Bankable Assets: Bank-Owned Equipment Finance Companies Contend with Shifting 2018
by Phil Neuffer July/August 2018
As bank-owned equipment finance companies continue to dominate the industry, they must deal with the changing times. Executives from PNC, CIT, Key and Regions offer their views on 2017 and 2018 performance, tax reform, alternative financing, technology and credit quality in the current marketplace.
Banks have been growing in prominence in the equipment finance and leasing industry. At this point, they are far and away the most dominant segment of the market, as evidenced by the data in the Monitor 100 and the Bank 50. This is nothing new. While the theme of bank dominance has continued into 2018, it doesn’t mean everything is the same as it was a year ago, or that bank participants are turning on autopilot and letting things run their course.
Before looking ahead, the banks must take inventory and identify what has been going right and what could improve, although there isn’t much of the latter considering the triumphs achieved by the bank segment in 2017. The reasons for that success are not uniform, either. For some, headline-grabbing initiatives drove success, such as PNC Equipment Finance’s ECN Capital acquisition.
“Our expansion of our vendor business with the acquisition of ECN gave us a significant small-ticket vendor platform in key industrial markets,” says Rich Doherty, president of PNC Equipment Finance. “Our bank footprint business had record growth in the various markets covered by PNC Bank by going to market as one team with unique insights and ideas.”
Adaptability is another hallmark of a successful equipment finance company, bank-owned or otherwise. Several leaders note this as a business characteristic which led to success, including Mike Jones, president of Business Capital at CIT, who says, “At CIT, we’re committed to investing in our people and processes while also holding each other accountable for results. We realigned our people to best support CIT’s growth. We evaluated our processes to ensure our work is adding value for our customers and our shareholders. We celebrated success and failure and held each other accountable for action. Best of all, our culture evolved to focus more on teamwork. Everyone on the CIT team supports the growth of our customers, who, in turn, ensure our growth. There’s always more to do, but you can’t argue with the results. It all starts with listening to and investing in your people.”
Doherty echoes Jones’ belief in constant evolution and how it can power success, not only in the short term but for the long haul.
“As a company we have done a good job of changing with the times by looking for opportunities through strategic growth businesses, acquisitions and our bank footprint,” Doherty says. “For example, we focused on key strategic growth businesses such as our rail, renewable energy and aviation product offering that differentiate us in the marketplace.”
Of course, adapting too much can make things run off course, so maintaining discipline and adhering to proven and successful strategies is critical as well. William C. Perry, managing director and group head of Regions Equipment Finance, says his company’s success came through reinvestment in core business strategies as well as education and process improvement.
“We have four core market strategies: direct strategy serves our client base, an indirect syndication desk, tax exempt platform and solar initiative. Fortunately, all had solid growth in 2017,” Perry says.
This mix of adaptability and sense of what has driven success has melded with the power of economic forces to help bolster results, which was the case for Key Equipment Finance.
“There are several factors that led to our record growth in 2017. First, we had a fair amount of activity at the end of 2016 that moved into 2017, giving us a strong start to the year. That was coupled with a strong level of production coming from new hires and our veterans closing some very large opportunities,” says Adam Warner, president of Key Equipment Finance. “We also added some new manufacturer relationships to our already growing vendor space. Finally, the passage of tax reform drove a significant amount of municipal and not-for-profit business in Q4 as these entities looked to capitalize on the higher tax rate in 2017.”
Technology in the Driver’s Seat
Success in 2017 wouldn’t mean much if it didn’t continue into 2018. Performance is top of mind for all executives, including those in the bank-owned equipment finance space. At CIT, embracing technological advancements and enhancing product offerings has only accelerated growth and prosperity. This includes the ability for customers to conduct transactions on tablets or PCs at elevated levels of efficiency without having to work outside of their own systems.
“What’s working is the advanced level of technology that we bring to our business relationships, which allows them to efficiently serve their customers’ needs,” Jones says. “We’re proud of our award-winning business-to-business integrated solutions. We’ve successfully leveraged this technology with some of the largest manufacturers and resellers in the U.S.”
Delving deeper into the technology discussion, one of the hot button issues in the financial industry as a whole, not just on the equipment leasing side, has been the growth of blockchain and cryptocurrencies. This trend doesn’t appear to be going away, but has it started to have more than a marginal effect on equipment financing? For now, the answer is no, but it might not be for long.
“Change is the one constant in our business. Those that stand idly by and ignore the rapid adoption of new technology, such as blockchain and smart contracts, could fall behind,” Doherty says. “PNC, as an institution, continues to innovate and invest in its technology. We embrace technology and new ways of doing business but we also look to develop ideas on our own to lead change through innovative thinking.”
“The adoption of blockchain at Key Equipment Finance has been slow and measured as we look to see where it will be most effective,” Warner says, noting the capital markets are of particular interest. “A distributed ledger technology could benefit syndicated relationships with multiple investors.”
Smart contracts, another technological advancement for the industry, are perhaps easier to understand and put into practice.
“We are very excited about embedding smart contracts into our platform in the coming months,” Warner says. “The use of smart contracts will help manage more of our flow business and allow our teams to spend their time on more complex financings.”
Effects of Tax Reform
Tax reform has changed the landscape of the financial industry, making the marketplace a bit different than it was a year ago. How has this affected bank-owned equipment finance companies?
“We are seeing moderate to strong growth in all of our sectors with the exception of tax-exempt financing. In the municipal markets, tax reform accelerated a lot of opportunities into the fourth quarter of 2017,” Warner says. “Our direct business with bank clients and prospects is strong and our vendor verticals in technology, industrial, clean energy and health care are all outperforming the first half of 2017.”
