Economic Growth: Is it Truth or Mirage?

by Lisa A. Miller July/August 2011
In a Monitor interview, Steve Battreall, GE Capital’s chief commercial officer, offers his candid view on a variety of issues facing the equipment finance industry. Here Battreall speaks to topics ranging from the much-discussed accounting changes to suffering equipment sectors. While much has been said that’s gloomy in nature, Battreall sees things a tad bit differently.

Steve Battreall Chief Commercial Officer, GE Capital Corporate Finance

Economic indicators point toward steady recovery, and most equipment finance providers are charting numbers that support the upward growth trend. The first half of 2011 supports the optimistic outlook, though clouds loom on the horizon as we keep an eye on economic and political unrest around the world. Closer to home, anticipated FASB and IASB changes to balance sheet accounting could throw an additional wild card into the mix.

Steve Battreall, chief commercial officer at GE Capital, Corporate Finance offers his perspective, informed by 23 years at General Electric and 17 years in the financial services industry. “When we went into 2010, half the people predicted a double dip while the other half expected a slow steady increase,” recalls Battreall. “Things really started to improve in the third quarter of last year and have continued to climb. Most amazing to me is just how fast our industry is coming back in terms of liquidity and competition.”

Cautious Optimism
Among his prospects and customers, Battreall perceives a predominant theme of cautious optimism. “People seem to expect slow, steady economic recovery but also feel we’re not out of the woods yet. There are potential events, such as those in the Middle East and Greece, which could push the economy back towards a recession. Our own government gridlock over the budget deficit and debt ceiling has the potential to change the economic course, too. Currently there are mixed but positive indicators in the U.S. economy: Industrial production is up, manufacturing capacity is holding steady, and the mergers and acquisitions market has picked up considerably and is expected to increase dramatically. These factors are driving people’s optimism.”

Battreall cites the uncertainty of world events as a factor that may have slowed the pace of economic growth but feels that most people expect continuous improvement. “Businesses are forecasting CAPEX investment at a more rapid pace in the third and fourth quarters, and I think the improved liquidity is driving a lot of the optimism around M&A. The high-yield market has also been very active.”

The team at GE Capital, Corporate Finance has identified trends that point to market stabilization and growth potential, but they are not ready to forecast clear skies just yet. “On a broad scale, the loan market is still a little unsteady,” admits Battreall. “There are many variables emanating from the uncertainties of the economy. We do see that arrangers are more aggressive due to the returned liquidity. Banks in particular are very aggressive on price and structure, especially as it relates to relationship-driven deals. In some cases, we see them using the revolver as a loss leader to gain and protect all the non-credit business they have, and that is often difficult for us to compete against. I expect these trends to continue into the second half and think we’ll see more liquidity, not less. Unless loan demand picks up significantly, there is still going to be a lot of liquidity chasing fewer deals.”

With business chugging slowly forward, Battreall feels the economy will weather any setbacks. “If Greece defaults and that reverberates into Portugal and Spain, banks holding some of the debt will have to reschedule and write it off,” he predicts. “The decrease in capital could impact liquidity, but barring something of that magnitude, I think the worst is behind us.” With conflicting economic data on housing starts, industrial capacity and unemployment, Battreall suspects growth may be uneven. “The numbers are making it a bit unclear as to the direction the economy is taking,” he says, “but I feel comfortable that we’ll manage through it.”

Accounting Changes Ahead
General Electric has been actively involved in the discussion about formulating the final exposure drafts on future accounting standards and is waiting along with everyone else for FASB and IASB to finalize the provisions. “There’s still a lot of uncertainty,” says Battreall. “We know that most equipment leases will come back on balance sheet — I think everyone realizes that — but that won’t have a big effect on how analysts or investors view a company. They are well aware of the off-balance sheet obligations a company has today and factor that into their valuation analysis. The asset values and cash flows will remain the same, so the debt capacity should not change as it relates to covenant levels — they’ll just have to be adjusted accordingly. A company’s profile doesn’t change just because the liabilities come back on with the associated right-to-use assets.”

