Buy Desk Perspective: Optimism at the Dawn of Market Change
by Lisa A. Miller March/April 2018
New tax legislation, accounting rules and rising interest rates will shake things up in 2018. After years of low spreads, too much money and too few deals, the marketplace may be on the brink of change. We tapped two capital markets veterans for their thoughts.
Working the buy-and-sell side of the market presents different challenges for different players. While operating in the same economic environment, each lender has its own go-to market strategy based on the goals of the organization and any parameters governing its activity. For large banks, that strategy falls within strict guidelines set by federal regulators. Independent lenders have more freedom in choosing their clients and balancing their risks.
As part of the third largest bank in the U.S., Wells Fargo Equipment Finance practices consistency from year to year in terms of transaction structures, valuations and residuals. “This can make it tough for us to be competitive in certain situations, but we pride ourselves on our discipline,” notes Bob Wright, senior vice president of the Capital Markets Buy Desk.
Stonebriar Commercial Finance, the second largest independent, likes credits that have a story to tell or a profile that may preclude those companies from traditional bank financing. “We look for large financings secured by essential use and income-producing assets between $10 [million] and $75 million, but our structuring and pricing requirements are stringent,” says Steve White, executive vice president and senior managing director of Capital Markets. “We target a relative value spread and underwrite each credit in identical fashion. Our goal is to fund profitable, well-structured loans and leases.”
Though both lenders did well in 2017, their experiences were different. “I’d describe 2017 as an OK year,” Wright says. “Some components of our business did very well within the Capital Markets group, but the large structured piece of our business didn’t see the quality opportunities we’ve done in prior years. The core Capital Markets business did well overall but not great.”
“Stonebriar Commercial Finance saw a strong flow of opportunities and a significant increase in volume year over year,” White says. “However, volume is not a metric we focus on when measuring the overall performance of our business. Generally, we expect to approve and fund one deal for every 10 we see. We do not chase volume.”
At the end of each year, Wright looks back at volume trends to get a complete picture of the year’s activity. Historically, business volume comes at quarter-end or year-end, so he was surprised to see what happened in 2017. “December was still our biggest month, but May was our second biggest month, and November was our third biggest month. When I looked at industry sectors, I saw that our Capital Markets tech business was softer than I had expected. We made up for it in other areas and have started off very well in that space in 2018.”
Stonebriar closed several strategic portfolio acquisitions, acquired a company that originates small business loans and increased its overall planned yield by 100 basis points. Its primary competitor in 2017 was the high yield bond market. “Rather than borrowing directly from a lender, some potential borrowers opt to issue bonds when that market pricing supports the additional effort and related expense,” White says. “The pricing difference between BBB-rated bonds and B-rated bonds was near an all time low in 2017. We are seeing this delta begin to widen in 2018, which will take some pricing pressure off our strike zone.”
Wright has not seen any drastic changes in the structure of transactions over the last couple of years. “Hot sectors still tend to drive structures more aggressively than they should, both in terms of residuals and length of transactions, but it doesn’t seem to be an issue across the board. I hope people have learned their lessons from times past and maintain a certain level of discipline.”
Wright was happy to discover the trend line of pricing spreads did not go down in 2017. “It was at a lower level than I like to see, but it was flat. For the past three years, that trend line has gone down, so I see this as a big positive. It gives me hope that we are bottoming out on price spreads, but time will tell.”
The power shift in Washington, D.C. resulted in some economic changes that could have lasting effects on certain industries. What does that mean for our lenders?
“The new tax law is probably the biggest change from Washington at this point,” Wright says. “Though we saw some impact at the end of 2017, the true test will occur in 2018. Obviously the 100% bonus will be positive for all of us, and there could be some new incentives for certain business types that will bring more deals to market. That has caused more optimism in the business climate. The more deals there are, the better it is for everybody.”
