Buy/Sell in Today’s Environment

by Lou Vigliotti Sept/Oct 2013
In evaluating the future of the equipment financing industry, GE Capital Markets' Lou Vigliotti explains that while much remains the same, there are trends — as well as regulatory and accounting uncertainties — that executives should consider as they position their companies for growth.

But corporate attitudes toward spending might finally be changing as the economy finds another gear and a cautious optimism takes hold. Investment in plants, equipment and software, which fell to $1 trillion in the depths of the financial crisis in 2009, is expected to hit $1.35 trillion this year and $1.55 trillion in 2015, according to the Equipment Leasing and Finance Association (ELFA). As investment grows, so too does financing, from $454 billion in 2009 to about $742 billion this year and $816 billion in 2015.

Many of the reasons that companies use equipment financing remain the same today as they have for many years: Obsolescence requires investment in new equipment; tax rules allow lessees to pass tax savings to lessors to reduce costs; budget realities make leasing equipment more feasible than outright purchases; and equipment re-financing and sale-leasebacks can unlock hidden equity.

While much remains the same, there are trends within the equipment financing industry — as well as regulatory and accounting developments affecting the industry — that executives should consider as they position their companies for growth. At GE Capital Markets, we’ve taken stock of the emerging environment and made some adjustments; specifically, we recently reorganized the teams specializing in the purchase and sale of equipment loans and leases in the secondary market, grouping them together and giving them a common reporting structure under the GE Capital Markets equipment syndications team. On the sell-side, we support six platforms: Corporate Finance, Fleet Finance, Equipment Finance, Rail Services, Commercial Distribution Finance and Canada. We in GE Capital Markets work closely with them, and the sell-side teams get involved early in the deal structuring process. We believe the revised group structure will serve the needs of both GE Capital and the market more efficiently.

Industry Dynamics

The financing of new equipment has been sluggish for the past few years, but one compensating factor was a very robust refinancing environment. Companies paying 5% saw they could refinance into a 3% loan and were willing to absorb prepayment penalties to do so. These re-financings frequently involved long-term assets in which the company had built up equity, such as commercial trucks and equipment in the construction and energy industries. Marine products are also an active category. Barges, for instance, depreciate to their value as scrap metal, but they do not become obsolete, which makes them a good candidate for refinancing.

Since June, re-financings had been tailing off. That coincided with the expectation that the Federal Reserve would begin winding down its aggressive monetary easing policies later this year. As interest rates crept up, re-financings slowed. Fortunately for the equipment financing industry, there were signs that new activity was picking up even before the Fed said in September that it would continue its buying program. In August, both manufacturing and non-manufacturing activity beat economists’ estimates, according to the Institute for Supply Management. That prompted The Wall Street Journal to write that new investment is increasingly probable: “A dearth of investment in new equipment has made it harder for companies to wring more from their employees. Productivity, as measured by output per hour, was up a scant 0.3% in the second quarter.”

Based on a 2013 survey by ELFA — and presented in its “What’s Hot, What’s Not In Equipment Leasing for 2013” report — equipment managers and leasing companies are particularly optimistic about medical equipment, oil/gas/energy and construction. The medical industry prefers to lease large equipment such as CT scanners and MRI machines, and the aging baby boom generation is driving increased demand on hospitals. On the downside, the Patient Protection and Affordable Care Act (commonly known as the ACA) is creating significant uncertainties, particularly in terms of reimbursements. This places continued pressure on both volumes of medical equipment sold and the average selling prices for this equipment.

As for oil/gas/energy, ELFA says the national push to become energy independent clearly bodes well for equipment financing. Barges and trucks are vital to the transportation of oil and gas. ELFA noted optimism for emerging opportunities in clean energy technology and equipment, but most of the activity in the past year was related to the fracking segment of the energy business.

Another hot industry for equipment finance is construction equipment. This segment benefitted from low interest rates that spurred housing and commercial construction activity in 2012, which has continued into 2013.

Regulatory Factors

There are several regulatory cross-currents that could affect the industry — although the impact remains uncertain. A big unknown are the rules governing how much capital banks and finance companies must hold against various investments. U.S. regulators, as part of Dodd-Frank rule writing, and European regulators, as part of Basel III, are drawing up these plans. Both groups of regulators want financial institutions to hold more Tier 1 capital, and they are toughening the definition of Tier 1 capital to make the financial institutions more resilient to financial shocks.

In the past, as long as the institution was comfortable with a borrower, it was free to finance any asset it liked — such as trucks, barges or planes, for example — without tying up significant amounts of additional capital. That may change going forward. For example, if a large regulated institution finances an airplane for a company with a credit quality equivalent to a B rating, instead of a BB rating, it will be required to set aside more regulatory capital. That, in turn, would negatively affect its Tier 1 capital ratio. In light of this, some lenders might scale back the types of assets they finance.

The effects of the new regulatory environment aren’t all negative — particularly in terms of buy-side demand for equipment lease paper. Regulators have told regional and community banks that they are too heavily invested in real estate and need to diversify. These institutions see equipment leasing as a good candidate for diversification, and we have seen an influx of new funding sources over the past 18 months as they have entered and/or expanded their equipment leasing capabilities.

While the new competition may mean fewer on-book assets, it is a positive development in the syndication arena. One challenge in syndication is to have a large group of reliable investors. Today, the majority of buyers we work with are bank leasing companies, a few pure finance/leasing companies and some insurance companies. Most investors are domestic. A large number of the foreign lenders exited the equipment space when the recession hit, or they scaled back to service only bank customers, so the influx of new buyers is beneficial.

Accounting Changes

The Financial Accounting Standards Board (FASB) is currently proposing changes to lease accounting as part of a joint project with the International Accounting Standards Board (IASB). These proposed changes could have far-reaching effects on equipment financing. In the spring of 2013, FASB decided by a 4-3 vote to move forward with a re-proposal on the recognition and measurement of leases. The lease proposal, which was open for public comment until mid-September, would require lessee capitalization of all leases on the balance sheet unless the maximum term is 12 months or less, a lease classification determination for purposes of lessee expense recognition based on a consumption principle and reassessment of certain items at each reporting period. In general, most equipment and vehicle leases would be accounted for differently from property leases.

The final outcome of the proposal is not yet known. Re-deliberations on the proposals are likely to start in the fourth quarter of 2013. A final standard is possible in 2014. The effective date is yet to be decided but is unlikely to be earlier than 2017. The final rules would apply to all leases that exist at the beginning of the earliest comparative period presented.

Conclusion

“Cautious optimism” is something of an overused term, but it really does apply to the equipment leasing industry today. A convergence of factors — obsolescence, declining productivity and increased economic growth — all seem to bode well. But the fact remains that a significant increase in activity has not yet materialized. Regulatory and accounting uncertainties are part of the reason. If these begin to sort themselves out over the next year, there might finally be the clarity and confidence to ignite equipment finance activity.

Lou Vigliotti is senior managing director for GE Capital Markets (GECM,) and has served as head of the equipment syndications group since 2009. GECM, a subsidiary of GE Capital, is a registered broker-dealer with the U.S. Securities & Exchange Commission and is a member of FINCA and SIPC.

Leave a comment

No tags available