Discipline, Strategy and Customer Relationships: Balancing Risk & Reward in a Competitive Environment
by Lisa A. Miller September/October 2015
Lisa A. Miller catches up with four industry leaders who discuss the current economic environment, industry sentiment and pending regulations. They say discipline, strategy and customer relationships are essential to maintaining a profitable balance between risk and reward in a market where competition threatens to disrupt that balance.
As autumn arrives, we turn our heads from thoughts of summer vacations and backyard barbecues to year-end goals and the new season. Just as students head back to the classroom and the seriousness of learning, business leaders and lenders sharpen their focus on volume expectations and strategies for the coming year. As part of its own fall ritual, Monitor sits down with industry executives to find out what’s on their minds.
Industry confidence holds steady, even as regulatory oversight looms large and pricing remains tight. Maintaining a profitable balance between risk and reward is critical to long term success, yet competition is driving that balance to difficult levels. “For the sake of growth, many in our industry have too quickly forgotten the pain of past over-aggression,” says Bill Fite, president of Regions Equipment Finance. “I see the bank-owned space heating up again, being driven by overbalance of lender demand against tepid supply of new capex opportunities. As typical in this stage of the cycle, pricing and deal structures begin to erode, and credit discipline weakens.”
“I believe companies are maintaining their risk profiles as they relate to the types of transactions and structures they will do,” states Rich Doherty, president of PNC Equipment Finance. “Price compression continues to increase, so for the same credit you did a year ago, the reward is less. That balance seems to be moving the wrong way.”
“People feel as if they are balancing risk and reward, because the cycle is so good,” adds Adam Warner, president of Key Equipment Finance. “Through market intelligence we see competitors doing things we wouldn’t normally do, and we think they are doing it to win. My concern is that lenders who relax their rules around credit and structuring to win transactions may get hurt in the next downturn.”
“We are now seeing things pop up in industries such as coal, oil and gas where they have their own set of challenges,” adds Bill Mayer, EVP/group head of Wells Fargo Equipment Finance. “We focus on providing terrific service and helping our customers succeed. We do not chase yield out on the risk curve; we remain disciplined from a risk perspective.”
To avoid going out on that risky limb, our participants cite the virtues of discipline, strategy and the power of customer relationships. “A year ago I was more worried about people stretching too far to get a deal,” admits Doherty. “Now I see them stretch for price but not necessarily for credit. Depending on what motivates them, I have seen lenders make offers where it is hard to see how it can be accretive to their organization’s profitability at the end of the day.”
Fite warns that you can’t be all things to all people. “At Regions, we are definitely not a growth-for-sake-of-growth business. We work hard with our bank partners to identify those businesses for which we can provide a differentiating solution that leads to long term, mutually beneficial client relationships. The concept of shared value is core to our mission statement where safety and soundness permeate our approach to the market, regardless of business cycle. It’s there that we build a basis to acquire, nurture and retain clients.”
“Risk and reward are part of the profit equation, but there are other ways to make profits,” Mayer says. “One of those ways is to manage expenses. I think of our business as a factory with a lot of things going through it. If we can improve the process and use technology, it will help us from the perspective of expenses and the bottom line. We are leveraging our overseas team members to help increase efficiencies there as well.”
Confidence among equipment finance executives looks solid on paper. The ELFF Monthly Confidence Index held steady for June and July with scores of 63 and 62.6, just slightly higher than 61.4 for both June and July 2014. August 2015 demonstrated new hope with a 67.5 rating.
“The equipment leasing industry is the most optimistic industry I’ve ever seen, especially when you compare it with other financial services industries,” says Warner. “That may be due to the entrepreneurial spirit that underlies our industry. I’ve watched the index over the years, and our industry confidence is usually pretty high. Even if the growth indicators are a little stagnant, you typically don’t see that reflected on the surface.”
