Buy Side: ‘Getting Out Over Our Skis’

by Lisa A. Miller March/April 2014 2014

Despite, or perhaps due to, increased competition, tightened spreads, stretched structures and other challenges, this year’s buy-desk participants report an overall positive feeling about their individual results for 2013. However, unless or until interest rates rise and/or economic growth accelerate, the consensus seems to be we can expect more of the same in 2014.

The phone rings with frequency at Capital Markets offices across the U.S., but record levels of competition and ever-tightening pricing continue to put excessive pressure on today’s buy-desk professionals. While it is not uncommon to hear a reference to the movie “Groundhog Day,” with its daily scenario repeating itself endlessly, all of our participants reported having a good year in 2013. We asked them to tell us about their experiences and whether they foresee changes in 2014.

“One of the biggest challenges in 2013 was pricing,” begins Bob Wright, SVP, Capital Markets Buy Desk at Wells Fargo Equipment Finance. “It seemed that pricing started the year low and just got lower. Spreads tightened throughout the course of the year, and that, more than anything else, made it challenging. There are a lot of new entrants in the industry, and the established major players are as strong as they have ever been. The economy is growing at 2% or less, and we all want to try to grow at a bigger percentage than that. That makes for a very competitive environment.”

Scott Kiley is VP, territory manager of Indirect Originations at Fifth Third Leasing Company and serves as chairperson of the ELFA Funding Committee. He attributes his company’s growth to a handful of very large deals that can ramp up the numbers quickly. “Consistent with that, we had more willingness and ability to increase our hold levels. Over the last several years, bank-wide, we have been willing to hold higher amounts that are still consistent and reasonable given our size. We are still fairly conservative from that standpoint, however.”
“The addition of new entrants and the need to replenish previously depleted portfolios added pressure on pricing as demand seemed to outweigh the supply of product available in the market,” says Joe Fantauzzi, EVP, Capital Markets Division head at Signature Financial, a subsidiary of Signature Bank. He joined the Signature Financial management team when the company opened its doors for business in March 2012, and 2013 marked the first full calendar year of operations. “After 22 months of operation, Signature Financial ended 2013 with a $1.6+ billion portfolio outstanding. This was a significant accomplishment considering that there was also a tremendous amount of time and energy devoted to building the business from scratch.”

“I do think there was increased supply in the number of transactions available, but there was even more of an increase in demand,” suggests Kiley. “Aside from new entrants, demand comes from long time players who have increased their budgets and are willing to do more in indirect originations to get there. The demand continued to exceed supply and that drove pricing down, especially on the better credits. But pricing was also down across the board.”
In addition to the growing number of new entrants, Fantauzzi lists other factors contributing to the heightened competition, including cash-rich companies spending their money in lieu of financing, a slowed level of refinancing opportunities and larger holds that impact the level of product available to the capital markets/indirect segments of businesses. “In 2013 we saw a modest movement in rates and a change to the swap yield curve that returned it to a more normalized curve. This change in the curve impacted pricing perception for some term players in the capital markets arena. With the average life swap index being the basis for many in our segment, the variances in the curve required some sources to make adjustments to their margin/yield expectations.”

“One of the big trends we saw in 2013 was an increase in straight-out loans or finance leases, or debt financing versus true leases, or tax leases with residuals,” notes Kiley. “In our space we do a combination of different types of equipment financing, and a much higher percentage of the product that was moved out this last year was traditional loans and finance or buck-out leases. The reason for that is two-fold and continues with some themes from the prior year: Interest rates in general are still at historically low levels, and profitable companies want to use the tax depreciation benefits themselves. So more companies want to do a straight-up loan rather than get into a tax lease. Most of my peers saw this big increase in financings and loans.”

“From my perspective, 2014 is just a continuation of 2013,” laments Wright. “The pricing levels that existed at the end of 2013 have not changed much. Equipment valuations are not much different from what we historically look at, either. You might look at certain industries differently, but we tend to be consistent in how we look at things.”

Stretching for Reward

“Most of the end users out there today have survived the storm, and the credit quality of what we see is pretty high,” continues Wright. “Hand in hand with that, pricing is the main issue. In some cases structures are getting stretched beyond what they might have been in the past, but the major difference is pricing and competition.”

“We have seen large balloon payments with amortization and pricing that have caused us to walk away from large syndicated deals,” remarks Kiley. “There were several $50+ million transactions taken to market last year, mostly in oil and gas. We were not comfortable with the stretching of the structures and the pricing. There is such a huge appetite out there that deals are getting done, but the risk has gone up and the reward has not. We are keenly cognizant of the risks and rewards of a deal. Sometimes you stretch a little more if you get paid for it, but that is not what is happening.”

