At the time, The Wall Street Journal reported investors were trashing companies that only had limited exposure to subprime mortgages, while The Los Angeles Times reported collateralized debt obligations were being re-evaluated. But such news and other indicators of softening economic conditions didn’t change the colors of this landscape — still described as bright — if not red hot, as investment capital pours in.

Ken Kremar, principal, Industry Practices Group, Global Insights, based in New York, spoke to investors and lessors about the chances of a recession, forecasting an only 20% likelihood. “There is nothing in the cards that suggests the bottom is falling out,” he says, noting a couple of hits to business confidence could increase demand for equipment leasing and finance.

In the asset categories he studies, he says freight cars are most volatile, and trucks are down, but should be back on track by 2008. He notes current exceptions are ethanol carrying tank cars and covered “hoppers,” which are doing well.

Investors are seeking what’s unique to asset finance: the high values of certain asset types, the niche players, the repeatable higher-than-average returns, and the wealth of talent and experience as old industry leaders assume the helm of upstarts.

For example, industry veteran Tom Wajnert, senior advisor for commercial finance of Bear Stearns Merchant Bank (BSMB), points out that organic growth — through strong originations — and corporate culture were important to his organization’s consideration and subsequent decision to invest in Alter Moneta, which has three locations in Buffalo, NY, and Ontario and Montreal, Canada. The asset finance company’s cross-border financing capabilities distinguished it from other companies, and the investment from BSMB is helping this already large independent to quickly expand its reach into the developing western parts of Canada and beyond the eastern United States.

“We are seeing investors, including hedge funds and private equity, enter the marketplace buying deals, buying companies or directly investing in companies,” says Ken Bentsen, president of the Equipment Leasing and Finance Association (ELFA). “We also see a number of equipment finance companies moving beyond traditional product offerings (e.g., equipment leases or loans) to floor plan or unsecured lending. Like commercial banks, both broker-dealers and insurance companies have tried to become financial supermarkets, cross-selling multiple products; it would appear such is occurring in our sector as well,” he adds.

Bentsen notes the industry used to measure its size by the amount of leasing transactions being processed — today the industry evaluates itself more broadly as a trillion-dollar capital market.

Pointing to GE Capital, CIT and CapitalSource, Bentsen says these companies just look at what’s needed to do the deal, and they do it.

CapitalSource, of Chevy Chase, MD, is a good example. This company reports its products range from asset-based lending to security finance and even vacation ownership. The firm was among numerous financial services companies, private equity houses and investment banks of all sizes represented at this year’s investment conference sponsored jointly by the ELFA and the Information Management Network, which had a record turnout of more than 350 attendees.

The financing path companies take varies dramatically depending on the goals and position of the company, as well as the business expectations of owners and their capacity to attract capital. Therefore, the whole continuum of financing was discussed, from equity and debt financing, to combinations of alternative finance, to funding structures that raise equity-like capital.

Spectrum of Finance
Allied Capital Advisors, of Washington, D.C., is one publicly traded private equity firm that can arrange financing across a wide spectrum of sources. Being a public company means Allied Capital can work with management teams over longer periods and access capital markets to raise more financing as needed, according to John Fruehwirth, the managing director.

“We look for niche companies with strong management that generate high levels of free cash flow,” he says. Beyond financial services, Allied also specializes in consumer products and business services seeking returns, which over time reach the high teens.

Fruehwirth says he learned what methods equipment finance executives use to raise capital at the conference, and that will help him in his pitch to such companies.

One company that intrigued him, he notes, was Southwest Credit. In 2002, this company created what is called the “cash-flow program.” Carlos Uribe, general manager of Southwest explains:

“We created two companies, one is the leasing operator that creates small-ticket leases [transportation, construction and medical] and another company for a $20 million investment conduit, funded by angel investors.”