“I tend to be optimistic in general, and I am relatively bullish right now,” Mayer says. “Wells Fargo Chief Economist John Silvia recently spoke positively about the amount of construction going on in commercial real estate, manufacturing facilities and hotels. That dovetails with what we see going on here at Wells Fargo Equipment Finance. Our construction business is up double digits this year. Once the construction is done, the next logical step is the need for equipment, whether that is office automation, forklifts, assembly lines or something else. The general pick-up in the construction phase is very positive in the short and long term.”
“I don’t see any robust growth, but I don’t see any drop-off either,” Doherty says. “We feel good about where we are for the type of business we are winning. We are right on plan or a little bit ahead. It’s just the competition that makes it more challenging. It is more intense, so we may not win as high a percentage of deals as we did in the past. The deals are won on price more than on terms, so you make a decision about whether you want to do a transaction at that price or not.”
“I also look at what is going on in the small business sector,” Mayer says. “Recently, the National Federation of Independent Business reported that the share of small business owners who made a capital expenditure in the last six months through July had risen to its highest level in 2015 and was at the highest level since the recession. One of the great things about that is that those capital expenditures — something like 42% of them — were for equipment.”
Fite’s view is less positive: “Though we reached a post-recession high in the MLFI-25 earlier this year, present mood in the market is cautious at best with respect to capital investment and hiring. With recent global market turbulence and the litany of weak macro overhang, businesses will absolutely have less than aggressive plans for new capex and hiring growth in months ahead until meaningful settlement occurs.”
Benchmarks & Projections
As lenders work to find, retain and expand business, they gain a unique perspective on real-time market activity. Though no one has the advantage of a crystal ball, there are certain signs that guide lenders. “Feedback from our sales force is my benchmark,” Doherty says. “They are the ones who talk to the clients and the manufacturers, so they are the closest to the pulse of the market. They feel good about the activity and the opportunities in front of us, so we expect the rest of the year to be fine.”
“More than anything, I watch measures that have to do with buying goods, such as the Purchasing Managers Index and durable goods orders,” Warner says. “If goods are not being purchased, there is not much to finance. If I had to pick a key factor, I would focus on what finished goods are bought and sold in the market, because there might be some finance or lease opportunities around them. Those indicators aren’t very strong right now, so to me, that means moderate growth for the rest of the year.”
“I don’t see a unique and single benchmark that would materially guide equipment finance demand in our markets for the balance of this year,” Fite says. “If pressed to identify one thing that would move sentiment, I’d suggest that a bi-partisan reform of our tax code would instill confidence and cause cash sitting on the sidelines to be put to work.”
“I look at a number of indicators, but my best indicator is probably what I see within our Wells Fargo entities,” Mayer says. “By looking into Wells Fargo Bank and working with the Business Banking group, the Commercial Bank, ABL group and the U.S. Corporate Bank, we get a nice cross-section of the entire business community. Through those various segments, I look to see whether companies are sitting on cash, investing cash or investing in their plant, property and equipment. People seem to be investing across all three of those spectrums, so it is nice to see how companies are using their credit facilities to make some kind of investment.”
The Monitor 100 companies projected a 3.3% volume growth rate for 2015, translating to a $7.3 billion increase over 2014 volume. We asked our panel their opinion of that forecast. “That projection sounds about right to me,” Doherty says. “I think the results have shown that those numbers are panning out year to date, and my peers in the industry are saying the same thing. No one is blowing the roof off, and most people are feeling about the same level of activity. You may find a smaller company with a lower denominator, so its business is going up in the percentage of booked deals; but when you factor it into the universal number for the industry, it’s really about the same.”
Warner and Mayer suspect the 3.3% projection is low. “Some sectors are doing very well right now: trucking and transportation, construction and certain areas of healthcare,” says Warner. “I wouldn’t be surprised if overall growth for the industry is closer to 5%, but I can’t speak to that with authority. I leave that to the forecasting experts.”
Mayer based his opinion on what he sees internally at Wells Fargo. “We are seeing some true growth as opposed to stealing market share from our competitors. It feels as if the economy is starting to strengthen a little bit, and I see that coming through all the business sides.”
