The jury is still out on whether the economy is due for a recovery or merely holding steady until its next decline. Analysts point to leading indicators and job creation as positive evidence. Kiplinger reported that the U.S. economy will grow 2% to 2.3% in 2012, faster than the 1.7% expansion in 2011. Consumers are spending again but cautiously, and the rising price of gas threatens wallet share.

It’s been one year since the Monitor checked in with capital markets professionals managing buy/sell desks at some of the industry’s leading financial institutions. Panelists David Coutu, president at MassMutual Asset Finance; Joseph F. Thompson, senior vice president of Capital Markets at AIG Commercial Asset Finance (AIGCAF) and William Badgio, managing director at PNC Debt Capital Markets, have more than two decades each in the equipment finance arena.

“If the amount of product is stagnant at best and the appetite is increasing, that tells you pricing will continue to be under pressure. In response, AIGCAF has given us the go-ahead to begin originating in the non-investment grade space. We plan to specifically focus on the B space, because we have a long history and significant expertise in that marketplace.”

— Joseph F. Thompson, Senior Vice President, Capital Markets, AIG Commercial Asset Finance

Banks Are Back

One quarter into 2012, the banks appear to have their houses back in order. What remains to be seen is whether a renewed focus on business development will take on an aggressive posture. “If that means not losing a deal over price, I think that posture was already there for many banks in 2011 as they sought to rebuild assets after the financial crisis,” suggests Coutu. MassMutual’s market includes lease and loan transactions of $2 million and up for near investment grade and investment grade credits. “As the fog began to clear after the crisis, we noticed banks winning and retaining large transactions that they would have sold down in the past. Since banks are our primary source for transactions, an increased origination focus should put more deals in the market, but as banks compete to win these deals, it will put pressure on pricing.”

“U.S. and Asian banks are indeed healthier and more active in 2012, which is really a continuation of the 2011 trend,” says Thompson. AIGCAF pursues primarily investment grade as well as single-B profile companies. Their average transaction size is $5 million to $25 million in the non-investment grade market and $20+ million for investment grade. “Banks tend to hold more of the opportunities they originate, and in the investment grade space, companies are flush with cash. In general, capital expenditures are still spotty and inconsistent. It is the confluence of these factors that drive down borrowing costs and manifest themselves in the contraction of bond spreads and tighter pricing.”

Badgio doesn’t think 2012 will be much different from 2011. “There is a fairly voracious appetite amongst institutions to employ capital in the commercial finance space. Some of the small institutions may struggle, but most of those don’t impact what we are trying to achieve in commercial equipment finance activities,” he says. On the buy side, PNC is focused primarily on middle, upper market companies and large corporate clients with credit profiles that are typically double-B equivalent and better. Transaction sizes range from $2 million to $3 million on the smaller end to $40 million to $50 million.

As more institutions compete for less transactions, could new tactics emerge to help gain an edge over the competition? “At MMAF, we don’t vary much from our strategy, regardless of the environment,” replies Coutu. “We will continue to focus on upper-tier credits where we see value in the pricing relative to other investment opportunities. Some companies might justify lower spreads in order to book volume, but that strategy makes sense if you are only striving to retain your very best customers — or, perhaps, win a key new relationship. Otherwise you have to ask yourself, ‘To justify the lower pricing, is there less risk in those credits than there was a year ago?’ I’d say probably not.”

“This is not complicated,” adds Thompson. “If the amount of product is stagnant at best and the appetite is increasing, that tells you pricing will continue to be under pressure. In response, AIGCAF has given us the go-ahead to begin originating in the non-investment grade space. We plan to specifically focus on the B space, because we have a long history and significant expertise in that marketplace.”

“In reality, all of us in the business are selling the same thing: capital,” surmises Badgio. “The key then becomes how you differentiate your capital from a competitor’s. Price is certainly important, but you try not to make that the number one factor. Other key factors are communication with your clients, how quickly you can respond with meaningful feedback, your knowledge of market issues and how reasonable you are to work with as an institution. It’s very important to establish relationships with organizations, especially in the buy and sell business where we work together to satisfy each other’s needs. Price, responsiveness and execution are critical, but it is also helpful if you can differentiate yourself by bringing something else to the table, such as the ability to buy as well as sell products.”

“Other than a brief time following the financial crisis, I don’t think we ever left the days of too many dollars chasing too few deals — at least for the better credits — and I don’t think we will. Players must be able to compete in a market that is consistently ultra-competitive. The successful ones are those that work hard to provide reliably good service in good times and bad.”

— David Coutu, President, MassMutual Asset Finance

Dollars for Deals

“Other than a brief time following the financial crisis, I don’t think we ever left the days of too many dollars chasing too few deals — at least for the better credits — and I don’t think we will,” says Coutu. “Players must be able to compete in a market that is consistently ultra-competitive. The successful ones are those that work hard to provide reliably good service in good times and bad.”

“In the investment grade markets, the customer has a lot of information on how to price borrowings,” relates Thompson. “Relationship is the key driver right now along with any arrows in your quiver that your competition does not have. For us that means larger deals and longer tenors, up to 30 years plus. A lot of banks prefer terms closer to seven years, so the fact that we’ll do significantly longer terms is a differentiator for us. If you have a deal with terms longer than 15 years, you should talk to us.”

