Scott Schauer Vice President/ Middle-Market & LAS Asset Management, Key Equipment Finance

Clair Wright Vice President/ Asset Management, BNY Capital Resources

Mark F. Ketchum Vice President & Senior Equipment Manager, U.S. Bank Equipment Finance

Brian Derusha Director/ Asset Management, AIG Commerical Finance

Gine E. Brown Equipment Manager, M&T Bank

On February 24, leasing specialists from across the country will descend on Scottsdale, AZ, for the Equipment Leasing and Finance Associations’ Annual Equipment Management Conference. If history is any predictor, the association can expect a good turnout this year. During the last economic downturn in 2001, 
the Equipment Management Conference experienced record attendance.

As Matt Philbin, the editor of the ELT, explained at the time, with increased competition, “residual equipment values are playing a bigger role than ever in the profitability of leasing companies and in the feasibility of transactions.” As a result, Philbin wrote in a wrap-up of the event, asset managers “have their work cut out for them.”

The same could be said today. While it’s easy to draw parallels between 2001 and 2008, just about everyone agrees the current market turmoil is like nothing we’ve ever experienced. For one thing, the 2001 recession lasted just eight months; the current downturn, meanwhile, is well into its second year and shows no signs of abating.

Over the past 18 months credit has atrophied, interest rates have plummeted and commerce has slowed to a crawl. And many of the markets that have been hit the hardest — freight, construction and manufacturing —are the very industries that depend most on equipment finance, and vice versa.

“This has been the most challenging environment that I have experienced in the equipment finance industry,” says Scott Schauer, vice president of middle-market and LAS asset management at Key Equipment Finance.

“While many industries have experienced some cyclicality over the years, this is the first time in my experience when most — if not all — of the industries in which we finance equipment are in a state of unprecedented uncertainty.”

Once again asset managers are finding themselves on the front lines as leasing and finance companies struggle to maintain market share in a stagnant economy. In 2007, with the first signs of credit market instability, some 70% of finance company senior managers polled by the ELFA said they expected equipment managers to become increasingly important to their businesses.

As 2009 begins and barely a month before the start of the Scottsdale conference, we asked a group of asset managers from some of the nation’s leading leasing companies to talk about the challenges of the past year and speculate what will be on asset managers’ minds when they gather in February.

Clair Wright, vice president of asset management at BNY Capital Resources, speaks for all when he says he thinks the atmosphere will be somber this year in Scottsdale. “It will be sad that many asset managers will be missing this year due to reorganizations and reductions,” he notes. “Many talented asset managers are probably in career transition right now as a result of the current financial landscape.”

Given that, Wright thinks a main topic of conversation will be speculation about what organizations will still be around 12 months from now and the best ways for asset managers who remain in their organizations to get a renewal or extension through their company’s credit committees in such difficult circumstances.

“I would expect a more subdued atmosphere based on merger and acquisition activity, specific finance market exits that have occurred over the last year, and a general sense of ‘shell shock’ in many industries,” says Schauer, of Key Equipment Finance. He adds that asset managers and firms with more workout, repossession and liquidation experience are likely to become more engaged this year as they gear up for increased activity levels.

“I think the discussion this year will focus on falling used equipment prices and increased inventory levels from repossessions and end-of-term returns,” explains Mark F. Ketchum, vice president and senior equipment manager at U.S. Bank Equipment Finance. “These areas impact the bottom line in every transaction. Having good sources to remarket used equipment and maximizing recoveries is important at lease origination and maturity.”

Ketchum is echoing a shared concern; the condition of secondary markets seems to be on everyone’s mind this year. The problem, say equipment managers, is that the spending slump has greatly impacted resale values, which is making it difficult to find markets for assets when they come off lease.

“The desire to purchase on speculation has nearly evaporated. The secondary market is only purchasing assets if they have already found a home for them. Everyone is holding on to what cash they have,” explains Brian DeRusha, director of asset management at AIG Commercial Finance.

Wright agrees: “If equipment is returned at lease-end it is highly likely that it will sit in storage for a significantly long time as secondary markets are becoming non-existent.”

“Used equipment prices have been down across all equipment categories,” adds Ketchum, “which has greatly impacted the pricing of new transactions.” But he notes the impact varies. Some markets, like machine tools, have only seen a slight decrease, he says, while others, such as construction, have witnessed a significant reduction in resale price. For this reason, Ketchum says, today more than ever maximizing recovery on inventory requires extensive research and the ability to place equipment with experienced and sometimes specialized remarketing companies.

For his part, Schauer thinks things are only going to get worse as lease returns increase. “I think the growing supply of used, repossessed or off-lease equipment will continue to put downward pressure on pricing — particularly in trucking, office imaging and some construction equipment,” he says. “We are seeing almost a ‘paralysis’ in terms of new equipment financing, and an unprecedented growth in inventories of used or returned assets for sale in areas such as construction equipment, trucks and trailers.”