He adds, instead of using the leasing company assets when approaching a regional bank, Southwest leverages its conduit. After receiving a bank line of credit that supports its leasing business, the company is now approaching institutional investors with the support of Carl Marks Advisory Group, LLC, Uribe explains. With senior debt, he says, he hopes to be able to grow the portfolio to $100 million in the next two years.

Other executives were impressed with the number of lessors doing securitizations, and the fact that young companies were able to leverage this as well. US Express Leasing (USXL) is on track to go to market again in 2007 after its inaugural deal in November 2006 and MeriCap plans to be doing this once its receivables (now in warehousing facilities) reach a higher volume.

“I don’t know how many issuers there have been, says Jim McGrane, president and CEO of USXL, “but we find accessing the term market an attractive way to raise capital because the execution is excellent compared to other alternatives available to us. It allows us to efficiently match funds in our portfolio with non-recourse debt. And it also provides yet another source of external validation of our business model.”

He notes how the company has had to refer to the rating industry, needing the right infrastructure with good portfolio data before institutional investors will buy it. McGrane says his company did the first deal in record time, 29 months after the company was launched, in June 2005. He explains it typically takes longer because rating agencies are rating the debt and usually a lot of history is needed in order to do that.

Philadelphia-based LEAF Financial Corporation is another young company that is doing some securitizations, but Crit DeMent, chairman and CEO, says he thinks the raters considered their successful past history in a previous company.

“We have a $350 million term deal anticipated to go out in April,” he states. The underwriter for the deal is Merrill Lynch Global Asset Based Finance & Securitizations.

What helps lessors today is that the leasing asset class is fairly well known among rating agencies, which have a good understanding of what they can expect with the underwriting, according to DeMent.

Risks Addressed
Risk was addressed in every session, especially with regard to the downturn in real estate financing and whether or not it is contagious. Richard Shane, an analyst at Jefferies & Co., notes the risk is limited now, and during what he calls “this dislocation” period more companies may be attracted to asset finance.

“There is no brush fire here, the bigger uncertainty is on the liquidity side,” he says. Right now, he is advising companies to be less dependent on outside capital.

At the conference McGrane talked about the focus needed when doing securitization, and Financial Guaranty Insurance’s Kenneth Degen, managing director, agrees, saying he likes assets with long, useful lives, such as containers and aircraft. Degen also notes it is important to have an exit strategy. AIG’s Debbi Adami, a senior portfolio manager, says her organization is interested in very particular asset characteristics and looks for a static pool analysis when considering securitized pools.

One way to mitigate risk in mergers and acquisitions is to ensure that the due diligence process is thorough. This subject was covered by a panel moderated by Mike Fleming, the former president of the Equipment Leasing Association and now a consultant with The Alta Group. Joe Nachbin, also with Alta as a principal, was on the panel and explains this due diligence service is in demand because there is increased merger activity, or the buyers may lack experienced resources to devote to the project. Buyers with availability of experienced resources engage Alta to provide an independent evaluation, in effect, a “sanity check.”

Nachbin says Alta recommends going beyond usual metrics and policies to examine the very cultures of buyers and sellers. “We need to identify any trust issues and evaluate the compensation plans to see if they will elicit desired behavior.”

“Normally,” he adds, “people start by looking at the current portfolio performance, but we look at where problems have been, going back through three years of charge-offs.”

He notes companies often will look at charge-off history and delinquencies one at a time and fail to review for trends and against industry benchmarks. He also adds credit skills need to be examined and determined for every type of business. “We’ve seen too many cases where they think a credit guy is a credit guy is a credit guy.”

From the legal perspective, Melanie Gnazzo, a partner at Chapman and Cutler, LLP, wants to look at end-of-lease term provisions, how they determine fair market value and the arrangement terms, as well as back end mechanics for payments. She says platforms should provide litigation history, permits, licensing and tax records.

