It’s been said the more things change, the more they stay the same. Considering what’s happened to the economy over the past 12 months, it’s hard to imagine anything is the same as it was a year ago.

Flashback to January 2007: the Commerce Department was predicting 3.5% GDP growth for the fourth quarter; the Fed had spent the previous eight quarters hiking interest rates, hoping to curb runaway economic growth; and the bulls on Wall Street were keeping the Dow moving consistently northward.

Fast forward: As the Monitor goes to press with its 2008 Risk Management Issue, the Fed is six months into an aggressive rate slashing program, GDP is predicted to hover just over 1% in 2008, and the “R” word (recession) is on everyone’s lips. Clearly conditions in the U.S. financial sector have done an “about face” — but recent discussions with leasing executives indicate the same may not be said for the commercial finance sector.

For the leasing industry in particular, last year saw heavy competition, with excess market liquidity diluting returns and compressing margins across the board. Lessors complained they were being forced to take greater risks for smaller returns while working to provide new and creative value-added services to customers.

Meanwhile, other lenders were reaching further down the credit spectrum, banking on the high yields they’d find there to compensate for an overly saturated marketplace.

But when the subprime bubble burst this summer, the river of liquidity began looking more like a desert; and the flood of available cash quickly turned to a trickle.

The result across the wider economy is a higher cost of funds coupled with mounting delinquencies. Private equity has dried up and deals have stalled. Now roughly seven months in to the subprime crisis, the party is over for most U.S.-based financiers — at least for now.

“Companies may no longer bask in the protracted period of deals that carried very few rules governing borrowers’ behavior, and instead may find that the steady creep of creditworthiness down the ratings scale carries more consequences than once thought,” S&P summed up so succinctly in a recent report.

Yet for all the upheaval in the wider economy, leasing analysts say not much has changed in the equipment finance sector. Above all, leasing companies appear to have emerged relatively unscathed from the subprime debacle.

“There’s a clear distinction between the subprime demise and commercial finance,” explained Bob Rinek, an analyst with Piper Jaffray, during a recent ELFA-sponsored roundtable discussion. “Commercial finance does not have the same problems. There’s an overhang from subprime, but this is an industry that has behaved itself well.”

Yet for all that good behavior, a continuation of last year’s margin pressure means making a buck is still a struggle. One would expect that dwindling liquidity would have effectuated a reversal of the compressed margin environment. But for the most part, the asset managers we spoke with this year are singing the same tune as at the start of 2007, which means much of the competition that characterized the past 24 months has persisted. “It is not clear that liquidity levels have changed for traditional lease structures with good credits,” says James Grace, SVP of equipment management at Banc of America Leasing.

His colleague ay Key Equipment Finance, Scott Schauer, voices similar sentiment. “We haven’t seen any significant improvement in the margin compression issue so far in 2007,” explains Schauer. “Spread compression and narrow margins continue to be challenges.”

Schauer, who serves as a vice president of direct/large-ticket asset management at Key, says, as a result, portfolio diversification and balance, along with careful asset risk assessment, have become ever more important in today’s equipment lending environment. He says he is hearing the same thing from industry peers.

“Compared to last year’s conversations, I think there are more similarities than differences in the discussions that I have had with colleagues,” he says. “A number of asset managers that I’ve spoken to indicate that the current environment has lasted longer than we thought it would have two or three years ago.”

“I think there are fewer deals out there and greater competition for those deals, much more than what has been the norm in the past,” adds Phil Cooper, senior vice president, asset manager at Regions Equipment Finance.

Grace says this persistent competitive pressure has had consequences for leasing firms beyond those caused by the economy at large.

“Intense competition for new lease business has led to increased residual assumptions and willingness to accept poorer return provisions,” notes Grace, echoing last year’s respondents. At the same time, he says, “Spread compression continues to drive the need for greater residual income, putting pressure on relationship management of lessees.”

