Asset Managers Adapt to Change Using a Team Approach
by Lisa A. Miller Jan/Feb 2015
With a fresh start to the new year, Monitor’s 2015 roundtable discussion with five asset managers provides insights from a variety of perspectives encompassing practices that are likely to continue amid the ripple effect of uncertain North American oil and gas markets.
The story starts the same way every time: “In an environment of increased competition, excess liquidity and slow economic growth, there continues to be too many lenders for too few transactions… .” It sounds like a broken record.
“We have a standard set of practices that we use whether the economy is up or down,” starts Terese Kramer, vice president, Equipment Management Group at BMO Harris Equipment Finance Company. “We use the fundamentals of appraising and then consider such factors as the lease term and structure, historical customer behavior, lease contract return conditions, regulatory issues, and equipment supply and demand. At the same time, equipment portfolio management and creating a positive customer experience throughout the term of the deal are part of our core asset management principles.”
Dennis A. Bolton II, senior vice president, Equipment Management Group at Wells Fargo Equipment Finance, notes that his company has developed and time-tested its approaches through all market cycles. “Our customer relationship focus through our specialty lending areas provides a unique competitive advantage in developing transparency and clear understandings into competition, market participants, operations, manufacturers/dealers, resellers and the associated equipment. By leveraging our scale, we identify developing trends, market and technological changes, and proactively manage corresponding opportunities and risks. By leveraging our knowledge and working with and for our clients, we eliminate the variability often seen in more opportunistic approaches.”
TD Equipment Finance hones its edge with a team approach to asset management. “Many asset management groups traditionally split their work into three main responsibilities — residual setting, portfolio management and remarketing — but our approach is more ‘cradle to grave,’” reveals Mark Polis, director of Asset Management. “Our front and back processes can be handled by any team member. With this approach, employees are more involved and communication is better.”
“We have developed a team of asset management specialists for every industry in which we operate,” says Rob van den Heuvel, senior vice president, Global Asset Management & Insurance, DLL (formerly De Lage Landen). “Strong internal resources coupled with external intelligence enable us to consistently provide a compelling value proposition to our vendor partners and end users. We are able to diversify our asset risk across different countries, business lines and customer segments to achieve the right balance based upon the macro-economic environments and other external forces impacting the way we do business.”
“Nothing in 2014 caused us to re-evaluate our position or stance on the market,” asserts William Tefft, senior vice president, Equipment Management at CapitalSource. “We did some direct remarketing for large equipment, reaching out to current and prospective customers, but even that wasn’t much of a change from prior years.”
Markets & Regulation
Despite the seeming monotony of the lending environment, each year brings its share of surprises. Staying on top of ever-growing regulatory issues and how they might affect future equipment values requires today’s asset managers to know their markets deeply while building strong relationships with third party sources of specialized expertise.
As the U.S. Department of Transportation gears up to issue rules around how crude oil tank cars must be built or retrofitted, Kramer said it is important for asset managers to get their arms around what those regulations might be and develop relationships with the experts who can guide them. “The onus of making sure these tank cars are up to the new standards will belong to the owner/lessor, not the railroad or the shipper. There are potential risks.”
“If you read through the proposed rule-making, the phase-out period could be anything from three years to a lengthy seven to 10 year phase out — or maybe there will be no phase out at all. It is a large question mark,” adds Tefft.
“The boom in oil production affects the rail tank car, marine barge and tank/truck trailer businesses as well as the construction industry,” continues Kramer, as she discusses the ripple effect of uncertain North American oil and gas markets. “The backlog for these types of new equipment associated with oil transportation is two years out. On top of that, oil prices continue to drop. When there is such uncertainty in the marketplace, there is also opportunity as long as the major factors are understood.”
The arrival of a new year brings everyone a fresh start, and Tefft looks forward to the change: “We are always starting all over, whether it is each year or each month, as we go out there to find an opportunity that is an institutional fit. With each new year, something will change. Adapting to that change provides us an opportunity to differentiate ourselves and develop or find a niche that didn’t exist the year before.”
Assessing the New Year
All of our participants agree that their current underwriting practices are likely to continue into 2015, though certain elements of risk assessment must change. “There are dynamics within each sector that impact values and our understanding of the equipment,” points out Kramer. “Asset managers need to be both subject matter experts and general machinery and equipment analysts. An asset manager must be more specialized, because the markets and associated regulatory issues are increasingly specialized. We complement our internal team with external subject matter experts.”