“What we’re seeing in terms and structure trends is that some of the institutions who may not be as competitive in pricing on the shorter-term deals are willing to compete by offering longer terms and/or higher back-end positions,” says Fantauzzi. “The normalization of the yield curve has benefited longer-term lending. We are also seeing competition result in weaker structuring in the market such as waiving corporate and personal guarantees to win the deal. The concern here is that, as an industry, we need to be conscious so as not to allow the competitive cycle to drive down the risk-to-reward balance.”

The atmosphere at credit review meetings usually reflects what’s going on in the marketplace, so we asked our panelists about the mood of their meetings. “Better financials directly correlate to better tenors at the credit review meeting,” expresses Kiley. “Two to three years of strong earnings, improving financial statements, decreasing leverage and increasing cash balances make for a more positive, optimistic committee. But there is a sense of having seen this before in 2008-2009 when things got stretched; we are still wary of getting out over our skis.”

“Overall, I think credit review committee meetings are more favorable today, going from a loss-prevention focus and returning to a prudent deal-doing approach and making reasonable risk-versus-reward assumptions,” encourages Fantauzzi. “With competition being a relevant factor, we need to ensure we maintain our credit discipline while making reasonable risk/reward assumptions.”

“We’ve grown a lot over the past five years, which gives us the ability to do larger transactions,” explains Wright. “When it comes to the credit review process associated with those larger transactions, we have added more structure around our internal processes. We try to pre-screen those larger transactions at a higher level within the organization and involve a higher level of management earlier in the process. This helps us get to a quality decision in a faster time period.”

Kiley says Fifth Third Leasing is cautious on the higher leverage deals, but that there is also optimism. “We are willing to hold larger dollars to a credit, but when we do larger amounts, it is often for shorter-term deals or where a strong collateral coverage is present. In my mind the biggest factor in determining credit risk is the term of the deal. If you compare a ten-year deal and a three-year deal with the same credit, the ten-year deal is a lot riskier.”

The talk at last year’s roundtable was about low interest rates, lack of demand and competitive pricing. Has anything changed for 2014? “Much is the same on the competitive front, based on supply and demand dynamics,” cites Fantauzzi. “During 2013 there was a bit more confidence that the economy was on a rebound. We also had early signs that our government would start easing its asset purchase program. That said, the uncertain healthcare landscape is the 100-pound gorilla in the room for most American businesses.”

“The strength of our industry is putting flexible, deal-specific tax lease structures in place; that is how we differentiate ourselves from a straight-up loan product,” stresses Kiley. “Rising interest rates and less cash would alleviate this situation. Leases do better in a rising interest rate environment when the economic numbers are not quite as good and businesses are more worried about cash-flow. Right now people are looking into the future, and they are not too worried about cash-flow — at least the good credits aren’t.”

“In 2013 pricing just got tighter and tighter, and I don’t see that changing in 2014,” says Wright. “There is a lot of money out there with a lot of people chasing fewer quality transactions. An economic downturn would tighten up money sources, but my hope is that we see more growth with higher interest rates and better deals out there. But it would have to be significant growth — more than just a couple of percentage points.”

Technological Dynamics

Rapidly changing technology has not escaped the buy desk, and the internet plays an active and ever-growing role in sharing information. “Virtually everything is passed through organizations electronically these days,” exclaims Wright. “You might have to follow up for paper, but the initial communications and sharing of information are all done electronically. A few years ago, it might have been half of what you do, but now more than 90% of the business gets transacted electronically.”

“Many of the large syndication shops are posting deals electronically and using websites like SyndTrak and others to post offering memorandums and financial statements,” agrees Kiley. “This creates a more efficient flow of information, and increasingly companies are using this technology.”

“On the buy side of our capital markets business, we are leveraging the use of various information-sharing sites hosted by some of our peers to process transactions being offered into the marketplace,” ventures Fantauzzi. “The use of these delivery sites allows us to efficiently distribute the material received by and between our business disciplines such as the buy desk, credit, asset management, documentation and legal. On the sell side, this is a tool that we will look to invest in and leverage as needed in the future. We have also used our asset management database to create some efficiencies in how we promptly deliver our valuations to our different business platforms, including capital markets.”

When asked if they recognized any emerging technological trends, Kiley mentions, “Some of the large Fortune 500 companies are starting to use electronic signatures, so you no longer have to physically sign a lease document. The signature is done electronically, and there are laws established to protect the parties involved.” Wright added that the way people communicate has changed a great deal. “Within our organization, it is now common to text coworkers about non-financial, non-sensitive information, and that didn’t used to be the case. Externally, texting might be used to pin down appointments or exchange other bits of non-material, non-financial information, too.”