In spite of a deflated housing market, other sectors, including rail, marine and corporate aircraft, remain robust, the asset managers say. Nonetheless, the impact on the economy has sent residual shock waves through even those healthy sectors, and left a lot of lenders holding deals that no longer make sense.

“The change in the market happened so quickly that it seems to have left a lot of people trying to achieve goals made a year ago under quite different market conditions,” says Richard Newton, SVP and manager of asset management at Chase Equipment Leasing.

Newton adds that in trying to meet those goals in a declining market, aggressiveness in structuring transactions has continued beyond what market conditions dictate.

In February, the Equipment Leasing and Financing Association (ELFA) will host several hundred asset managers for its annual Equipment Management Conference, held this year in Miami, FL.

Grace says he suspects so-called “green” investments — 
for example, those in renewable energy — will be a major topic of conversation this year among lessors looking for new markets to bolster returns.

“Most investors were not focused on alternate energy investment opportunities until this year,” explains Grace. “The number of opportunities is increasing and greater analysis of the market risks and benefits will follow as savvy investors evaluate the attractiveness of this product.”

He says other topics of discussion this year are likely to include the need for greater sophistication in setting accurate residuals, and the shrinking and aging talent pool of equipment managers.

On this last point Cooper agrees. “Fewer people are entering the profession and people with multiple ‘business cycles’ in their past are becoming harder to find,” he says. “Couple that with a reluctance of people to relocate and you tend to find positions harder and more costly to fill,” on the current talent pool. But above all, conversations in Miami will echo those going on in boardrooms and conference halls across the country.

“I think the primary area of focus right now is the economy,” says Newton. “Is an economic slowdown imminent? If so how deep and how long will it be and how will it affect our asset management operations?”

Even if the equipment finance industry has so far managed to dodge the subprime bullet, credit stagnation elsewhere in the marketplace — and often within a lessor’s own company (particularly among bank-affiliates), have placed additional pressures on leasing units; this pressure by extension, translates into added challenges for equipment managers.

“Asset management has had to adjust to assisting in making a deal work as well as educating people why a deal does or may not work rather than just giving valuation input and moving on to the next deal,” says Cooper.

Newton agrees and says in light of market conditions, the onus has increasingly fallen on equipment managers to offer back-end solutions to front-end problems.

“There really seems to be two distinct parts of 2007: an aggressive, high-performing market before the subprime mortgage markets imploded, and a tighter, slower market with lots of competition for every opportunity,” he explains. “This latter situation tends to bring equipment analysis under closer scrutiny and gives rise to greater pleas for stronger values to bolster thinner transactions.”

Cooper thinks given the opportunity, asset managers will play a significant role in leasing companies’ maintaining a level of competitiveness through tough economic times.

“This is where the ‘relationship’ factor between the lender and the customer comes into play as an advantage,” he said. “For asset management, it is important to be a value-added piece of the overall decision process through providing insight to the current and estimated future value of the specific equipment in question, but also the industry.”

How the subprime shakeout will affect the equipment finance sector remains to be seen, but this year’s respondents all agree the outcome will largely depend on how each lender chooses to approach their deals.

“I think good credits and appropriately structured transactions will not see much of a negative market reaction whereas the more marginal credits and equipment types considered to be risky, or short-lived assets, will have a more difficult time finding a lending source with highly favorable terms as they might have in past years,” says Cooper. “It all depends on the appetite and volume goals the company sets for itself and the market segment they are trying to capture.”

Newton says even though leasing companies have remained somewhat insulated from the wider economic upheaval, the industry is not immune and can expect to feel the pressure going into 2008.

“On one hand, demands may be lighter for new transactions. On the other, there may be increased need for oversight and evaluation of the existing portfolio,” he adds. “An asset manager needs to be nimble and courageous in his or her calls.”

“Leasing companies are certainly ‘sharpening their pencils’ with respect to reviewing transactions,” concludes Schauer. “The market has tightened and no lender is immune from the backlash from the subprime lending debacle.

In this environment, he says, “portfolio diversification and balance, as well as asset risk assessment, become that much more important.”