks versus rewards are not as favorable today,” comments Thompson. “With artificially low interest rates and taking a long term view, some would say risk/reward is out of balance. There have been new entrants to the market on the bank side. Fewer portfolio and funding issues translate to more focus on new business generation, and credit spreads have decreased. This results in a risk/reward that is not as favorable year over year.”

Provencher finds that things have not changed much in terms of risk versus return. “Delinquencies are lower, but pricing is compressed. Demand for products is up, and supply is relatively flat with very modest growth, so returns will probably be compressed as the year goes on. But all these factors are fairly stable over the prior year.”

“From the credit risk perspective, we pride ourselves on being very consistent,” admits Kiley. “We focus on the better credits. If more people are chasing those deals, price comes down and we have to operate in a world of lower spreads. To make up for that, we have to do more deals or sprinkle in some that have lower credits and higher spreads.”

Credit Conversations

“All financial institutions have additional or more robust oversight since 2008,” remarks Thompson. “Every transaction and every industry has unique elements. At AIG we find there is no standard question in the typical credit review meeting that we face more often now than we did then.”

“Financial statements have improved over the last few years, and more companies are making money,” says Kiley. “When talking to credit people, everyone is looking at more optimistic numbers and better credit results, so the conversations are more positive.”

“Regulatory considerations are a much larger part of the credit process than they have been in the past,” adds Provencher. “Compliance and ‘knowing your customer’ have moved front and center as much as the credit metrics of the transaction or opportunity.”

“At Fifth Third we don’t just lob a deal into the credit shop,” states Kiley. “We are expected to do the initial analysis, to understand the deal and articulate the credit. We need to feel good, collectively, about the deal before putting it on the earning assets.”

“Whereas in recent years, we haven’t pursued certain asset types or industries,” relates Provencher, “the veil has been lifted and analysis is based more on the specifics of the transaction. For example, our focus in the aircraft space has shifted from prior history and performance issues to the opportunity itself. We now consider the characteristics of risk and return as opposed to just looking at prior constraints in industry terms.”

Technology Talk

With increased business focus on efficiency and automation, capital markets groups also benefit from new technologies. “We have focused resources on leveraging our technology and business intelligence to be more efficient and competitive,” says Thompson. “These efforts led us to win the 2012 ELFA Excellence in Technology Award. Our system allows for information integration and collaboration from initial marketing efforts, asset management, credit, booking and account maintenance over the life of the account. In real time, we can access detailed information on a customer, including financial information, credit ratings and information on the company’s recent financings and press releases. Services such as Bloomberg, Capital IQ and Salesforce.com have revolutionized the speed at which we can understand and analyze a company.”

“Many syndication shops have developed information portals where they post deals on a secure website where investors may look confidentially at the offering memorandum and financial statements,” asserts Kiley. “This is more efficient for everyone involved. As an approved investor, I can log into that site and pull down the information or receive an email telling me a transaction has been posted. When it’s time to close the deal, the documents are often transmitted through that portal, too. This technology saves us from making a lot of phone calls and potentially missing information.”

Provencher is quick to add, “Our business is still very much a relationship-oriented business. Deals are discussed, won and lost over the phone. We do get emails and have access to deal information from online sources, but buying transactions is not a high technology business.”

Getting Started

If a new entrant wanted to join the business of selling off participations or whole transactions, our panelists took measure of their own experience to offer tips on the best way to enter the market.

“The ELFA website is the best place to start,” suggests Kiley. “Companies post profiles outlining the types of deals they buy and industries they serve. When looking for a buy shop, it’s important to know what each shop looks for in terms of credit type, average deal sizes and collateral.”

“Hire an experienced syndicator who knows the market,” recommends Thompson. “The syndicator should understand the transaction completely and present it concisely. Time is precious, so we try to work with sources that know and control their transactions.”

“No sellers are created equal,” warns Provencher. “We are in the business of managing risk, so we need to be sure that those we are buying from have our best interest, as well as their own, at heart. With a larger pool of reputable sellers, you have a greater choice of transactions. You want the pool to be as large as possible, but you also want to know your sellers and know they can execute on their promises.”

“As a buyer, we want to deal with people who are going to market with the credit types, deals and pricing parameters that hit our sweet spot,” says Kiley. “At Fifth Third we tend to play with the bank lessors, because we often want to sell as well as buy, and it helps to have a reciprocal relationship. I need to be efficient, so I want to work with the people who bring me the kind of business that has the best chance of getting approved.”

“Details are critical and impact your ability to execute on both sides, which helps you establish a strong reputation,” finishes Provencher. “In a competitive environment, reputation can make or break your business.”

It’s Groundhog Day

Last year’s roundtable discussions centered on low interest rates, lack of demand and competitive pricing. Have things changed? “It’s Groundhog Day!” exclaims Provencher. “There is slow growth in supply of quality opportunities but heightened demand to add assets. Interest rates remain low, and I expect them to remain low for the coming year and then some. With more parties looking to buy deals, pricing will continue to be competitive. We have seen a little of that early in the first quarter as increased competition drives pricing. New entrants looking to ramp up their portfolio will add pressure.”

“Demand is up, but competitive pricing and low interest rates are the same,” agrees Kiley. “I have more competitors than I had a year or two ago. We’ve been doing this a long time and we are good at it, but I find that others have gotten good at it, too. Fifth Third’s competitive advantages include responsiveness, but I’ve noticed that others have gotten smarter about how fast they can react.”

When asked about capacity utilization being below desired levels to spur new investment, Thompson says, “Every market has its dynamic, and there are numerous important metrics to recovery and expansion. Capacity utilization just means our customers have more business, but that is only one factor, among many, in a decision to finance long term fixed assets. Increased business helps spur investment in new equipment, employment, housing and all factors that drive GDP.”

Whether optimistic or anxious, there are obstacles to doing business at the levels capital markets teams are committed to deliver. “There are new entrants and everyone wants to add assets,” insists Provencher. “You need to be realistic and model yourself around the slow growth while managing expenses.”

“One of our challenges was manpower,” recalls Kiley. “We have portfolio managers who also work as our credit underwriting shop. As the portfolio grows, these employees are increasingly tied up with portfolio management activities. We’ve added three new people to allow us to look at more deals.”

“There is a place on corporate balance sheets for long-term fixed rate financing,” insists Thompson. “CAF’s primary obstacle is that many customers are not aware that longer- term financing is an option, and they default to a shorter-term, floating rate product. Our goal for 2013 is to get our message to the market that AIG is healthy and has substantial appetite for investments from ten to 30 years.”

“Looking down the road, I am optimistic because we are transitioning from a recessionary phase to a growth phase,” professes Provencher. “To be realistic, you have to anticipate that growth will be modest and focus on growing your bottom line. We can’t change the economy, but we can try to increase our market share through continued relationship-building and expense management.”

Lisa A. Miller is a freelance writer who has worked in the equipment financing industry for 17 years.