White expects more CAPEX spending due to strong economic fundamentals and a favorable tax environment. “We anticipate higher interest rates that will benefit some sectors but hurt others. When interest rates rise, borrowers’ cost of funds rise, and this puts stress on highly leveraged borrowers’ earnings. Many of those companies, once good bank credits, become ‘fallen angels’ that now fit into our credit space. We thrive in a choppy market, because it brings us more of those deals.”
Risk and reward characteristics remain largely unchanged, and there is still too much money chasing deals. “Spreads are too low, and the risk/reward is not where it ought to be,” Wright says. “The rising rate environment might help, but I’m not convinced yet. I don’t expect any real change in 2018.”
White says lenders that chase volume must compete on price and offer more lenient terms and conditions. “We focus on our standard criteria where the primary metric is ROI. We like to say, ‘We plant many seeds, remain patient and wait for the call.’ Let’sjust say the phone is seldom quiet. Even so, we price and structure to the risk. If the risk/reward equation is not there, we pass.”
Though rising interest rates may be considered a positive economic sign, Wright and White are wary. “Many economists are predicting three or four rate increases by the Fed this year,” Wright says. “This concerns me, because many people in the industry today have never lived through a rising rate environment. Managing through that is going to be the tallest order for many players this year.”
“We are in an unprecedented period of economic gains, but many of us have been around long enough to experience the down cycles as well,” White says. “We should all be very thoughtful about the transactions we approve in this environment. As we all should have learned by now, the never gonna happen… can happen in a blink. Former financial giants in our space are a testament to the tenet that chasing volume rarely ends well.”
“Even for those of us with more than a couple years of experience under our belts, it won’t be easy,” Wright says. “We may know what to be aware of and how to protect ourselves, but there are still competitive pressures. There are always a few players who don’t behave as they should, and they can cause problems for others. You have to stay disciplined.”
The Future is Today
Technology is a major consideration in the financial services space, and it represents a big investment. Wells Fargo Equipment Finance is taking a fresh look at its sales platform. “We will deploy it in a broader, more disciplined fashion and take it to the next level. We will use it in a way that protects our clients and the information we obtain from them, and it will allow us to coordinate our efforts more effectively. It’s going to be a strong communication tool for us, especially between the buy and sell sides of Capital Markets.”
Stonebriar takes advantage of technology through cloud-based applications and storage to outsource most of its operational services, such as back-end portfolio accounting and technology support. “This lets us maintain instant access to the information we need to run the business from day-to-day and results in huge cost and time savings in virtually everything we do. By outsourcing the functions that make sense, we can focus on what we do best.
“We participate in social media to keep the industry aware of activities and accomplishments and use web-based sources to mine information daily,” White says. “We recently hired an experienced professional as data processing manager to help us streamline our internal processes and reporting capabilities. This will allow management to have up-to-the-minute access to information on transactions from the front to the back end of the process.”
Today’s lenders need to be increasingly creative in how they approach the market. As a private independent with no depository relationships, Stonebriar’s direct originators continue to develop other avenues to find deals and develop new connections. “One such initiative is expanding efforts to include other sources such as private equity firms, family offices, financial consultants, attorneys, turnaround managers and accounting firms to source more deals and potential customers,” White says.
“We plan to greatly improve the coordination between the buy side and the sell side while looking for more reciprocity between the buyers and the sources on both sides of that fence,” Wright says. “We’re going to improve our communications and do a lot more joint calling between the two sides. We’ll pay much closer attention as we bring more discipline to the ways we coordinate our buy and sell efforts.”
All in all, both of our participants feel good about the year ahead. “Stress in the market works to Stonebriar’s benefit, because it creates more fallen angel companies that will need capital when the banks turn them away,” White says. “On the other side, when the bank lessors hit their limit on exposure to a credit, but the bank wants to maintain the relationship, they call us. We think business is only going to get better.”
“I feel optimistic about 2018,” Wright says. “Our goals are significantly higher than they were in 2017, which was a year that presented some challenges. But there is a lot of optimism out there, and we have a lot of momentum going into 2018.”
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