As the economy continues its prolonged crawl toward recovery, we asked three independent equipment finance leaders to comment on availability of funding, credit quality and deal flow. While some note moderate improvement over recent years, the overriding sentiment is concern over the lack of robust economic growth to generate demand for funding.
Although most businesses have been approaching economic recovery with cautious optimism, a steady stream of mixed financial news reflects ongoing uncertainty. While some indicators show that the economy is exhibiting glimmers of improvement, other reports suggest muted confidence in any measurable growth.
In fact, 77.1% of executives responding to the Equipment Leasing & Finance Foundation’s February 2013 Monthly Confidence survey predict that their business conditions over the next four months will remain the same. Likewise, 77.1% of those surveyed believe demand for leases and loans to fund capital expenditures will remain the same during the same four-month period.
We invited the leaders of three independent equipment financing companies to share their thoughts on the state of the industry and the impact of economic uncertainty on independent lessors and third-party originators. Phil Carlson is president and chief executive officer of Nations Equipment Finance, which was founded in September 2010 and whose transactions range in size from $1 million to $50 million. Paul Menzel is president and chief executive officer of Financial Pacific Leasing, which was established in 1975 and originates and services a portfolio of equipment leases that generally range from $5,000 to $75,000. Robert Fisher is senior vice president of business development for Ascentium Capital, which grew out of its predecessor Main Street Bank and was launched in August 2011 to finance equipment from $5,000 up to $500,000.
Deal Flow and Originations
When asked to characterize the level of activity versus a year ago, Ascentium’s Fisher, who manages the indirect wholesale platform that provides financing to brokers around the country, saw deal flow as moderately higher year over year, with an increase from existing sources. With regard to finding deals through the broker channel, Fisher says Ascentium is not a niche player and that the company’s approach is to foster vendor relationships.
“At Ascentium Capital we maintain a controlled number of brokers and focus on working closely together and developing relationships for growth. We spend a lot of time with our brokers to understand their needs and markets. Overall in the company approximately 30% activity comes from brokers,” Fisher adds.
Menzel says that for the first half of 2012, Financial Pacific was on track for record originations, then, beginning in July, the rest of the year dropped off. He characterizes the market as being static to down, while politicians are playing “games of thrones” at the expense of the general economy. “Small businesses, especially micro-businesses, are continuing to be cautious and practice austerity. That’s what is preventing any meaningful rate of recovery and growth,” Menzel explains. Almost all of the company’s business comes through third-party originators.
The Equipment Leasing and Finance Association’s Monthly Leasing and Finance Index (MLFI-25) showed overall new business volume for January was up 16% year over year. Although the MLFI-25 is not a proxy for small-ticket, independent lessors and their market dynamics, Menzel’s concern regarding economic stability and fiscal wrangling among our elected officials is reflected in a statement by ELFA president and CEO William G. Sutton, who said in the MLFI-25 news release, “The year begins where 2012 left off — on a positive note — as new business volume continues to trend in a positive direction… This good news belies an overhang of continued uncertainty that lingers in the marketplace, as policy makers in Washington continue to struggle with fiscal matters, which only serves as a damper to economic growth.”
At larger-ticket Nations Equipment Finance, Carlson says the company recently has experienced significant activity. In fact, the company announced that it completed 12 transactions totaling $35 million in December 2012 involving construction equipment, tractors and trailers, machine tools, school buses, motor coaches, cranes and motion picture equipment. The growth is due in part to team of direct salespeople hired throughout 2012, the company’s second full year in business, Carlson says. Nations now has seven direct salespeople and three people who deal with the broker community.
“The level of activity in the last year from the broker community has been much less than it was in 2011. It seems like they have fewer transactions than they used to, and that’s being offset somewhat by our direct origination force. There are just fewer deals on the market for brokers until recently,” Carlson notes.
As 2013 unfolds, these industry leaders weigh the potential for continued growth against the general state of the economy. Fisher explains, “There is no crystal ball, but our thought process is fairly simple: as the economy creeps forward our activity will slowly increase. We do not anticipate large growth in new equipment demand, but there will continue to be a steady need for replacement equipment for small businesses. We do expect that new equipment requests will begin to increase toward the end of 2013 and into 2014 due to aging equipment and a much needed upgrade cycle resulting from a few years of cautious optimism.”
Menzel, speaking from the perspective of the small- to micro-ticket businesses, says that segment of the market is not recovering as quickly. At the same time, he adds, there is a tremendous amount of liquidity that needs to be deployed. “What you have is a pie that’s not growing at any appreciable rate, but you have an in increasing number of lending firms trying to put capital to work. It’s classic supply and demand — there is a lot of money supply chasing static demand,” he explains.
At Nations, however, Carlson adds that based on his company’s success in January and February, he expects a much higher level of activity for the remainder of 2013. “Oil and gas and construction are active right now for us,” he notes.
Funding and Credit Quality
These independent finance companies did not experience difficulty in obtaining funding in 2012, especially compared to a year ago. Carlson explains, “We haven’t had a problem accessing funding, but it’s better than it was a year ago because the securitization market for secured leases and term loans is much more active or robust than it was a year ago. For us the biggest difference in accessing funding is the ability to get to the securitization market with our assets, now that we’ve been in business two and a half years. Otherwise, our bank lines have been good for us all along.”