“Most on my team have learned the art of becoming equipment generalists, and they need to be well-versed in as many different equipment verticals as possible,” informs Polis. “Each of our asset managers can do 90% of what the other asset managers do. With that said, each also has a very specific specialty that is strategic to our business plan such as aircraft, medical and construction.”
“We will try to minimize our exposure to equipment in volatile market segments such as energy exploration and production as well as in industries that are subject to current or pending regulatory change or scrutiny,” says Tefft. “From recent highs, crude is down 50% since June 2014.
Superficially, as demand decreases for a commodity, there is a domino effect on the equipment used in the production, exploration and transportation of that commodity. With respect to coal, continued environmental focus on cleaner burning alternatives continues to depress related equipment values.”
Bolton underscores that their current underwriting practices, which are based on fundamentals, remain consistent. “We may make adjustments to our outlooks, but Wells Fargo’s strength is its consistent approach to risk management, which is engrained in our culture.”
“DLL has always put the long-term value proposition with our partners as a higher priority than any short-term profit goals,” says van den Heuvel. “That’s because we believe in genuine partnerships — the kind built on personal trust and not just numbers. We develop our approach to risk management by considering what will work best for our partners and end-users. We are extending our asset risk appetite position in such a way that we can support customers’ needs for new concepts, such as usage rather than ownership, the circular economy and other developments in the value chain and markets of our customers.”
Residual Values Past & Present
“Because we primarily finance critical-use equipment, most of our customers exercise their fixed early purchase options,” says Kramer. “When we are in a situation to negotiate an end-of-lease event, we have done well on our residual gains.”
Both CapitalSource and Wells Fargo experienced strong residual realizations and exceeded forecasts in 2014. Bolton attributed their success to two key drivers: economic recovery and his team’s experience. Tefft credited favorable trends in the transportation, material handling and energy segments.
“Over the last ten years our realization trends have historically been managed to be in the 125% to 135% range,” reports Polis. “Because we work so closely with TD Bank customers, internal business decisions may impact a specific realization. We are not willing to lose good customers over unreasonable end-of-term negotiations.”
Van den Heuvel warns that competition and aggressive paths to market share put pressure on residuals in some markets. “We don’t want to respond to short-term pressure and make decisions based on immediate circumstances; we will stick to our consistent long-term approach. DLL saw similar activity during the financial crisis, and because of our sustainable business practices, we hung in there and withstood some of the toughest times in our industry.”
“Exogenous events — such as soft markets or greater dislocations — can’t be predicted with any reasonable accuracy,” relates Tefft. “The challenge is on the front end, when we compete for new business that we believe will be profitable at end of term in any reasonable business cycle. The other front-end challenge is the competition. Stiff competition can drive the market to make assumptions that we cannot match, because we don’t believe that particular asset can go full term and provide that favorable residual realization.”
“I don’t think our residual realizations are going to change much in 2015, because the leases reaching maturity were won and awarded five to seven years ago and were structured much differently than they are structured today,” observes Polis. “Because competition has changed so drastically over the last year or two, I am more concerned about the effect of that realization five to seven years from now.”
“Our portfolio is relatively young in terms of lease maturities, so we just started seeing maturing leases with residuals in the last 36 to 48 months,” admits Kramer. “Even with the economic cycle, competitive market and young portfolio, we have done well.”
“Realization trends are consistent with only minor variations throughout the economic cycle,” says Bolton. “Competition is stout and sometimes unrealistic. Where other lenders enter and leave relationships based on cycle-driven opportunities, our viewpoint is long-term customer commitment, and that has served us well.”
“Over time our risk/reward assessment hasn’t changed dramatically and that continues to hold true despite economic cycles and levels of competition,” van den Heuvel says. “Certainly we are mindful of external headwinds and adjust accordingly, but fundamentally DLL maintains a consistent approach to asset risk management.”
Areas for Growth
“In 2014 we saw the most demand in rail, corporate aircraft, marine and food manufacturing equipment,” says Kramer. “In the medical sector, hospitals are investing again, especially in IT hardware and software. We suspect that exploration and production equipment sales will start to slow unless oil prices improve.”
