Changing Dynamics: Industry Leaders Share Their Insights

by Lisa A. Miller September/October 2017

Lisa Miller sits down with four executives, each representing a different corner of the equipment finance universe, to discuss the current state of the industry. They share their thoughts on 2017’s ability to live up to expectations, their outlook for the rest of the year and the myriad ways recent natural disasters will inevitably affect the industry.

Tom Guse,
President,
Volvo Financial Services USA

Dave Fate,
President & CEO,
Stonebriar Commercial Finance

David Coutu,
President,
MassMutal Asset Finance

Rich Doherty,
President,
PNC Equipment Finance

Hurricanes, wildfires and earthquakes have dominated the news headlines for the past few weeks. Watching the widespread devastation affects us emotionally as our hearts reach out to those affected. The economic toll is yet to be seen, though certainly billions of dollars will be directed toward cleaning up, restoring services and rebuilding infrastructure, homes and businesses.

When we got together with our four equipment financing executives, we couldn’t help but ask how the effects of Mother Nature will affect the equipment lending industry. Dave Fate, president and CEO of Stonebriar Commercial Finance, lives and works in Texas where Hurricane Harvey had its biggest impact. Because Stonebriar is diversified across North America, the direct effect on business was minimal, though the company has a few customers with barges, push boats or cranes in south Texas.

Relieved that none of his customers have reported injury or loss of life, Fate expects the next few quarters to be challenging for businesses in the areas worst hit. “Most companies have insurance to cover damage and disruptions to their business, but in the midst of recovering from such a significant natural disaster, it may take a while to get back to full capacity. Most lenders will work with their affected borrowers by waiving fees and granting extensions, but it can also result in businesses being put on a lender’s ‘watch list,’ which in some cases may cause further restrictions of capital.”

Many parts of Florida will have the same issues. “We are very concerned about the fires in Montana and the Northwest that will almost certainly affect the lumber supply and mills there,” Fate says. “Houston and Florida will need lumber, and prices are already up this year by more than 20%. The current administration imposed tariffs on the import of Canadian lumber to drive up production by U.S. lumber mills, but the fires and upcoming high demand will have a long-term impact on that production. The result will be cost increases for lumber and plywood.”

All of these natural disasters cause a trickle-down effect related to supply and demand. “In addition to the impact on the lumber industry, the auto industry will be affected,” Fate says. “It is estimated that in Houston alone, up to one million cars were flooded or otherwise destroyed. Without significant inventory on hand, manufacturers will have to boost their supply chain as well as reallocate cars from other areas of the country to the areas that are being impacted by these devastating storms. This will drive up the value of used cars, put pressure on resources and create jobs at the auto plants. Many other industries will be similarly affected.”

“Cleaning up the debris will create a huge need for equipment, and rental machines are going to be in dire need,” adds Tom Guse, president of Volvo Financial Services USA. “The same will be true for vocational trucks such as waste-haulers and dump trucks. Similar to what happened with Hurricane Katrina, I suspect the equipment will move from one state to another as people assist in clearing the mess. Yellow iron will be strong for the next couple of years as they continue the cleanup and begin to rebuild.”

While we cannot discount the hardship of all the people involved, we have to admit the circumstances can also create lending opportunities. “We refer to the affected businesses as ‘fallen angels’ allowing us to structure around the perceived risk and underwrite to the real risk, thus providing the capital they need,” Fate says. “Customers with assets involved in cleanup, repair, maintenance, construction and inspections will be in high demand for years as these areas recover.”

Casing the Business Environment

Shifting our focus away from storms and back to the current lending environment, we asked our roundtable participants if they agreed with the 7.8% volume growth rate projected by the Monitor 100 companies for 2017. With each panelist hailing from a different corner of the equipment finance universe — a bank, a captive, an independent and an NEC (Not Elsewhere Classified) — it is no surprise that their perspectives vary.

“The forecast feels right to me,” says Rich Doherty, president of PNC Equipment Finance. “Activity seems up from 2016.”
“That figure does not sound unreasonable, especially since last year was effectively flat for volumes in the industry,” says David Coutu, president of MassMutual Asset Finance. “As a player in the indirect channel, our volumes are dependent on both overall industry volumes and how much direct originators will sell to the indirect market. Therefore, our volumes do not always track industry growth rates; it often depends on the sell-side attitudes of other participants.”

Guse counters that the volume growth rate depends upon the industry and product being referenced. “We are seeing good order activity in construction equipment and Class 8 trucks. As long as a major negative macro-economic event doesn’t crush the current momentum, the projected rate seems reasonable.”

Fate suggests the number is overstated. “Bank leasing companies were very optimistic starting 2017 with new initiatives. We saw them expand into different markets or credit spaces. However, as the regulators and risk functions get involved, that optimism is tempering. They may have felt good when they projected 7.8% volume growth, but it’s not what we see or hear in the markets right now.”

