While Business Investment Remains Lackluster, Leasing Industry Leaders Say It’s ‘Full Steam Ahead’

by Christopher Moraff September 2010
The summer of 2010 ended with a thud as August indicators ranging from housing sales to employment confirmed the economic recovery is still on tenuous ground. With economists split on whether we’re in store for a “double-dip” recession, we decided to ask a group of leasing executives how they saw the past year, and what they think is in store for 2011. What came across is that the industry continues to see the glass half full.
Clif Gottwals Clif Gottwals CEO, Chase Equipment Leasing
Adam Warner Adam Warner President, Key Equipment Finance
Walter Rabin Walter RabinSVP, Capital One Equipment Leasing & Finance
President, Fifth Third Leasing Company David Merrill President, Fifth Third Leasing Company
John McQueen President & CEO, Wells Fargo Equipment Finance

Just when it looked like economic recovery was underway — albeit in slow and grinding fashion — second-quarter indicators came out that shook up the field and left a lot of folks shaking their heads. As the Monitor went to press, some analysts were forecasting that the U.S. economy could slip back into a so-called “double-dip recession.” Others, adhering to a more optimistic outlook, insisted that we’d hit a serious bump in the road that threatens to stall economic recovery for the foreseeable future, but that we will not plunge backward into another recessionary cycle.

“I don’t think we’ll double dip, but it will be a close call,” Mark Zandi, the chief economist of Moody’s Analytics, told reporters at the end of August. Still, even he put the chances of a double dip at 30%, higher than his previous estimate of a 20% chance.

Why all the gloom and doom? Well, for one thing, the housing market is still in the slumps and doesn’t show signs of changing any time soon. The National Association of Realtors (NAR) said existing home sales in July were at the lowest level since the total existing home sales series launched in 1999; and single-family sales — accounting for the bulk of transactions — are at the lowest level since May of 1995.

On top of that, businesses spent much less capital than expected during the summer investing in equipment. Orders for big-ticket manufactured goods increased a fraction of what economists had hoped for, rising just 0.3% in July instead of the 3% forecasted.

When you take transportation out of the equation things look even bleaker, with durable goods orders falling at the steepest rate since January. Meanwhile, business orders for capital goods took their sharpest drop since January 2009, at the height of the recession.

For lessors, perhaps more than most businesses, that’s discomforting. Because as long as business investment remains lackluster, there is little likelihood of a bounce back in the equipment financing sector. And so many leasing executives watched the summer end with the realization that a full recovery — which last year many had forecasted to be under way by now — would have to wait.

Against this backdrop, we asked a select group of leasing executives to reflect on the recovery so far and give us their take on the future. What came across is that the industry continues to see the glass half full; despite the temporary setbacks, we consistently heard talk of bad news qualified by a renewed sense of opportunity.

For instance, Clif Gottwals, the CEO of Chase Equipment Leasing, says the last 12 months have been difficult, but points out there are some positive take-aways. “First, this cycle has helped to reset the commoditization of our product in terms of pricing, structure and go-to-market positioning,” he says. “With fewer competitors and more attention paid to risk-return trade-offs, we are seeing more rational execution in the market.”

What’s more, Gottwals notes, economic cycles are good opportunities to test and train talent, which is something he says the industry needs to take advantage of. “We have a generation of young talent that had not seen a full economic cycle,” he says. “We have taken advantage of this cycle to ensure that we have optimized the learning and exposure that the next generation of management needs from these types of experiences.”

Adam Warner, president of Key Equipment Finance, describes 2009 as “volatile” but adds that last year, Key Equipment Finance reacted by exiting certain markets that were either risk-challenged or had limited ability to build sustainable relationships. The payoff is that the company has been able to leverage its core competences to its advantage.

“We’ve gone from a position of limited liquidity to our current state of being able to build strong risk-rated assets,” he says. “An intense focus on enterprise risk management has developed across Key, and I believe that will now always be part of the fabric of our organization. As such, growth in our core segments will primarily be replacing runoff in our exit portfolios.”

