Asset Managers Sum Up 2011, Forecast for 2012

by Lisa M. Goetz January/February 2012
The asset managers assembled for this year's Monitor roundtable saw in 2011 a stuttering economic recovery as they led their respective institution's equipment management activities. During the slow and bumpy ride, they experienced a rise in equipment values, favorable end-of-term residual realization, increased used equipment sales, strong competition for desirable deals and a proliferation of government regulations. And, at the dawn of 2012, these leaders forecast more of the same mindful that certain factors could bring about the winds of change at any given moment.

Reflecting on a lethargic economic recuperation that wobbled its way through 2011, the equipment management leaders participating in this year’s Monitor roundtable all agree that consistent asset management discipline was key to successfully weathering the ups and downs of last year. That guiding principle will be essential in steering their respective organizations through 2012, as they predict a continued stretching out of the recovery.

“In 2012 we’ll see an ongoing healing of the economy. It will continue to be a bumpy road like 2011 was but maybe with a bit more good news,” explains James Grace, senior vice president of Equipment Management at Banc of America Leasing & Capital.

Steve Robbins, senior vice president of Asset Management at Capital One Equipment Leasing & Finance, concurs, “Although the economic conditions have improved, this doesn’t mean that risk management will play any less of a role. What has changed is that the portfolio has stabilized and inventory levels have gone down allowing us to shift more of our focus to the front end where we assist in developing and transacting new business.”

At Key Equipment Finance, maintaining a consistent approach regarding asset management discipline over the past few years led the organization to make the strategic decisions to exit certain businesses that no longer fit its risk profile, according to Scott Schauer, vice president of Asset Management. “We’ve actually had a substantial increase in asset management contributions for 2011 over the last three years due in part to consistent asset risk management practices and follow through on same,” he explains. “Overall economics are remarkably similar to where they were January 2011. I don’t think anyone was predicting a fabulous recovery during 2011, and I’m not sure they are for 2012 as well. ‘Slow and steady’ are the words of the day,” he adds.

Grace notes, “Underwriting practices tend to be evolutionary. Sound practices will carry forward along with improvements made to those practices during the year. The only ‘change’ I would envision is in how we evaluate markets and set residual risk positions, based on a more sophisticated way of analyzing those markets and measuring value volatility.”

Improving Residual Realizations

With the economy slowly improving in 2011, realization trends turned the corner, and for the most part write-downs, workouts and negative residual realization were rendered unpleasant memories from the Great Recession.

William Tefft, senior vice president of Asset Management at CapitalSource, explains that 2011 was his group’s second year in terms of portfolio building and their efforts continued to be origination focused. He adds, however, “Anecdotal information from people that I’ve spoken with suggests that 2011 was a very good year, with respect to end-of-term residual realization activities. Inventory levels declined precipitously due to strength in the secondary markets and also as a result of declining equipment returns from repossession or bankruptcy.”

At TCF Equipment Finance, 2011 brought strong realizations thanks in part to a high percentage of end-of-term purchases, according to Mark Loken, vice president of Equipment Management. “What we saw, especially in construction and even some of the tooling markets, was lessee end of term preferences changing dramatically towards purchasing. We are enjoying strong realizations on our off-lease sales because of improved asset values and reasonable residuals that were set over the past five years. I foresee that positive trend continuing through 2012.”

Loken also predicts a continued decline in inventory because of fewer defaulted contracts or repossessed assets and a reduced supply of new equipment from manufacturers that do not want to overproduce and push too much equipment into the marketplace. He also sees a significant increase in demand and prices for three-year or newer used work trucks, tractors, trailers, yellow iron and cranes. “We forecast our inventory levels as being very light in 2012. Customers are telling us they want to buy. Even if the work hasn’t increased significantly, it seems companies remaining in the marketplace want to maintain or grow their businesses. Along with the replacement that has to go on regardless of utilization, this year is going to be strong for equipment values in the asset classes we finance,” he says.