The ELFA Monthly Confidence index has held steady for June and July at 63.5, 10 points higher than last summer’s ratings. We asked our panelists to tap into their day-to-day experience with decision-makers and give us their sense of the mood.
“I don’t think we have seen a major swing in demand for equipment overall over the past several years, despite changes in that index,” Coutu says. “But I hope the index does signal the uptick that many of us have been waiting for.”

“The current mood is positive,” Doherty says. “Our business is up year over year, which is partially attributable to a more favorable economic mood.”

“I perceive CFOs and companies as being optimistic but thoughtful and selective in how they allocate their CAPEX spending,” Fate says. “They are looking for that spend to be immediately accretive to their business. Companies are hiring and investing capital, but they’re also closely managing the right side of the balance sheet.”

“The mood is very strong, especially within the construction equipment channel,” Guse says. “A couple of years ago, we measured the customer’s work backlog in terms of weeks, but now we measure it in months. Our dealers who deliver Volvo equipment are upbeat and actively ordering new equipment for inventory to sell. The second half of this year looks good for our industry. The pipeline for sold equipment is very healthy, and the overall mood is incredibly strong despite some macroeconomic events that have the potential to impact that mood.”

While it would be nice to rely on the proverbial crystal ball to predict future performance, lenders must depend on other benchmarks to determine what’s ahead. For MassMutual Asset Finance, the backlog of approved transactions provides insight. “While we are off a bit from what was an out-sized year last year, our backlog is stronger at this time of year than it was at this time in 2016,” Coutu says.

“We inspect our client activity reports and proposal pipeline,” Doherty says. “Rising interest rates move some clients to acquire equipment now to protect from higher financing costs down the road.”

Volvo Financial Services tracks two key indicators. “The first is consumer spending,” Guse says. “It’s two-thirds of the U.S. GDP and remains very good. We also look at the inventory-to-sales ratio, which has dropped over the past 12 to 18 months. When that particular ratio drops, it indicates that there’s going to be a future need to manufacture new goods to refill the store shelves. We feel very upbeat about that, because both indicators are signaling a good economy for the next few quarters.”

“We look at the spread between high-yield and investment-grade bonds,” Fate says. “The spreads are indicators that the markets are overheating, and risk versus return is out of balance. Regulated capital is beginning to dip lower into more heavily leveraged companies and B-rated credits. That’s a very telling sign. We watch a lot of the same metrics that everyone else does, but we might interpolate them differently. Commodities such as oil, gas and agriculture affect the transportation sector, which has a direct impact on our rail leasing and maritime joint-venture businesses. We remain very disciplined in our pricing.”

Dealing with Changing Dynamics

Everyone depends on technology to deepen research, provide valuable data and speed turnaround times. Finding the right balance between technology and the personal touch is a constant challenge. “Similar to brick-and-mortar stores that are building out online networks, and online stores that are building brick-and mortar infrastructure, you need both approaches,” Coutu says. “You should take advantage of financial and online information and its efficiency, but don’t lose sight of the face-to-face, voice-to-voice approach. You also need to bridge what seems to be a generational divide when it comes to applying technology and still communicating effectively.”

“Increased technology is a good thing, but it does have the potential to discount the value of a personal relationship,” Guse says. “The key is in how you apply the information that technology makes available. Whether it’s new information or the speed with which it is provided, you have to figure out how to use that information or speed to bring appreciable value to your customer.”

“Technology plays an important role in more efficiently moving transactions through our system,” Fate says. “We have minimal touch points due to our streamlined process that helps us quickly and accurately assess the viability of a transaction. Combining technology with the expertise we develop internally in our origination, underwriting and asset management departments is a big advantage and makes our lives much easier. No matter how we originate a transaction, every deal we review requires direct customer interaction to properly underwrite it.”

“Providing a technology solution that a client can use to access data, process requests, submit applications and execute documents 24/7 offers them the flexibility they need,” Doherty says. “Fulfilling their requests with a human touch via e-mail or telephone maintains the personal contact you want to preserve.”

The equipment finance industry is evolving, thanks in part to customer demand to finance less traditional assets and bundle managed services with equipment finance contracts. Moving into new lending territory requires added precautions as lenders figure out the lay of the land.

“When looking at non-traditional assets such as managed services, it’s critical to figure out the product life cycle for the particular service,” Guse says. “Will it be replaced by something better six months or even two years from now? This is a real concern, because that service may suddenly become old technology that customers see little value in. In addition, you have to make sure that you completely understand the strength of your customer who may be forced to make the difficult decision of choosing between keeping the old technology and upgrading to something new or different.”

Coutu believes both sides of these transactions must have reasonable expectations and realize they may not be able to have traditional structures or terms on such 2017assets. “Financing services that have yet to be provided creates additional credit risk, which should be considered when pricing such transactions.”

“We stick to our knitting and focus on a couple of things,” Fate says. “Is it a company we know, and does anyone care if it goes away? We focus on essential, integral income-producing assets. We’ve had very good portfolio performance. We have a game plan, and we don’t change it to win a deal.”