“PNC has an excellent feel for what we are looking to accomplish and can get done internally,” insists Badgio. “We’re very responsive and reasonable. We execute based on what we say we can do, and I believe the syndication market views our product suite and prices as competitive. PNC Debt Capital Market/Equipment Finance is a two-way shop — both an active purchaser and an active seller.”

As certain industries and asset classes climb back from the economic decline, some are showing more promise than others. Recovery in these sectors might encourage lenders to expand their credit box or find ways to structure around the risks that may come with credit-sensitive transactions.

“As a regulated entity, there are additional requirements that may need to be followed, but there is still a wide client spectrum you can finance,” responds Badgio. “At PNC, we have defined those clients and opportunities where we think the credit, structure and asset risks are commensurate with the returns. We employ certain portfolio management tools and lending disciplines to do this. Obviously the further you go out on the risk scale, the less capital you will employ even if you can get the proper returns. If we have a credit and an asset that is in the top tier of the continuum, we are willing to lend a lot more dollars for that opportunity at the appropriate return. Conversely, if we have a credit, asset and structure that occupy a more uncertain place in the industry, we would have limited capital to put toward that opportunity.”

“In a lot of the deals we see and pursue in the investment grade world, the underlying asset is not the key driver,” explains Thompson. “Many industries have been flat with very little cap expenditure, but the energy sector, for example, has held up well and even grown. At AIGCAF, we like industries that do not have a lot of cyclicality, the ones that don’t rise and fall with the general economic trends. The relative stability of such companies helps us when stretching the term. We also consider unsecured transactions and transactions involving real property, which further differentiates us. The addition of non-investment grade appetite helps expand our box as well.”

“We don’t see any particular industries as being in a growth mode, except maybe oil exploration and production and healthcare, both of which seem to have momentum,” says Coutu. “We would welcome the ability to structure around more credit-sensitive transactions, or price them at an appropriately higher yield, but the competitive landscape of the market doesn’t permit this approach on a large scale.”

“The transportation segment is said to be a leading indicator in our economy, and we are seeing a lot of activity in that sector, some replacement and some growth. Hopefully we will see a little bit more expansion in other industries. There has been a lot of spending in the technology sector, and we don’t anticipate that that will slow down or change. Healthcare is a big growth initiative within the commercial lending sector, too.

— William Badgio, Managing Director, PNC Debt Capital Markets

What’s in Store for 2012

Slower than expected economic growth, low interest rates and more corporate liquidity continue to be challenges for equipment lenders. Many businesses have limited their CAPEX spending to the extent that they are now forced to replace equipment. Lenders are anxious for signs of added capacity to fuel future growth.
“I don’t think there will be a large spike in CAPEX in 2012,” says Thompson. “I expect the growth to be similar to the economic recovery: slow and steady. Many very large, creditworthy companies have lots of cash on their balance sheets, availability under their bank lines and ready access to public markets. This is what we are competing against. But fixed rates are highly attractive, which is why there has been a large issuance of bonds by corporations. So, the opportunities will be there but not abundantly.”

“I don’t think things are as bad as you might think from reading the headlines, so I do see opportunities for growth,” expresses Coutu. “Railcar loadings are up, and auto sales are somewhat decent. Consumers, for the most part, seem to have adjusted to gasoline at $3 to $4 per gallon, and consumer product companies continue to show sales growth. However, if gasoline heads toward $5 and fears of the large shadow inventory of unsold homes materialize, we would have a different scenario.”

Badgio sees an emerging trend toward more capital expenditures. “The transportation segment is said to be a leading indicator in our economy, and we are seeing a lot of activity in that sector, some replacement and some growth. Hopefully we will see a little bit more expansion in other industries. There has been a lot of spending in the technology sector, and we don’t anticipate that that will slow down or change. Healthcare is a big growth initiative within the commercial lending sector, too.”

A New Way of Thinking

When asked if one thing has altered their way of thinking when approaching a new opportunity, each of our panelists was ready with an answer. Coutu recalls, “The difficult conditions over the past several years have given us and other players the focus to concentrate on only those things we do best, rather than seeking the next hot market or business strategy.”

“Since AIGCAF began originating investments for our insurance companies, much has changed,” remarks Thompson. “We now take a relative value approach to pricing and gather much more information to accurately price risk. When looking at companies and transactions, we are not constrained to the U.S. and Canada, and can consider deals in most well-established countries for investment grade credits. Our general approach to the non-investment grade is the same as always. We can now penetrate a much broader geographic reach and credit spectrum.”

“We have learned a lot during the 2007-2010 timeframe, and you employ what you learn and hope not to repeat some of the blips you’ve experienced over the past in your portfolio,” instructs Badgio. “Increased regulation impacts how we behave and move forward. Many things are different, including regulatory agencies that oversee financial institutions. Basel III implications will impact the industry and how it lends and structures in the future. We will continue to learn and adjust our processes and positions according to the demands of the marketplace.”

Badgio offers the advice he shares with his colleagues. “I always tell my people that you can have all kinds of challenges internally; those are controllable. But if you have an institutional financial and capital structure that is significantly impaired, that can be very difficult to fix. At PNC, we don’t have those problems and that gives us a leg up, so that we are well positioned to capitalize in the present and the future.”

Lisa A. Miller is a freelance writer who has worked in the equipment financing industry for 15 years.