“Despite struggling manufacturing, energy sectors and other obstructive macro undercurrents, we’re still enjoying 2% or so GDP growth,” says Fite. “From where I sit, an improving economy should provide continued lift to the U.S. economy over the balance of 2015. That said, that projection feels high.”
Life at a Bank
There is often a different perspective when your equipment finance company is housed within a bank. How do the challenges compare to the benefits? “Right now our greatest challenge of being embedded in a bank is around the changing regulatory and compliance requirements and everything we need to do for that,” Mayer says.
Doherty agrees: “Since 2008-2009, we spend a lot more time working through the requirements. It hasn’t stopped us or hurt us as an institution. We operate in a regulated industry, and we make the best of it.”
“The only real disadvantage is the cost associated with regulatory compliance,” explains Warner. “It’s challenging to manage your overall cost infrastructure and manage your regulatory requirements — especially when they change pretty often — in an environment of compressed margins. We also have to keep in mind that we are not the only regulated industry. We have to consider the cost of regulatory compliance in any industry or market we enter. If you finance railcars or commercial airliners, you have to consider regulations coming from the DOT or FAA. You have to think of that not only from an infrastructure perspective but also from a cost perspective.”
One of Fite’s greatest challenges is earning the right to be considered a core contributor to his commercial bank’s client strategies. “It’s not enough to be yet another hand stuck in the door by another product partner wanting to be taken to a client. To me it’s about bringing your ideas with your resources and your action to drive results for your bank. It’s about aligning your equipment finance organization’s goals with your bank partners’ goals as if they were your own.”
Everyone agrees that one of the biggest advantages of being a bank is the ability to work with other areas of their franchise to leverage cross-sell initiatives. “Our platform is our biggest benefit,” Mayer says. “We have great geographic coverage, varied customer sizes and, most importantly, we have a history of cross-sell and trying to help our customers succeed.”
“PNC goes to the market as one,” Doherty adds. “We look at the opportunity and the customer to determine what needs he might have from a financial institution such as ours. We then look collectively at how PNC can solve the riddle and provide the solution. If the customer chooses one of our equipment finance products, that’s great; but if he chooses one of my colleague’s products, that is just as good.”
“We developed specific initiatives using the equipment finance product as ‘tip of spear’ to help our banking teams acquire new clients and deepen existing client relationships into more holistic client relationships for our bank,” Fite explains. “Time and again, it’s been the technical skill sets of our people that have made the difference in helping our bank win a new relationship. It doesn’t take long for good news to travel among bankers, and then a sea change begins to occur.”
“Another advantage is the cost of capital,” Warner adds. “Raising capital as part of a large bank, either through deposits or debt issuance, is still cheaper than borrowing in the open market. Marketing and brand recognition are very important, too, and surveys tell us that the reputation of banks has recovered since the recession.”
Over the years, bank-owned equipment finance companies have labored to demonstrate their worth and persuade the banking community to use them as a tool for bringing in new customers and expanding relationships. Has the new day dawned?
“When we provide financing to a client with a leasing product, that company usually becomes a broader bank client,” affirms Warner. “We have data to back that up, and we share that data with our bank partners to remind them that leasing is a really good way to start a relationship. In some areas, it’s very natural to cross-sell products with the bank, but in others it is not a seamless fit. But that doesn’t mean we don’t try.”
“We encourage each of our sales people to work with our banking partners,” reports Doherty. “We evaluate them on the new relationships and opportunities they bring to the bank. That’s part of the value we bring. When we talk to a customer about a lease, we bring along a banker and introduce him. Over time we hope that customer will do business with PNC on multiple levels.”
When Fite joined Regions Equipment Finance (REFCO) six years ago, its equipment finance organization was designed primarily to generate tax benefits for the bank. With the goal of becoming a contributor to commercial client strategies across the bank franchise, REFCO sought to realign with its bank partners. “Our goal was to become an ‘indispensable partner’ to our commercial bank brethren. I tell the organization that being indispensable means, on January 1 of the new year, when that young banker in Jackson, Mississippi, looks out across the market and asks the question, ‘How am I going to bring XYZ Company into the bank?’ he immediately thinks, ‘I don’t want to fight that battle without REFCO at my side.’”
