Loni Lowder CEO, ACC Contract Finance

Paul Menzel President & CEO, Financial Pacific Leasing

Phil Carlson President & CEO, Nations Equipment Finance

Gary H. Souverein President & CEO, Pawnee Leasing Corp.

Leading indicators show that the economy is chugging slowly forward, but the experiences of the last two years have left their mark, changing the environment in which we do business. Large corporations able to rely on foreign business to boost profitability may be holding their own, but companies dependent on domestic consumption are still struggling. Small businesses are hesitant to invest in the assets necessary to expand, middle-market companies must jump higher hurdles to prove creditworthiness, and companies of all sizes feel the pinch of tighter access to funding.

Within our own industry, originations and deal flow seem to be improving, though credit remains tight. The impact on independent lessors and third-party originators doing business within multiple segments is significant. We invited the leaders of four independent equipment financing companies to share their experiences. Phil Carlson is president and chief executive officer of Nations Equipment Finance, Loni Lowder is chief executive officer of ACC Contract Finance, Paul Menzel is president and chief executive officer of Financial Pacific Leasing, and Gary H. Souverein is president and chief operating officer of Pawnee Leasing Corporation.

“Most of our competitors have had really tough times, unless they had a strong capital base that survived the decline,” begins Lowder, whose company felt it from both ends. “We found our own sources drying up, in addition to a decrease in the companies coming to us for financing.”

Financial Pacific retained its access to funding but found the company needed to provide more information to satisfy its sources. “There was concern about whether there would be renewals, terms were shortened, and some of the advance rates were tightened,” says Menzel.

At a time when many leasing companies were struggling to recover, Nations Equipment Finance opened its doors for business in October 2010. “We were able to attract capital, because we are new and have an experienced team that’s been in the industry a long time,” explains Carlson. “Being new is important, because leasing companies that have been in business for ten years or so may have a portfolio that is not performing well. As a new company, we started with a clean sheet of paper.”

Changing Times Require New Approaches
In response to the economy, each company looked for different opportunities and changed its approach to business to meet the changing market. “The economy forced us to reinvent ourselves,” admits Lowder. “We dusted off a product we had used in the late 1990s. Now we look for companies that have won large contracts with investment grade end-users, and we provide the funding to fulfill the contract. We do that by taking an assignment from a portion of the future contract revenues and taking a security interest in the equipment necessary to provide that service or agreement. We present value future revenues and give the provider the money he needs now.”

Over the past two years, while most funders were decreasing their offerings and exposure to the broker market, Pawnee Leasing expanded its market footprint. “While each funder’s business model requires a different approach, whether it be tightening credit or getting more creative, we always felt that a common sense, bottom line approach serves us best,” says Souverein.

Because of the dislocation on the funding side, Financial Pacific saw that there was a void between its niche (second and third tier credits) and top tier “A” credits. “We work through third-party originators, primarily brokers,” states Menzel. “To support them, we came out with a lower priced product for higher credit quality. This allowed us to go after more vendor-originated business that used to be fully funded by the marketplace. Our second tier credit product helps flex the credit window for vendors and allows them to approve more customers.”

“We formed our company because we saw a void in the market for small- to middle-market companies [that] were having difficulty getting financing from banks and finance companies,” relates Carlson. “Many companies lost revenue and the ability to service debt due to the recession, making it difficult to attract a lender. They might have a bankruptcy in their recent past or perhaps aren’t doing as well now as they were two or three years ago, but they still have assets of value. Nations Equipment lends against that asset value, with less regard for how they are doing financially.”

Credit Standards and Deal Flow
Economic conditions have had their impact on credit, forcing companies to exercise more stringent standards that may now be loosening as the market opens up. Pawnee Leasing sees the credit pendulum swinging back slightly. “As funding sources continue to heal, we believe there will be a return to less stringent, risk-based pricing,” predicts Souverein. “However, there will not likely be a return, in the nearer term, to the very irrational environment that existed pre-2009 when our industry seemed to lose all perspective on credit risk and lease pricing.”

“We didn’t increase standards but went out for investment grade credits that were no-brainers to fund,” comments Lowder. “I would still consider credit to be tight, but we are seeing a few wholesale lenders reaching out and looking to expand their businesses by providing funding.”

“Our credit standards fit into a box that we don’t really deviate from,” says Carlson. “We look at a company’s general financial strength and, more importantly, the assets we are lending against. We operate as a senior debt lender or as a lessor [that] owns the equipment and provide loans against assets for which we think we can get paid back, if the company has financial problems.”

“We saw an opportunity after ‘B+’ funders exited the marketplace and ‘A’ funders drifted downstream away from the small ticket space,” remarks Souverein. “We sought to fill the vacuum by offering risk-adjusted pricing in the 14% to 26% range. This allowed us to pick up strong credits at attractive risk-adjusted margins.”