At Banc of America Leasing, Grace notes that 2011 was a record year for residual gains and that his group’s philosophy of financing “essential use” assets will continue to pay off.

Schauer adds that 2011 was kind to Key Equipment Finance as well: “Other than a business we exited a couple of years ago, we have not experienced negative residual realization in any of our asset categories and, on a portfolio basis, our asset management group has had a very substantial positive effect on the company’s earnings for 2011.”

At Capital One, Robbins states, “In 2011, we saw our first maturities in our true lease portfolio with our residual realization being positive. Generally, lessees are renewing their leases in order to delay new equipment purchases and avoid capital investment at a time when budgets are still constrained. At the same time, our portfolio has continued its positive trend reducing Asset Management’s involvement in workouts as well as its inventory exposure.”

Regarding residuals, CapitalSource’s Tefft says, “I did not see 2011 as a year characterized by pressure on residual values. Residual discipline was maintained throughout the year, but it will come under increased pressure in 2012 as a way to stay competitive or become competitive. I think 2011 was the year of ‘increased customer concentration’ or the willingness of organizations to hold a greater exposure for customers than they have traditionally. I think 2012 will be the year of either decreasing margins or increasing residuals, as organizations will not continue to increase hold amounts and/or take the risk into the credit area. I think they are going to look to push it elsewhere and/or possibly be faced with the prospect of doing less business, which might be a prudent thing. I suspect that 2012 is going to be the real competitive year.”

Asset Class Demand

As the economy improved in 2011, so did demand in certain asset classes bolstered by replacement demand and newer used equipment purchases.

Capital One’s Robbins explains, “Our core asset classes include construction, mining and over the road. Overall, demand has definitely increased over the prior two years with mining probably seeing the largest due to higher commodity prices, especially for precious metals such as gold. For these reasons mining has actually been a solid contributor for us throughout the recent downturn. Trucks and trailers, more specifically Class 8 tractors, saw a decent increase in both new deliveries and orders in 2011. This sector is still in a replacement mode with demand not where it needs to be to reach a normalized cycle. The demand for construction equipment continues to be somewhat sluggish. The economy needs to continue to stabilize and strengthen, which should lead to a renewal of investment in the new housing market and a subsequent trickledown effect on the construction, woodworking/stoneworking and other industries that support it. No one’s fully sold on the economy and availability of credit remains an issue for some.”

At Banc of America Leasing, Grace says most assets types showed a moderate increase in demand. “We tend to be a very diverse lessor. We play in just about every market out there. Most industries experienced improvement in overall markets, not only in new business financing opportunities but also in the beginning of recovery of equipment values. The number of used equipment sales taking place in most industries improved in 2011, and I look for 2012 to be much of the same, a continued recovery in values and an increase in activity across most of those spaces.”

Grace adds that trucking enjoyed the fastest recovery because of the lack of new investment activity over the past few years, and he reports a “very nice increase” in secondary market sales of rail assets. There was mixed demand in marine and corporate aircraft, he says. In the marine space, Grace sees brown water improving slightly, but blue water ocean-going vessels like container ships and bulk vessels struggling because of new factory deliveries saturating the market.

Tefft at CapitalSource notes promising growth in energy. “In 2011 the energy space, specifically land-based directional drilling, has been a boon for financing activity because without it we’d be looking at a smaller pie to be shared by everyone. I suspect that the trend is going to continue and that there will be a lot of CAPEX in that segment of the energy market in 2012.” He also states that, “somewhat surprisingly” machine tools have made some big rebounds with legitimate growth CAPEX, unlike trucking, which was more replacement demand.

In terms of new business requests at Key Equipment Finance, Schauer says it has seen very good diversification of asset types, particularly in the harder asset classes like rail, marine, construction, transportation, mining and manufacturing. He adds that his group also has done an number of IT, healthcare and PV solar projects.