“Inventory levels were low as many industries continued to work through their replacement and into the expansion cycle,” recalls Bolton. “Transportation, oil and gas-related industries and manufacturing performed strongly. Aircraft and medical remained anemic.”
“In 2014 we saw demand in renewable energy such as solar systems and conservation measures where entire facilities were reconfigured to employ energy-savings improvements,” says Polis. “We also saw increased demand in IT, medical and surface transportation. We expect to see increases in energy, surface transportation, rail and marine in 2015. Medical should grow: The average age of an MRI right now is eight to nine years old, so we anticipate replacement. As the medical facilities convert to electronic medical records, there should be significant IT growth, too.”
“The corporate aircraft space continues to attract investment, with loans to high quality borrowers at very low yields. However, the risk appetite for residuals has moderated, reflecting the collective experience of the past six years,” says Tefft. “That trend has been underway for several years but has become more prevalent across the industry. In 2007 a residual assumption for a corporate aircraft might have been 70%; today that same transaction might get 50%.”
“Our performance, recently and into the near-term, is reflective of the macro-economic data and trends we see globally,” shares van den Heuvel. “Construction, transportation and industrial are performing well due to infrastructure expansion and, specifically in the U.S., health in the economy and favorable interest rates. We are very conscious of declines in the healthcare market, which we feel are mainly because of the unknowns surrounding the Affordable Care Act and its impact on hospitals and clinics. With a major shift toward a digital world, we have grown our traditional copier business to partner with some of the largest software companies in the world.”
Bolton says, “2015 will be an interesting year. The biggest challenge will be developments and shake-out in the oil and gas-dependent industries. We expect to see current oil prices impact numerous industries from the exploration and development sectors to the various logistics support entities. Companies on or above the price margin will present challenges; industry consolidation and equipment values are likely to feel a negative effect.”
Not much changed in the dynamics between replacement demand and capacity expansion in 2014. “We saw measured, but timid capex financing growth,” remarks Tefft. “Interest rates drive refinancing, and it is attractive to borrowers to reduce their payment in a falling or low rate environment. We encourage our customers to take advantage of this, but it doesn’t seem to be a great motivator. Low rates have become the status quo, and people block out that it could change.”
“We are cautiously optimistic about business growth in 2015,” offers Kramer. “It is going to be a good growth year, but there will probably still be issues around margin compression and spreads. Customer demand for new equipment is improving, but it is improving slowly.”
“If you look at transportation, such as trucks and trailers or construction, you’ll see significant if not explosive growth in those markets,” states Bolton. “Towards the first half of 2014, a lot of focus was on replacement, and then it shifted toward expansion. Every industry except coal mining has been in the replacement cycle, and many crossed into expansion cycles.”
“Businesses have been stingy with their capital investments over the past few years, and now their aging equipment is forcing them to replace,” speculates Polis. “The economic indicators are starting to show that manufacturing is expanding, so I think we will see a good drive in both demand and capacity expansion.”
“We have increasingly found that our partners and their end users are not just looking for off-the-shelf, one-size-fits-all products but rather total asset or full-service solutions such as managed equipment services,” says Van den Heuvel. “We have started and plan to evolve a number of managed services projects, mostly in healthcare and office technology. DLL also recognizes that the customer is willing to take less risk, and bundling services with equipment helps mitigate risk. Therefore, we are working on new services for specific markets to support our customers’ fleet optimization with circular business models.”
The Decision to Invest
Bolton says the biggest factor in companies’ decisions to invest has been the need to finish updating capital equipment as the economy recovers. “The second half of 2014 benefitted from expansion buying as well. I believe this will continue in many industries, such as trucking, but at a slower rate, and it will be dependent upon the general economy.”
“The favorable interest rate environment and continued strong demand in land-based drilling activity early in 2014 created investment demand,” comments Tefft. “Energy is a big part of our economy, and it appears to be materially softening going into 2015 when measured by coal, natural gas and oil. This establishes uncertainty around new financing opportunities, potentially slowing the pace of new equipment demand and ordering as the year unfolds.”
“We are all doing more with fewer resources, and I think most manufacturers have adapted that philosophy as well,” informs Polis. “Manufacturers have learned to become highly efficient as they stretch the useful lives of their equipment. Expansion and the need to replace equipment will drive our business over the next couple of years.”