Fisher describes Ascentium as a very well-capitalized independent. “Our liquidity has never been stronger. The capital markets have embraced Ascentium Capital because our leadership team and history are strong and our focus is consistent with underwriting and pricing strategies that remain consistent.”
Credits that these independents see are generally better than they were a year ago. Menzel explains, “Credit quality is good. The surviving businesses have right sized their balance sheet in order to sustain their activities. We have seen a change in borrower behavior in our credit niche. Borrowers are more cautious in terms of taking on debt. They are afraid to take on excess debt, so they put it off or borrow short term. Not until lessees see their top line revenue grow significantly and consistently will we see robust economic growth. In the meantime, lessors are loosening credit in reaction to strong portfolio performance and the need for assets.
However, Carlson isn’t convinced that the quality of credits will improve in 2013. “We are of the mind that the economy is not going to get better this year, so we don’t expect credits to get better this year — if anything they might get worse. Taxes are increasing and that’s not a good thing for the economy, people are going to be spending less and there will be less demand in the market,” he says.
Fisher adds that the recovery time frame for credits has been completed, adding: “The healing process has been done for some time in our opinion; and those that did not heal or make it through the hard times are pretty much gone. We are simply dealing with a new normal and as a result we focus our resources, energies and efforts on the future and not the past.”
Keys to Broker Success
The Great Recession and subsequent crawl toward economic recovery have been hard particularly on brokers in the industry, with many survivors still facing challenges.
Although some continue to predict the demise of the TPO/broker model, Menzel begs to differ, noting that brokers who bring a consultative value to their customers are more important today than they were ten years ago because banks continue to be cautious in the micro-ticket business space.
Fisher sees banks moving away from broker-source business because the small amount of business from the broker channel and the cost of doing business are not worth the risk or resources to banks. Therefore, he advises small broker shops to identify with a funding partner and build business with them, or even merge.
Carlson’s advice to brokers is that they need to balance structure and pricing for both their customers and their funding sources. His most important tip for brokers is that they should develop and cultivate relationships with funding sources that they trust and know are going to deliver for them. He explains, “For instance, we have relationships with about 100 brokers, but really we see most of our broker deals from ten of them due to solid relationship building. They become as valued as an employee of the company.”
Menzel adds that brokers should think of themselves as more than just a “business finder.” “Be a consulting intermediary. If you approach it that way, you’ll have customers for life. That’s the lesson that we learned from the last downturn. There was so much capital, the market was expanding and people were borrowing. A lot of the TPOs got into the habit of being a business finder, and they had plenty of business. A lot of those companies are gone. The most successful TPOs now are those that are getting repeat business from their customers,” he says.
Fisher notes that brokers will not see an over-supply of transactions in today’s environment, unless they have a strong relationship with a solid vendor. He explains that it’s critical for brokers to know the vendor’s business thoroughly in order to bring added value, and at the same time know their funding source well. “Matching the right vendor, collateral, credit and structure is paramount — and not try to force square pegs into round holes.”
Focusing on fewer than three dozen brokers gives Fisher the ability to work very closely with them in developing business. He adds that brokers might be better served by partnering with a direct lender, defining their value proposition, identifying an area of expertise and knowing they have the access to capital to serve the needs of the vendor. “My opinion is that the mentality of ‘getting the deal done’ is not a successful business plan and certainly not a strategy for long-term sustainability for a broker,” he says.
Key for brokers is aligning themselves with a funding source that is committed to them for the “long haul,” Menzel explains. “I’m starting to see competitors tap into the TPO channel who, in the past, have disdained brokers. As soon as the market shifts, they will drop the TPO channel very quickly. The funding source relationship is the most valuable for the broker community. It doesn’t always equate to the lowest rate and the easiest credit player,” he advises.
Menzel suggests that brokers find a funding source that is a good risk manager and confident in its decisions in long-term portfolio growth, rather than securitize and sell. “You don’t want a boom-bust business model. Some TPOs or brokers in 2006 through 2008 are no longer here or are a shadow of their former selves because they got on the fast-moving train and didn’t think about themselves in the longer term,” he says.
Opportunities and Challenges
According to Carlson, the key challenge facing independent equipment finance leaders is whether or not the economy will maintain its strength in order to sustain activity levels. Nonetheless, Carlson sees opportunity in less traditional transactions, explaining, “We remain a source of funding for non-vanilla transactions — for companies with recently poor credit history or unusual equipment they are trying to finance. Or, for companies that are in industries that are out of favor, such as a potentially environmentally sensitive industry. We take the time to figure if there is real risk or not. We’re creative, responsible and professional, and we have a lot of capital to deploy.”
For Menzel, the overabundance of capital chasing a static market is a significant challenge. “We just had our best January in our history, yet the uncertainties remain. We’re starting to see ‘irrational exuberance’ in lending again, and it’s manifesting itself in low rates and higher-risk credit underwriting.” But in that challenge, he sees opportunity: “If we drop into another contraction, the proven risk managers will prevail and many new competitors will go away like they did in the last downturn.”
For Fisher, the biggest challenge — and opportunity — is to keep focused on what works and to be nimble enough to admit when a change needs to be made. He notes, “You have to identify your value-add and if it make sense to move forward with the vendor. Then, together identify how we’re going to get the vendor’s customers to delve into their capital. I think there is a lot of customer capital on the sidelines, but the economy isn’t conducive for them to release it yet.”
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