Based on the earlier exposure draft, Battreall does not believe the changes will force lessors to behave much differently. “Companies will need to change their systems and processes, because it will be more complex to account for leases in the future,” he cautions. People have questions, and there are not many answers. GE Capital tries to stay ahead of the topic by educating its customers. “We hold webinars to share the most recent public information and let companies get the answers from our senior level managers who are on the front lines of the proposed changes,” continues Battreall. “We work to position ourselves not as people who have the answers but as people who are aware of what is going on.”

GE Capital helps companies understand the main drivers behind leasing: 100% financing, cash-flow benefits and the ability to manage assets. “People want to preserve capital, whether it is for working capital, M&A or different revenue-generating assets, and those benefits are not going to change,” affirms Battreall. “It’s a foregone conclusion that assets are coming back on balance sheet. But if that’s your sole reason to lease, then you probably ought to re-evaluate anyway.”

Growth for Suffering Sectors
The equipment-intensive industries of transportation, construction and manufacturing are still struggling. “The residual position taken by lessors that drives down monthly rents is especially useful in these industries, because it helps cash flow,” explains Battreall. “One hundred percent financing preserves cash that can be redeployed in higher returning asset classes or acquisitions. The flexibility at the end of term is a plus, too, because customers can extend the term or return the equipment. Lessees can rely on the marketing capability of a large lessor with an extensive remarketing team who can probably get more value and pass that value back through a higher residual. As a company’s business changes, its need for assets can change, so shifting the risk of obsolescence to the lessor can be a smart move.”

Battreall’s outlook for these industries is mixed for the second half of the year. “Intermodal traffic is up almost 10% year-over-year, which should result in increased capacity utilization which will be positive for transportation companies as it relates to freight rates,” he says. “One of the dynamics that happened in this industry occurred when companies, due to the weakened economy, pushed out the replacement of their fleets. Changes in emission standards and new truck technologies have driven up the cost of transportation assets dramatically. Companies tried to avoid that initial investment, but trucks do eventually have to be replaced. As they get older and gain mileage, they cost much more to maintain. Now the replacement cycle is beginning.”

Manufacturing output is getting better, too. “Outside April, manufacturing has been increasing for about the past ten months,” he states. “Capacity utilization is at about 76%, so inventories are no longer being drawn down instead of built up. Industrial production is up, but there is a long way to go before hiring resumes. A lot of companies in this space are placing their emphasis on productivity and technological investment. So while productivity rises, it has not resulted in more jobs.”

Construction is coming back, too. “Most people will tell you that non-residential construction is finally bottoming out, and the improving economy will likely have a positive effect on the late cycle construction activity. Just as we worked through the commercial real estate glut, values are beginning to appreciate, and you actually hear people talking about building commercial real estate again.”

More Signs of Hope
GE Capital’s lending business has been particularly strong, and year-over-year volume is up. “Our asset-based lending market has been impacted somewhat by the strong cash and high-yield markets,” reports Battreall. “Competition has picked up in the asset-based space, to a large degree, because of the way it performs. During the downturn, ABL losses were significantly lower than what we saw on the cash-flow side. As a result of the additional liquidity, we continue to see a compression of spreads. Structures are beginning to loosen up and become more borrower-friendly.”

Battreall identifies a new trend in the marketplace: The acceptance of bifurcated term loans. These loans separate the ABL facility secured by a company’s working capital assets from the term loan secured by the fixed assets and stock of the company. “They are generally viewed to have more risk than the revolver, because they are secured with less liquid, fixed assets,” Battreall says. “We saw very few of these deals last year — they just weren’t accepted in the market — and now we are seeing a lot more of them.”

Overall, Battreall says he has been surprised by the resiliency of the equipment finance industry and what has grown out of the financial crisis. “Liquidity has returned quickly, and competition has ramped up. Equipment loans, cash-flow loans, ABL loans and spreads have returned to almost pre-crisis levels. There weren’t a lot of financing companies out there for the last couple of years, but they are returning to the market,” he concludes. “I thought this would happen over time, but I never thought it would happen this quickly.”


Lisa A. Miller is a freelance writer who has worked in the equipment financing industry for 15 years.

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