Menzel adds, “Because we could still lend, we actually benefited from that contraction. We expanded our product offering a little bit and took the opportunity to improve our underwriting tools; this helped our market share and helped us be opportunistic. We also benefited from less competition. Remarkably, the quality of our applications is the highest it has ever been!”

The Return of Demand
Is business picking up? The experience seems to differ from company to company. “There is more demand for equipment financing recently, and we are seeing quite a bit of deal flow through brokers,” affirms Carlson. “A fair amount of startup companies are surfacing, especially in the energy market, and trucking companies are telling us they can get more business if they can acquire more equipment. They are looking to buy new and used trucks and trailers, reinvesting in their fleets to meet growing demand.”

“Our application flows are not sending clear signals that suggest pent-up demand,” relates Souverein. “We think that businesses are only now, in 2011, seeing modest top line growth, and excess capacity is likely to mute the positive effects of that growth.”

Lowder is optimistic, “In the last year I’ve been looking for lenders to step up in the middle market to buy our contract finance product and haven’t had much success until just recently. I am hopeful that it will get some use in middle market and possibly small ticket.”

“Our approval rates and close ratio are as high as ever for the deals we end up funding, but application flow has steadily declined over the last two years as a result of a de-leveraging economy and fewer TPOs,” says Menzel. “Because of our increased efficiencies in areas such as credit scoring, fast turnaround and strong customer relationships, we have been able to maintain our production. In terms of our application flow, we may just now be starting to see some upward movement.”

Back to Basics With a New Outlook
All agreed that the current environment calls for a back-to-basics approach. “We have learned to verify, verify, verify,” states Lowder. “At first blush something may look okay, but you have to ask more questions, glean more detail and get more information.”

“If a funder in our segment of the industry doesn’t view himself as a risk management and collection business, he will be destined for failure,” adds Souverein. “I hear much less chest-beating on funding volumes nowadays. Many chest-beaters unfortunately went the way of the leasing graveyard over the past three years — too many of them. Those that understand risk-based pricing and have an inherent focus on collections will do well in the near term.”

Having taken creative approaches to bring in business during changing times, companies strive to develop products and services to set them apart from the competition and attract new business. “We differentiate ourselves through our deal structuring and our willingness to do the unusual,” reports Carlson. “We recently did a $2.5 million refinancing for a trucking company whose existing bank would no longer lend to them. We added a million dollar line of credit for more equipment, so they could better compete. They didn’t ask for it, but we thought they needed it.”

“We have a very distinct niche, so we don’t have a lot of competition,” explains Menzel. “We balance lower credit quality with risk-based pricing. This is something we’ve always done, and the economic downturn validated our model.”

Looking Ahead
Third-party originators play an important role in the success of these businesses, but given all the changes in the marketplace, it stands to reason that their role must change, too. “This is a time when vendor participation makes sense again,” emphasizes Menzel, “so don’t be afraid to ask a vendor to discount invoices to lower the price to the customer. The rules have changed, so take advantage. Think creatively.”

Brokers must adjust old behaviors to fit the emerging marketplace. “People have to be adaptable these days,” says Lowder. “So many brokers are so used to doing things the way they’ve always done them.” Souverein agrees, “I still talk to brokers who are complaining about why they can’t get their ‘B’ credits approved at ‘A’ rates like they once did.”

“Find new places to look for business,” suggests Lowder. “We’ve found investment banks, private equity firms and venture capitalists to be useful sources.”

“Our most successful brokers have substantially increased their outbound marketing efforts,” continues Souverein. “If you are in the small-ticket arena, examine your sales approach and ask yourself if you have the confidence to sell a 21% buy rate to a 675 FICO candidate. If you don’t, your competition will, and you’re losing a large part of your market.”

Sometimes brokers don’t let a funder talk to their customers, making it hard for the lender to really understand the customer’s needs. “Second-hand information is never as useful as first-hand information,” urges Carlson. “I would advise brokers to find funding sources they trust and let them speak to the customer early in the process so we can build a better offer. Pick two or three sources best suited to the kind of customer they go after, then cultivate a relationship with the funders and market toward their goals.”

Small businesses are a leading driver in the U.S. economy. They employ about half of all private sector employees and account for a large percentage of new job creation. They also hire more than 40% of high-tech personnel working for the companies often responsible for developing new frontiers for economic growth.

“In past recessions, it always seemed to be that the small-to-micro business person was the leading economic indicator — the first to feel it and the first to lead us back out of the recession,” concludes Menzel. “This is the first recession I remember where they are the last to participate in the recovery. They are scared about where the economy is headed, and psychologically they are not willing to take on more debt yet. I think things are starting to pick up, and it’s slowly but surely trickling down to the small-to-micro customer. But until that happens, I don’t think our economy will start making an impact on unemployment and actual growth. It’s nice to see the stock market doing well, but that is not a window into the mind of the small business owner.”