Over at Capital One Bank, Walter Rabin, senior vice president at Capital One Equipment Leasing & Finance, says that despite the rough patches over the past year, a number of the company’s business sectors, including municipal leasing and taxi medallion finance, have presented some great opportunities for the company. “The economic turndown has helped validate our strategic imperative of portfolio diversity, which has been the cornerstone of how our business was built over the past ten years,” he says. “The shifting financing demands and collateral types that we’ve seen in some industries have also given us an opportunity to fine-tune our operations and portfolio management.”

David Merrill, president of Fifth Third Leasing Company, says 2009 offered leasing companies the opportunity to adjust business models and prepare for the future. “In my mind the challenge was to determine which sectors of the market would not recover, which ones would recover slowly and which markets would present growth opportunities after the economic reset,” says Merrill. “Ultimately, I think that companies that revisit their business model during the economic reset will have a competitive advantage when the markets start to improve.”

But experts say that’s taking longer than expected. In a speech at the end of August, Fed Chairman Ben Bernanke admitted that recovery was proceeding at a slower pace than he and his colleagues in Washington had planned for. “The task of economic recovery and repair remains far from complete … the pace of growth recently appears somewhat less vigorous than we expected,” Bernanke said, adding, “Financial conditions are generally much improved, but bank credit remains tight…”

This last point is an area of some contention among lenders and has given rise to a kind of “chicken versus egg” (or better yet, availability versus demand) debate about why so little credit appears to be flowing. On the one hand, there are those who say banks and other lenders are being tightfisted with capital, on the other are the lenders themselves that say capital isn’t moving because businesses simply aren’t borrowing. Among them, Warner takes issue with the myth that there is no available credit.

“We hear the populist statements by politicians that ‘banks aren’t lending’ but the reality is that loan and lease demand is soft,” he says. “Many companies are deferring new equipment acquisitions by investing in the maintenance of older, less efficient equipment.”

Merrill says from where he sits, banks and leasing companies are actively looking for business and that competition remains “fierce for the right credits.”

“In my opinion the weakness is on the demand side of the equation,” he says, which is echoed by John McQueen, the president and CEO of Wells Fargo Equipment Finance, who notes: “Wells Fargo has not significantly changed our underwriting standards… The slow down in loan underwriting is more a factor of demand than credit tightening.”

“We are certainly here to lend and capital is available,” Rabin concurs, “but there is no doubt that lending standards in the industry have been refined through the economic downturn.”

Gotwals says the diminished financing demand is fundamentally driven by softer demand for capital equipment. “If you look at the orders for durable non-defense goods over the past 18 months and look at the massive decline and very slow recovery of orders … that is your answer to the question,” he says. “Our lending standards in the commercial middle and large corporate markets have not changed.”

This soft demand is easily seen in the numbers coming out of the Equipment Leasing and Finance Association (ELFA). The ELFA’s 2010 Survey of Equipment Finance Activity (SEFA) suggests that 2009 was a particularly troublesome year for the equipment finance industry as a whole.

New business volume among a sample of member companies was down 30.3% in 2009, compared to a 2.2% drop in 2008. ELFA President Woody Sutton said industry performance data for 2009 simply mirrored the difficult conditions prevalent in the broader U.S. economy and went on to express optimism that “the worst is behind us.”

But Sutton’s optimism does not appear to be shared by much of his group’s membership. Even if most lessors can manage to pull some bright spots out of the gloom; the ELFA’s Monthly Confidence report for July finds that confidence in the sector dwindled considerably. Just 33.5% of leasing executives said they believe business conditions will improve over the next four months (through October), a significant drop from 53.5% in June.

Among businesses the picture is worse still. Small business confidence in the economy continued to drop throughout the summer. According to Moody’s Economy.com’s most recent Survey of Business Confidence, global sentiment is fragile and has weakened measurably since peaking in the spring.

“Confidence has weakened across all industries and throughout the world,” Moody’s said. “Most notable is the softening in responses regarding businesses’ assessments of present conditions and the outlook into early next year.”

Merrill says the dip in confidence hasn’t been helped by the media’s focus on the negative aspects of the economic recovery. “Headlines regarding the state of the economy have become increasingly negative and that has a direct correlation to public sentiment, in this case, confidence in the economy,” he says.