Gina E. Brown, an equipment manager with M&T Bank, offers a bit more optimism. She thinks that attendees of this year’s Equipment Management Conference will be looking ahead, eager to identify the new opportunities that are almost certain to come when the market begins its turnaround. In particular, she notes: “I would expect to see discussions regarding what effect [the Obama Administration’s] new federal infrastructure plan will have on our industry.”

In December, President-elect Barack Obama unveiled what he called, “the largest new investment in national infrastructure since the creation of the federal highway system in the 1950s.” The administration plans to spend upwards of $700 billion to overhaul the nation’s roads, bridges and transit systems, creating 2.5 million jobs in the process. Among the firms expected to benefit are construction equipment manufacturers like Caterpillar, Case and Terex, as well as some manufacturing, engineering and logistics firms. Equipment leasing and finance companies are likely to ride their coattails and experience increased activity once the projects begin.

Whatever the new initiative brings it will be a welcome change from the past year. AIG’s DeRusha compares the industry environment in 2008 to a hurricane. “At first, we saw the approaching clouds; then, the storm hit — exemplified by the complete demise of available capital and the resulting shutdown of accessible credit in the marketplace. Now it’s like the calm eye of the storm, with the government’s attempts to settle the markets. Nothing is moving and everyone is in stand-still mode.”

Wright, of BNY Capital Resources, sums up 2008 with one word: “terrifying.” He adds, “With the financial landscape changing on a daily basis, one doesn’t have a level of comfort that customers, partners and fellow leasing organizations will exist in the near future. There are issues that will affect asset managers and their organizations that have yet to be identified.”

This sense of the unknown, and the knowledge that things can go from bad to worse with little or no warning, has pervaded the entire finance industry in 2008. The resultant angst is compounded by the fact that no one seems to know just how long the crisis will last or what will be left when the smoke clears. “I think we have only begun to see what the fallout will be,” admits DeRusha. “It will be a completely different landscape 24 months from now from what we have been accustomed to.”

As for Philbin’s comments in 2001 about the increased responsibility on asset managers during economic downturns, everyone seems to agree they were right on point.

“That is completely true. Lessees are more knowledgeable on lease structuring 
and the competitive environment is fierce,” seconds Ketchum, when asked if the statement reflects today’s environment. “Margins get squeezed and the only place to make it up is your residual assumption and end-of-term process,” he adds.

Wright agrees that as leasing organizations struggle to find capital and profit, positive residual dispositions are playing a significant role. But, “residuals and pricing do not seem to be the barrier to new transactions,” he adds. “The main issues today with new transactions are credit quality and exposure.”

Brown says that beyond residual value and end-of-lease considerations, there has also been an increased emphasis on portfolio management over the past year. “The overall economy has taken a toll on our customers, and we want to make sure our equipment is maintained well,” she explains. “This means emphasis on the basics of equipment management is critical — physical inspections, maintenance record review, current valuations of significant exposure, and keeping a pulse on the industries where we have high portfolio concentrations.”

Like Brown, DeRusha says the current environment has led to a more conservative and proactive approach to equipment management. “I think the emphasis for asset managers has changed from a reliance on profitability to the safeguarding of our current portfolio,” he notes. “This entails an increase in on-site inspections, reviewing current residual positions that are due to mature in the next 12 to 24 months and establishing dialog with our customers before issues surface.”

“Experience has taught us that our involvement earlier, rather than later, in the process is critical to mitigating our exposure to risk from troubled accounts,” adds Brown.

Finally, Wright says the nature of the market in 2008 has forced some equipment managers into rescue mode.

“With credit defaults rising, recovery of equipment and working with legal in protecting a leasing organization’s assets in bankruptcy proceedings is taking 
a larger part of an asset manager’s day than residual forecasting,” Wright says.

Like everyone else in the finance sector, asset managers are entering the new year with baited breath, holding out hope that the U.S. Treasury Department’s $700 billion Troubled Asset Relief Program (TARP) will extend some benefits to the equipment finance industry. But so far the flood of cheap lending that was supposed to follow TARP’s has yet to materialize; many are fearful to lose what they have left. Schauer thinks that for the time being the benefits of TARP might be limited to bank-owned leasing companies.

“The TARP program certainly has a positive effect on the overall stability of bank-owned leasing companies, including enhancing market perception and investor sentiment,” he says. “I think that is good news for well-managed, stable, bank-owned leasing companies.”

Still others think it’s unlikely there will be any significant turnaround for equipment finance companies until at least next year. “I think [TARP] will have some impact on the financial side of the industry,” explains Ketchum, “but that will not necessarily turn into an increase in more customers looking for lease financing. I believe that in 2009 we will continue to see significant downturn in the economy, but in 2010 we will see some level of improvement.”