“Capital providers need to avoid ‘following the herd’ until they fully understand the characteristics of a product,” Doherty says. “Take the time to understand the legal, credit and tax risks of a new offering. Early entrants generally command better pricing, but understanding what you have will pay big dividends.”

Every lender struggles to differentiate its business, products and solutions from the next provider. In an aggressive lending environment, it is hard to stand out from the crowd. “Everyone hates to admit it, but let’s face it: We mainly compete on price,” Coutu says. “That being said, if you can deliver excellent service — which may be a quick turnaround time, a unique structure, a steady partner or whatever your strength is — I think smart borrowers/lessees recognize that value.”

Doherty admits that service and value are the differentiators. “Agreeing to service levels and meeting them will maintain client loyalty. In specialty areas, the key is to provide real value by understanding the client’s challenge and offering a solution to meet it.”

“We structure and price to the perceived risk in the transaction; we underwrite to the real risk and create the arbitrage or the delta in between,” Fate says. “That is how we get the preferred structures and the economics.”

“Aside from the terms, structure and rates, we are in a relationship business, and people want to do business with people they like and trust,” Guse says. “There is no substitute for that. For all of us, the cost of getting into the game is to have a competitive offer. The critical differentiation happens when you solve the customer’s need as a solutions provider rather than as an equipment-finance provider. To provide that solution, you have to thoroughly understand your customer’s business.”

Here and Now

“This year appears more challenging than last for both price and volume, but I seem to say that every year,” Coutu says with a laugh. “Booked volume is off a bit, but on the bright side our backlog is high, signaling a strong second half. As a generalist, we do not chase specific industries, so we look at the big picture and try to have reasonable expectations. For the last several years, those expectations have been for fairly low growth, consistent with GDP.”

“We’ve had some unique opportunities this year,” Fate says. “We get phone calls from many institutions that are trying to sell assets, and we have taken advantage of some of those. They know we are a large-ticket independent who can get things done in a timely fashion outside the regulated environment. We are having a very good year so far and feel good about the rest of the year.”

“Our production is up over 2016,” Doherty says. “We will exceed our budgets as long as we keep executing. The profile of opportunities for 2017 is very similar to 2016.”

Guse expects the industry to have a good year with a second half that is even stronger than the first. “I think 2018 will be better than 2017. The predictions for Class 8 truck unit sales are very good for 2018, and we expect those sales to go up as much as 10% to 15%. We believe truck demand is a general precursor to the rest of the economy, and we trust that construction equipment will follow along accordingly. We are very optimistic.”

Even with a mostly positive outlook, there are still plenty of challenges ahead. “Because we’ve had multiple years of arguably tepid demand for equipment, our primary challenge remains finding transactions that have the right balance of price and credit protection,” Coutu says. “That is the art of this business: Have you priced and structured your transaction appropriately for the credit risk? It is a constant ebb and flow.”

“Maintaining our culture of being client and employee-focused is our ongoing challenge,” Doherty says. “Client demands seem to be ever increasing, and the workforce needed to meet those demands is changing.”

“We like to say if a deal is not a ‘Hell, yes!’ just say no,” Fate says. “There’s always another deal. We have the same attitude when it comes to hiring people. We are committed to mentoring emerging talent and like to hire talented people in their 20s and 30s to support the long-term path for our company’s growth. We are developing young talent, because that’s where the future lies.”

“Each person, from sales to documentation and funding to collections, touches the customer directly or assists someone who touches the customer,” Guse says. “It is critical for us to find people who have the ‘customer first’ mindset, and that’s extremely difficult.”

Despite the fluctuations of the sales environment and the challenges associated with running a successful business, our leaders find their work rewarding and gratifying. “Positioning PNC Equipment Finance to exceed our client expectations while providing our employees a rewarding career path brings me great enjoyment,” Doherty says.

“As an industry leader, the most rewarding aspect to me is seeing the successful results of a dedicated staff that has stuck to its core principles and honed its business model over many years,” Coutu says. “Many of our employees have worked together for almost 20 years, through positive cycles, challenging cycles and everything in between.”

Guse likes watching how finance companies develop the industry and shape future interactions with customers. “I get excited thinking about how we can help customers purchase equipment from our OEMs. I also get great satisfaction from developing an overall succession plan as our senior leaders contemplate retirement. I enjoy watching people develop as we groom them to take over the business.”

“I have thoroughly enjoyed creating value for our customers and stakeholders by encouraging my team to be creative and think outside the box,” Fate says. “I enjoy coaching our strong leadership team members, each of whom brings a diverse set of skills and background. Confidence in my team allows me to focus on the bigger picture and be available and responsive to our stakeholders. I enjoy the relationships within our organization and the relationships I have developed over 30 years in our industry. I get to see deals across a lot of asset classes and industries. I can’t imagine retirement — I’m having too much fun!”

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