The good news is that the equipment finance industry as a whole is strong. In the wake of the 2008 recession and recovery, the U.S. economy is thriving, which is creating significant opportunities for the industry.

But many of the positive factors currently boosting the industry could lead to some significant challenges, particularly if companies are not proactive in improving a competitive edge. Additionally, a few wild cards that are out of the industry’s control could also have adverse effects down the road.

The Good

Throughout the recent economic downturn, equipment finance firms exhibited great resilience, largely due to the industry’s low loss rates. Since equipment is integral to a company’s ability to operate, essential equipment is typically the last obligation that a company will default upon.
With the economic recovery firmly in place, businesses have moved from simply undertaking replacement and maintenance projects into funding expansion projects. This has been a boon for the equipment finance industry.

The EFLA-MLFI 25 Index bears this out, indicating steady industry growth across all key metrics during the last 12 to 18 months (see chart on page 43). The June 2015 index reported $9.5 billion in new business volume, up 4%t from the prior year. Another positive statistic, credit approvals have remained steady while employment among equipment finance firms was up 5.2% from June 2014.

The industry also benefits from its ability to seize opportunities driven by new technologies. Today, companies are devising ways to finance cloud-based services along with the backbone equipment. For a healthcare organization, for example, this could mean financing software along with cloud-based storage to develop a full-fledged electronic medical records system. The line between services and physical equipment has blurred, and that is creating new avenues for equipment finance firms.

Finally, the influx of young talent indicates promise for the future. New or recent college graduates are joining our industry, and grassroots efforts such as regional industry networking events and guest lecture programs at colleges and universities are attracting new talent. The key will be to figure out how to develop and retain these young workers for the long term. Continuing education classes and broader industry development helps with this goal, but this has the potential to be a key challenge for industry leadership in the years to come.

The Bad

Although the economic rebound has largely been a positive for the industry, it has also created some negative consequences. Potential customers have more liquidity, which means using cash for equipment purchases is sometimes a more attractive option, even with interest rates continuing to hover near record lows. Furthermore, while attractive loss rates have led to increased investment in the industry, that liquidity has driven returns sharply lower in turn.

Internally, the industry is contending with the homogenization of its products and delivery mechanisms. Competitive pressure, which is greater now than ever before, is driving this unwelcome trend. However, while the industry has largely learned the lessons of maintaining fundamentally sound structures in the wake of the recession, pricing has fallen off a cliff. The result is equipment finance companies have stopped differentiating their services and instead compete largely on price. This has essentially commoditized product offerings across the board.

Compared with previous periods of intense price pressure, spreads have compressed to a point that has led some in the industry to wonder whether their parent companies and outside investors will begin to look elsewhere for growth. This is why it is vital for firms to demonstrate value beyond the transaction price if they want to win sustainable business.

The solution is to give clients an experience that makes it worthwhile to pay a premium. This could include increasing human interaction during the process, providing more comprehensive services or offering conveniences such as electronic documentation. It’s one thing to set your price low enough

to win a customer looking for a one-time financing deal. It’s another to secure a client that values a long-term relationship.
Another potential challenge relates to syndication. During the last 15 to 20 years, the industry has transitioned to a capital markets-style originate-to-distribute model, which has opened up new avenues for liquidity by creating tradable securities out of leasing contracts. As spreads have compressed and deal values have plummeted, creating income from those instruments has become more difficult. Deals that companies arrange today are likely to be on their balance sheet for the term of the deal. These instruments are less liquid due to current interest rate conditions, negating one potential source of future fee income.

The Wild Cards

Along with the internal issues outlined above, the equipment finance industry is also contending with factors outside its control. In these cases, companies can only anticipate what these factors will mean to clients down the road.

The regulatory landscape presents several unknowns for the industry. Regulatory pressures on data, reporting and heightened standards have the potential to raise the bar and increase costs for all of the industry’s companies. Accounting changes, such as the standards convergence of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), also have the potential to create meaningful change. In the works for nearly 15 years, the convergence will likely change the way customers reflect lease contracts on their balance sheets and may potentially change the industry’s financial offerings.

The potential for corporate tax reform also exists, which could be a significant change for the industry. There is a risk that interest deductibility or depreciation schedules may change. Given the fact that many of the potential benefits we offer to clients are tax related, a change made to either schedule would be a potentially difficult challenge for the industry to navigate.

Finally, while the industry is currently enjoying a wave of business driven by the strong economy, its final challenge is anticipating the next downturn. The typical response to competition and tightening of spreads is to loosen structures. While the industry is resilient during economic downturns, being too aggressive on structure and price can leave firms with less room for error, and the Great Recession taught us that is not a sustainable solution.

Typically, the deals completed in the six months prior to a crash are the most aggressive. Correctly anticipating the next downward cycle will help firms determine when to start being more conservative about structures.

All in all, there are plenty of reasons for equipment finance companies to celebrate. However, one thing the industry can’t afford is complacency. It will take hard work and a willingness to innovate to build on the gains we achieved during the past several years.
From both an opportunity and a young talent perspective, the future is bright. As industry leaders, our responsibility is to keep our industry bright for generations to come.