“Our customers tend to hold on to their equipment whether there is an economic downturn or whether the economy picks up,” says Kramer. “Because it is critical-use equipment, they start to look for new equipment or upgrades, either for replacement, expansion or both.”
“In a resource-constrained world, the linear economy of ‘take, make and dispose’ is unsustainable,” cautions van den Heuvel. “We need to reshape business models to the circular economic model, where goods and materials are reused and recycled. This is good for the planet and business. DLL supports this innovative business approach by offering its Life Cycle Asset Management program. This program embraces the economic management of assets throughout their entire technical life — not just the first three or four years.”
The Changing Role of Asset Management
“If you have a well-seasoned asset management group, it can play a major role in an organization,” emphasizes Polis. “We can assist in structuring at the front end. We are not simply setting residuals in a vacuum anymore. The asset management group needs to understand the lease documents and how they can help or hurt us. By understanding the customer’s expected usage, maintenance practices and the equipment’s environment, we can help predict more accurate and meaningful retention and residual realization ranges.”
“It’s up to the asset manager to understand these specific markets well enough to contribute and make recommendations when we decide to focus on certain sections of the market,” adds Kramer. “This business is a team sport. The equipment manager, along with his subject matter experts, is an integral part of that team. It is incumbent on him to provide the right balance of robust yet prudent residual. In the current environment, it can be a differentiator in winning business.”
“The competition for commodity assets and equipment is off the charts,” says Tefft. “Rate has been a bigger factor than residual, which leaves institutions competing against each other in the form of yield. Equipment professionals compete on their respective outlooks, but perspectives on most types of equipment are currently aligned, so there is not a lot of contrary thinking between different institutions.”
“Our mission is to enable businesses to use the assets they need to contribute meaningfully to the world, both economically and socially,” stresses van den Heuvel. “We create successes for our partners, their customers and ourselves by seeing what really counts. We are working together with our partners to develop new finance products and services — anticipating their future needs. The asset manager is playing a key role in identifying how end users are using their assets and how the technological developments of assets can impact the usage and future value.”
“The asset manager is critical in identifying, understanding and communicating the risk/reward paradigm as part of the overall approval,” articulates Bolton. “We strive to fully understand our customers and their transactions, risks and opportunities to support them in ways our competition may not see. Wells Fargo is large and diverse, which allows us to offer just about any product our client wants or needs. Our balance sheet is also strong. If a client is looking for $100 million, we are able to offer that amount and have the flexibility to syndicate any portion that is over our limit.”
Winning with a Team Approach
“We utilize a team approach to proposing on deals and keep the mantra of ensuring a great customer experience at the heart of everything we do,” voices Kramer. “That translates into strong open lines of communication between our customers, service providers, internal sales and support teams.”
“We don’t operate in silos with credit here and asset management over there,” says Polis. “The asset management group is brought into pricing discussions, and we help negotiate lease documentation to remain competitive. It works much better this way, and the experience gives the employee a sense of importance and job satisfaction.”
“When we talk to customers, we talk about complete financial solutions across numerous products,” proclaims Bolton. “We work with all our business partners and bankers to understand our client’s needs and engineer solutions to meet them.”
“Institutionally we are nimble and flexible with unparalleled execution,” boasts Tefft. “We try to market this advantage to customers who value these attributes. We closed a transaction for a manufacturing client last year where we identified, inspected, appraised, documented and closed in less than 30 days for equipment at 11 locations in five states. We accomplished this by dedicating one person from each of our asset management, credit, documentation and sales teams to coordinate all of the activity necessary for credit approval and closing.”
“Over the summer DLL signed a major global program agreement with a vendor partner who was previously identified as a key player in the healthcare space,” says van den Heuvel. “Country coordination was critical in developing the program as was collaboration across multiple business units. In Europe various business units and commercial finance teams worked together to share information and leverage knowledge that resulted from their individual experiences with the customer. After working hard for three years researching, preparing and executing the potential partnership, the global agreement now provides the framework for a roll-out in 26 countries covering five continents.”
“Asset management used to look at a deal in a box and simply provide a pricing residual that became part of the structuring and approval process,” remembers Polis. “Our role has evolved over the last 10 years, and I am pleased to see it. Today’s asset management group is a profit center that can add significant gains to the bottom line.”
Lisa A. Miller is a regular Monitor contributor who has worked in the equipment financing industry for more than 15 years.
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