TCF Equipment Finance has enjoyed the demand for newer used equipment. Loken explains, “Equipment in the three-year old range is very strong. I have vendors soliciting my assets to sell on consignment or buy outright, whether it’s over-the-road trucks and trailers to yellow iron construction.” He also says agriculture has been good and machine tools in the shorter term.

Considering asset demand in 2012, Grace remarks, “Expansion financing opportunities will be slow to build. I don’t think we will see much capacity expansion financing until 2013 and beyond.”

Schauer adds, “I think there may well be some additional growth in 2012 related to older equipment replacement/expansion particularly in the areas of food processing, metals manufacturing and construction. IT and healthcare financing demand has also held up well over the last couple years.”

It’s the Economy…

Although the roundtable participants are optimistic that 2012 will bring slow but steady growth, they agree that the economy still has a long way to go before it is considered healthy. “Unemployment and housing need to get better before you will see any sustainable CAPEX growth. You don’t increase capacity without increased spending by the consumer,” Grace says.

Robbins adds: “Domestically, expansion is a difficult term to put your finger on as we continue for the most part to be in a replacement mode. A large part of our country’s economy revolves around small business and services, but that’s not going to create a lot of expansion in our equipment markets until we return a more normalized economic cycle.”

Schauer concurs, “I agree there is still a great deal of uncertainty regarding perspectives on overall economic recovery in almost all industries in which we provide financing. Unfortunately, this becomes a bit of a self-fulfilling prophecy in that businesses aren’t willing to make major new investment commitments until they feel more certain that economic recovery is gaining momentum, and that same momentum won’t be realized until the investment commitments occur.”

Likewise, Tefft remarks, “We are not certain that demand at the consumer level is credible and lasting, and that is making companies reluctant to engage in anything other than replacement CAPEX. Most of it is small and incremental, not big projects.”

Loken suggests, “In 2012, I don’t expect anything great to happen regarding the economy, but I speculate that because there are fewer companies than there were three years ago in the industries, they are able to survive and do quite well. The credits I saw coming in to buy used equipment in 2011 were much better. Companies that survived the downturn are leaner and there is less competition. They are going to need equipment, as they take advantage of the growth that will eventually occur.”

Competing for Desirable Deals

If fallout from the recession has left fewer companies seeking equipment, the role of the asset manager is even more vital as landing desirable deals and new business has become more competitive.

Grace at Banc of America Leasing explains, “The role of the equipment manager is always to set supportable residual positions and service your clients’ needs. It is important for the equipment manager to help the leasing company evaluate the good deals for them to finance and steer them away from or help price appropriately those transactions that aren’t the most attractive as far as overall yield and gained income opportunities. As our economy heals, increased spending by our clients should provide increased opportunities for lessors.”

At Key Equipment Finance, Schauer points out, “Making absolutely certain that you have the most specific, comprehensive and up-to-date industry and asset information, pricing and trending gives today’s asset managers the best insight on collateral values, short- and long-term trends and how to best compete. It can be all too easy to guess what your competition is doing from an asset risk or residual value perspective only to find that a given transaction did not actually get completed at the promised levels and comes back around for a second or third time. We tend not to make radical changes to the strategy in risk management practices. What we have in place has been adapted over the years and has served us well.”

CapitalSource’s Tefft suggests that the competitive environment took a short break toward the end of 2011, as the threat of the euro-zone collapse gave a pause to the market. However, as 2012 gets underway, the quest for deals has resumed.

Loken says lately he has been spending most of his time at TCF setting residuals on new transactions either for new or used equipment and new markets, noting that rate pressure is significant. “We have large finance companies and banks trying to put assets back on their books. The markets are very competitive, they are chasing this business pretty aggressively. The risk going forward is not in what we have done but where do we want to play and how do we position the portfolio from a residual standpoint.”

In this competitive environment, asset managers increasingly are working with business development and origination teams. As Grace explains, “It is incumbent for equipment management to work with the originations group to find ways to be more successful in doing leases. Any way we can help support our originations function to do more of that attractive business and not just be a loan shop is very beneficial, although some percentage of our clients just want us to provide them with structured loan financing for their equipment purchases.”