But he admits that’s not likely to change until some of the key economic indicators show sustained positive trends. “I’m personally watching investment in equipment and software, housing prices, auto sales and perhaps, most importantly, the unemployment rate. When we see sustained momentum in these areas, the CFOs will have confidence to invest in capital equipment,” he says.

McQueen tends to agree, noting that U.S. companies are concerned about expanding their business or investing in this market. “As we ended the second quarter, GDP and housing slowed dramatically, unemployment didn’t improve and the stock market returned to the lower end of the recent bandwidth. The news had the effect of creating a more negative view of opportunities in the second half. We need to create jobs, and improve housing delinquency and pricing, to see an increase in capital expenditure.”

Rabin goes even further and says a return to confidence has to start with the consumer before it will translate to businesses. “Consumer confidence translates to business confidence in a very concrete way,” he explains. “There is a direct correlation between consumer confidence levels and private sector job creation and business confidence in their near and longer-term growth potential and their willingness to commit to increased capital equipment spending.”

Gottwals concurs. “We will need to see real, sustained consumer spending recovery to take up the slack in the production capacity,” he says. “At that point we will see the economy coming back on line.”

Meanwhile adjusting to the new environment brought about by the halting economic recovery has been easier for some than it has for others. Some, like Gottwals, say the “new normal” is more like “business as usual.”

“We’ve always tried to manage through the cycle; meaning that we work to execute lending and business practices that make sense in good times and tough times,” he says. “We never allowed ourselves to get pulled into the super aggressive lending and residual practices that many engaged in during the peak of the market.”

Others, meanwhile, find themselves streamlining their approach to the market. Warner says that while growth remains important, it needs to be more focused from a market perspective. “At Key, we have a mandate to grow revenue but that growth cannot come at any cost,” he says. “It needs to be revenue that provides a good return on equity and is properly risk-weighted. The last thing this fragile recovery needs is banks and financial institutions taking credit charges because they didn’t properly evaluate the risk of the clients or markets they’re investing in.”

Rabin says the new paradigm needs to involve embracing some of the historical basics of equipment finance, a responsibility that will fall on both lenders and borrowers. For instance he says: “Over the last 20 years, 100% financing has become the norm — no money down has been the expectation of lessee/borrowers regardless of credit strength and competitive pressures made requests for security deposit or down payments unrealistic. Going forward, borrowers will need to be more realistic about their credit worthiness and the price associated with credit.”

Going forward, there remains little optimism that things are going to pick up with any real speed until at least the end of next year.

“We have a more positive outlook for the next year than we were looking at 12 months ago,” Rabin says. “Attention is coming back to increasing revenues through strategic growth. While we continually look at opportunities to grow our existing platforms organically, we have not ruled out strategic opportunities that could enhance our market share or provide additional capabilities into attractive U.S. industry sectors. In short, our focus today has shifted to looking for new business origination and prospects, and that’s a much better place to be.”

“We expect 2011 to be a stronger year,” adds McQueen. “We are forecasting low double-digit growth in revenue, a slight decline in spreads, a reduction in credit costs and a significant improvement in our net income after tax. Increased revenue will remain the biggest challenge.”

And yet, on the big stage, there remains little optimism that things are going to pick up with any real speed until at least the end of next year. “Personally, I think we will see a slow pull out with real improvements not evident to until mid-2011,” says Gottwals.

Merrill agrees that the economy will continue to improve, but will do so very slowly. “It will be like watching your kids grow up,” he says. “You don’t see a lot of changes on a day-to-day basis, but when you look back to a picture from a year earlier you are surprised by how much growth there really was. The markets will recover and many of them already have to a degree. There are definitely pockets of growth, and we are eager to do business where we can get an acceptable return with credit-worthy clients and an appropriate structure.”

Merrill says he expects a “slow to no growth” environment for the balance of the year with the rate of growth accelerating in the second half of 2011. “I would not expect investment in equipment and software to return to 2008 levels until 2013 at the earliest,” he says, adding stoically, “Our industry has weathered many difficult cycles and has the capacity to weather this as well. The economic reset has presented many challenges for our industry but overall our portfolios outperformed most other specialty lending areas that banks and independent financial institutions own. This is something that we can all be proud of.”

Christopher Moraff is associate editor of the Monitor.

Leave a comment

No tags available