“Customers tell us that tax reform has certainly contributed to an increase in some of the markets we serve, particularly in our Industrial segment,” Jones says. “Many of our core customers have also seen significant revenue increases, primarily in the used equipment space.”
“The newly available capital created from the reduced tax burden has been used for dividends, share repurchases, research and development, higher returns, new hiring and, yes, capital expenditures,” Warner says. “The trick here is the balance of how that capital is used. For equipment financing, it seems to be close to neutral.”
Beyond tax reform, Perry has seen a general increase in optimism when it comes to the economy as a whole. Whether due to the new tax law or something else, the immediate result has been an appetite for expansion.
“I think it’s a multitude of contributing factors,” Perry says. “Tax reform has certainly played a role but more so there’s a renewed confidence in the economy that has allowed our clients more confidence to invest in expansion and organic growth initiatives.”
Quality Credit for Quality Transactions
With improved technology and the seemingly positive effect of tax reform, among other components, an underlying level of confidence exists in the bank-owned equipment finance space. How well this equates to success is based on a few factors. One of the most important is credit quality. Even if there are more deals to be made, sacrificing credit quality can turn negative quickly. Traditionally, banks are more hesitant to lend to weaker credits, so continuing this strategy should continue to aid these businesses, even if there are some obstacles in the way.
“The quality of transaction has not deviated too much; we’re still seeing properly structured transactions that meet the market,” Perry says. “However, we are seeing continued spread compression due to the number of institutions hungry for assets.”
Thanks to CIT’s broad range of offerings, the bank doesn’t adhere strictly to one specific type of customer, but this doesn’t mean credit monitoring is not an important aspect of getting a transaction done.
“Our business supports equipment and real estate transactions from small- to mid-ticket, both direct and vendor,” Jones says. “Those are all very different categories, so we don’t really have a ‘typical’ customer. That said, across the general portfolio, the credit quality of our customer base has remained solid, and we have seen no significant changes thus far.”
Credit quality can obviously be affected by the industry of a customer, which has led to a shifting understanding of what good credit actually is for some of these distressed industries. This has, in turn, led to new competitors for bank-owned equipment finance companies to deal with.
“The credit quality of applicants continues to be quite strong, with the exception of certain industries that remain under duress,” Warner says. “We have seen some non-bank finance companies come into the market to serve the non-investment grade space and that has contributed to economic growth.”
Warner also notes Key has experienced an increasing number of requests for non-standard documentation.
“In these cases, we have to work harder to ensure we are included in the conversation early enough to provide input around terms and other details,” Warner says. “This is more prevalent in the vendor space where the manufacturers may be offering very simplified financing terms and then looking to take those terms to market. Those documentation risks need to be carefully managed.”
While credit quality may be shifting, banks are not as concerned with a deterioration of transaction quality. Perry, Jones, Warner and Doherty all reported very little deviation in the types and quality of transactions their businesses are working on.
Alternative Finance and Other Challenges
Banks aren’t just competing with other banks in the equipment finance space. Many challengers are out there, and additional factors can affect business performance. For many, the rise of new alternative lenders presents one of the greatest concerns.
“Coming into 2018, I was most concerned with how our industry would deal with non-standard finance offerings,” Warner says. “This started in the technology sector and is slowly moving into other markets that are technology- and usage-driven like health care and clean energy. The concerns here are the non-credit risks being taken by the finance provider and if they are properly understood. Mid-year, I am probably more concerned with Federal policy uncertainty. The volatility and disruption in Washington, talk of trade wars and the upcoming elections make it difficult to forecast impacts to our economy.”
A similar sentiment is running parallel to PNC’s work in the equipment finance space, even if optimism still reigns supreme.
“A growing concern is the proliferation of nontraditional financing sources entering the market as the result of forecasted growth both domestically and internationally,” Doherty says. “We remain optimistic about the economy and continually review trends that could negatively impact us in the future.”
Another concern looming prominently is the fluctuating interest rate environment. The Federal Reserve has already raised rates twice this year and there is reason to believe additional hikes are on the horizon.
“My greatest concern at the beginning of the year was how the industry would react in an increasing rate environment and how long it would take before market rates would catch up,” Jones says. “Despite ongoing Fed increases, there has been little movement in market rates, so it remains a concern.”
What seemed critical in January can change as the year progresses, which was the case for Perry, who was originally concerned about the reaction to tax reform and is now focused on other potential turbulence.
“Today, [my] primary concern is we [will] start to chase yield and lose fundamental disciplines that begin to impede on portfolio integrity,” Perry says.
Challenges and concerns are nothing new — they will always exist in one form or another. It is up to the banks and their leadership to ensure progress is made.
“There remains a tremendous opportunity to assist clients with structures that maximize the new tax code,” Perry says. “I think this will continue to spur measurable growth for those institutions that can take advantage of being a true consultant.”
“After record growth last year and on top of tax reform, we expect our bank segment will grow at a more modest rate in 2018,” Warner says. “We are carefully watching the markets with a correlation to oil and gas as well as commodities. Additionally, we are reviewing potential impacts from looming trade tariffs.”
“Relationship lending has always been a key part of our business strategy, delivering an exceptional client experience with a dedicated team of individuals focused on differentiating our ideas and offerings for our clients,” Doherty says. “PNC continues to expand across the U.S. and equipment finance is a key product that we deliver to our customers. With the strong economy and new markets we are fully present to offer equipment finance and leasing solutions to this growing client and prospect base.”
“When I talk with my peers, we are all seeing the same thing: modest asset growth, consistent portfolio performance and continual margin compression,” Jones says.
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