At TCF, the downturn brought asset management to the forefront, and now Loken and his colleagues collaborate with senior sales management on an annual basis in terms of strategic planning. Moreover, asset management sign-off is required as the organization gets into new programs, brings on new vendors or enters new business segments, he says. “That’s really been a shift for us.”

Robbins sees similar collaboration at CapitalOne. “Our input tends to increase as deals get larger and more competitive, becoming more integral to the whole transactional process. We are very involved in deal structuring and customer relationship building, working very closely with our direct and indirect sales teams so that we may offer the best product possible to the customer. At a higher level, asset management also interacts with strategic planning adding its expertise on assets types, potential M&A opportunities, and leasing in general.”

Lease Accounting Changes… Wait and See

When asked about the impact of the proposed accounting changes on the equipment leasing industry, the roundtable participants all take a “wait and see” stance until the final version is released. Regardless of the final outcome, there is a consensus among the group that the fundamental attractiveness of leasing will not change.

At CapitalSource, Tefft says he saw one transaction last year that was oriented specifically toward compliance with the future changes. “It may foreshadow the end of general equipment lessors, as they begin to narrow or refocus around certain equipment types or categories. But we are still too far out to know that,” he adds.

Robbins provides further insight: “In the future there might be a move to shorter-term leasing, depending on the asset, as this will allow for a larger residual position, which is not capitalized on a lessees’ book. You will still have most of the general positive aspects of leasing, except for operating lease treatment by the lessee for any lease term greater than 12 months. Once instituted, these changes to increase transparency will require the lessee to capitalize the present value of the minimum lease rentals, reporting both an asset and a liability on their books. Thus the potential move to shorter-term or true operating lease structures, which will put more emphasis on the asset management capabilities due to the need to take higher residual positions and being prepared to deal with the asset when it comes back. It’s not a bad thing.”

Grace points out that leasing will still be an efficient mechanism for lessees to manage obsolescence risk, making it an attractive financing method. “As it relates to equipment management and the leasing business, I don’t see a profound change coming based on the international accounting standards changes proposed to date. The vast majority of those that were doing leasing in 2011 will still view it attractively in 2014 or 2015 when the international accounting standards ultimately fall into place.”

Moreover, Schauer notes that the equipment finance industry has demonstrated remarkable resiliency to accommodating accounting or tax law changes over the last 20-25 years. “Once the proposed accounting changes become finalized and are implemented, the MLFI 25 are still on a relatively level playing field and I believe similar equipment will still be financed for similar industries and customers with some structural changes as it has for many, many years,” he says.

Unknown and Developing Challenges

While the asset manager roundtable participants anticipate acquiring measured growth in 2012, they are mindful of factors that could change the game at any time. They indicate global economic health, consumer spending, job growth, the political climate and upcoming elections, cost of oil and terrorism against the U.S. as possible threats to the fragile economy.

In addition, several participants express how increased government regulation has changed the role of the asset manager.

Tefft at CapitalSource remarks, “I think a developing trend over the past four to five years, that has become more and more prevalent and consuming, is regulatory compliance in underwriting. It was something that was previously not part of my work, but now it’s routine and present in each transaction. Institutions that are deposit-funded are more subject to regulatory compliance and scrutiny, so this is becoming a big part of the industry.”

Capital One’s Robbins concurs, “I feel as an asset manager that the continual increase in government regulation and oversight of financial institutions, especially for large banks, adds complexity and cost to our operations.”

Loken agrees, “The trend for increased government regulation is huge. Bank-wide we have expanded our legal and compliance departments to address the expanding regulations. They are onerous on finance companies and banks, very expensive and, at the end of the day, the cost is going to be passed along to the consumer one way or another.”


Lisa M. Goetz is an associate editor of Monitor.

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