Advice to Newbies

Our panel offered seasoned advice to new entrants wanting to participate in the process of selling off participations or whole transactions. “A new entrant needs an experienced person with established relationships or someone who knows how to build them,” insists Wright. “In this industry niche, it is all about building credibility and trust with the individuals and organizations you do business with. That person must also clearly understand the capabilities of the company he or she is representing. To build credibility, you must know what you have to sell, and you need to deliver on your promises. From a process back-end perspective, your decisions should be as close to the source as possible, so that the results are responsive and show understanding.”

“We look for a complete underwriting package that includes numbers as well as insights into those numbers,” shares Kiley. “For publicly held companies you can rely on the 10K and 10Q filings for management analysis of the company, but for privately held companies, all you have is an audit with numbers. We look for the insight to those numbers — why did margins go down or profit and sales margins go up? Lastly, we look for folks who can document, fund and service the deal, and collect the payments.”

“Reach out to all the primary contacts in the industry and get a sense of where the market is,” advises Fantauzzi. “Provide a good concise profile of your business — what you do, how you do it, the background of the executive team and how you currently fund your operation. I recommend joining the ELFA and leveraging all it has to offer, such as business directories and databases, the annual funding symposium and convention, and the various other conferences and sessions it offers.”

“Similar to any relationship, it is a two-way street,” reminds Wright. “From the buy perspective, you have to deliver what you say you can deliver. From the sell side, you also have to deliver what you say you can deliver while being cognizant of the relationships and the give-and-take that must exist between your respective organizations.”

“Operationally, you need to convey what your underlying back-office capabilities are and that your documentation is within industry standards,” adds Fantauzzi. “A quality, industry-recognized attorney can help streamline negotiations of master assignment agreements and service agreements that memorialize the parameters of how you do business. Ideally, these agreements should be reversionary in nature so they work for both the buy and sell sides of your desk. Upfront due diligence is critical in determining who your partners are.”

“When considering a source, we look for people who have an awarded transaction that has been committed to them by a company,” states Kiley. “We want our source to have reasonable credit exposure to the relationship, rather than looking to flip a deal for a fee. We want the seller to have at least as much skin in the game as we do. When things start to go bad, often the selling source becomes your fiscal agent, so you want your source to have similar interests in the deal.”

New Business Opportunities

In a saturated market, lenders need to get creative when looking for opportunities to develop new business. “We are a broad organization, so we are not focused on growing a specific industry or asset class,” says Wright. “We are constantly looking at different opportunities and trying to determine if we want to go deeper.”

In Kiley’s segment of the business, his budget gets bigger every year. “One of the things we’ve done to develop new business is to capitalize on existing relationships to do smaller deals. We have assigned a smaller budget to a younger colleague who is charged with financing transactions that are typically under $5 million. If he goes to our sources and comes back with a $2 million deal, it is much more significant to his budget than it is to mine. This allows us to offer more services and solutions to our sources that may have smaller deals that they have had to take elsewhere. We also have some good sources whose everyday deal is a million dollars, and they only come to us for the $15 million deals. We already have the relationships and the documents in place, so this way my colleague can cater to their other needs. It lets us be more of a full-service shop and close some extra business.”

“As our portfolio grows at Signature Financial, we will continue to expand our retained positions and capture additional market share for our existing clients,” relates Fantauzzi. “We currently have five business platforms in place and are always looking to further diversify through the addition of complementary segments. In addition, we want to leverage our syndication capabilities. As we look to expand our client hold positions, we will also utilize our syndication team to take more of a win-all-the-business approach so as to maximize the client relationship. I expect this to be a major push for us in 2014 and beyond.”
“It will be hard to repeat the volume we did in 2013,” surmises Kiley. “We had a lot of large ‘lumpy’ deals. These are the occasional $50+ million deals that come in and pump up our numbers. It will be interesting to see if any of those deals come to the market in 2014. We’re committed to growing our business, and so far things look positive.”

“There were many challenges outside our control in 2013, and many of them will continue into 2014,” predicts Fantauzzi. “The confidence level in our economy and how government action or inaction impacts how businesses decide to invest in capex could impact the supply side of the equation. New entrants in 2014 or existing sources that decide to expand into our markets can affect the demand side of the equation. Last but not least, an increasing interest rate environment could change refinancing activity levels and sale-out-of-portfolio activity.”

“My clients are also my competitors, and all of our organizations are trying to grow our balance sheets,” concludes Wright. “Given that we are in the business of trying to purchase transactions that match where we want grow our balance sheet, my big concern this year is the lack of product. Is there going to be enough product sold to keep everybody happy? If there is enough product, I feel confident that we are going to do just fine.”

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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