“Our sales members always sit down with the bankers and talk to them about their customers, their portfolios and opportunities where Wells Fargo Equipment Finance can add value,” says Mayer. “My predecessor, John McQueen, did an excellent job over the years of building industry and equipment expertise, so when our team members go out to speak with a specific customer, they can talk the talk and walk the walk in any industry.”
When we asked our participants to rate the magnitude of the regulatory challenge within their bank environment on a scale of one to ten, most gave it a score between six and seven. “It takes up more of my time each day, but not in a bad way,” Doherty says. “It’s just that there are more questions and more benchmarks.”
“We compete against captives and non-regulated entities that don’t have to worry about the same requirements, and they can sometimes act faster,” Mayer adds. “We are processing hundreds of thousands of transactions every year, and our challenge is to nail the various requirements and maintain our high level of service and turnaround time for our customers.”
Warner agrees with Doherty and Mayer’s assessment but adds that regulations on the types of equipment they finance fall between four and five. “A lot of the compliance around equipment we finance, such as tank cars, changes based on accidents that have taken place. Most of the onus is put on the lessee, but if the lessee doesn’t comply, the owner of those cars might be the bank.”
“It is certainly a cost of doing business, and it definitely impacts the bottom line,” Mayer says. “The one department where we’ve added the most team members is in our compliance department, and obviously that comes with a cost.”
“The compliance and regulatory side of our business is simply a part of our new world,” Fite says. “It’s with us all and permeates every aspect of how we go about our businesses today.”
The New Year
“The biggest challenge for 2016 is a stagnant economy and companies that choose to conserve capital,” Warner says. “That environment could hamper our equipment acquisitions. I worry more about an unknown market disruption that could trigger some sort of credit event. Could it be something around leveraged lending or less regulated alternative lenders? Who would have thought China was going to devalue its currency? Something will trigger a downturn — we just don’t know what it will be or when it will happen.”
“I hope we start to see some stabilization in pricing compression and rates,” Mayer says. “July was one of the first months where our margins firmed up a little. Even a slight interest hike, in the 25 to 50 basis point range, will help us. From what I see in the construction space, it feels as if the economy is starting to show some good signs of growth. With a slightly improved economy, a small rate hike and a handle on our compliance and regulatory issues, I expect 2016 to be another good year.”
Doherty thinks activity will exceed what it was in 2015. “The challenge will be to determine what deals we really want to do. We have maintained our credit profile, and it will be a question of price and yield to determine where we want to compete. We can do as much business as we want; it’s a matter of how aggressive we want to be on price. That will depend on different factors such as whether it’s a new client, an existing client, a client we want to protect or a client we want to expand our relationship with.”
“The greatest challenge I see for our industry segment going into 2016 will be managing to market vagaries related to unfavorable supply of finance opportunities against competitive demand for them,” Fite says.
“We will continue to battle through the compliance and regulatory issues,” Mayer says. “We need to make it as invisible as possible to the customer. If we have increased burdens, we need to find ways to do it through technology or other means. We can’t let it impact our relationship or how we service that customer. That’s at the top of my list.”
It’s hard to look ahead to the new year without commenting on the impact of GE’s decision to sell off parts of its financing business. Warner predicts the change will create a lot of new competition. “As large as it was, GE was centralized with all its expertise in one place. As those pieces and parts get broken up and doled around to other financial services companies, those companies will create new competition in their particular markets. The industry expertise is not going away; it will just be a different playing field.”
Fite agrees that the landscape is changing and that it’s hard to imagine the industry without GE Capital: “The GE organization has been a source of creativity and talent generation that has fueled our industry in a positive and powerful way. They set industry standards that framed how many of us went to market and conducted our business. GE provided thought leadership for our industry and was a magnificent training ground for so many — a number of which are my employees — and for that I’m truly grateful.”
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