It was noted that underwriters are examining customer profiles and policies and finding them turned around at times. Underwriters find automatic declines are preventing a waste of time but they may also be preventing business. Fruewirth of Allied Capital says he has seen numerous small ticket transactions that are turned down that could have been approved. “It’s important to look at credit policies against what is being approved and try to eliminate the bad decisions and the false positives,” he says.

New Entrants
David D’Antonio, founder and managing director of Diversity Capital, based in Cinnaminson, NJ, who wrote an article on common forms of debt leverage in the March edition of the Monitor, says he was impressed to see large banks backing very young companies, such as Boston-based NewStar Financial, as well as the entrance of Babcock and Brown, which previously targeted advisory services.

NewStar, a specialized commercial finance company focused on complex financing in the middle market, corporate, commercial real estate and structured products group, arranges transactions of up to $100 million for syndication to other lenders. According to SEC filings in 2006, out of $1.4 billion in originations, $158 million was syndicated. The company, formed in 2004, raised $235 million and completed its IPO in December 2006.

Tom Calhoun, managing director of its Structured Products Division, said the company is not a hedge fund but does some of the same types of assets. “We look at assets like we did in the conduit world, with loan levels of $10 million to $40 million,” he says. “Leasing is a space we like a lot because it is capital intensive.”

“There is a dearth of investors,” D’Antonio explains, observing that investors are in the position of pitching to leasing companies, rather than the other way around as it was five years ago. Smaller companies still need to prove themselves, however. “These companies need to show performance, the ability to leverage properly, maturity in management, and potential to provide liquidity to equity and subordinated debt investors. Liquidity is very strong on the senior debt side, limited recourse facilities and commercial paper facilities.”

He adds the company has clients that are very leveraged and have reduced term spreads to almost half of what they were paying two to three years ago. “The faucet is running wild!” he says. “It is at a point now that lenders are bidding against each other for higher risk assets, with looser structures and questionable reporting and credit underwriting.”

He admits he is amazed to hear of smaller companies receiving large subordinated investments and large commercial paper facilities. “The cycle appears to be near the peak and many of us have experienced this before.”

New investors include Ian Berg, who recently founded ETF Venture Funds, which is already on its second round of a second fund. He is known in the industry for successfully building Copelco Financial Services and selling the leasing company to Citicorp in 2000.

Another new company introduced at the investor conference was Gulf Pointe Capital LLC, which is taking a non-traditional approach in the market. Joe Wold, its president and COO, based in Naples, FL, says the company is raising money not only to fund lease transactions, but also to fund the growth of early-stage companies.

“We come in behind the venture capital firms and before the banks,” Wold explains. He went to private investors, formed a limited partnership for $25 million to $50 million in funds, which are for short-term 36-month lease transactions, and followed by a layer of equity play in the portfolio companies. He says Gulf Pointe performs a very thorough analysis to determine the credit worthiness of these early stage companies.

He says it is a unique model that depends on having a savvy cross-selling strategy. Gulf Pointe Capital is 100% owned by Aspen Opportunity Fund formed in 2006. Wold, who previously held senior positions with AIG and Capital Associates International, says he’s been “flush with opportunities” in three areas: technology, telecommunications and medical equipment — assets with intellectual property. He has also seen a couple of energy transactions. His company plans to explore the alternative energy market. The portfolio size of this market is 25-30 companies and he wants to manage the growth.

Learning From the Pros
Many of the attendees at this conference are seasoned veterans and that is one of the attractions — the wealth of experience. Babcock and Brown’s Steve Hirsch, who is the firm’s managing director, has 30 years of experience in asset-based structured finance. “There’s always a good run in a good economy, but we take comfort in a business involving people who know how to weather a downturn,” he says. Hirsch is with the company’s Structured and Specialty Finance Division, and looks for niche companies that are leasing and lending while exhibiting a competitive advantage.

DeMent, of LEAF, is another seasoned executive who is weathering current fluctuations in the marketplace with confidence and optimism. He notes the company is raising private equity not from large ventures, but from individual investors one at a time in average amounts of $60,000 each. LEAF does this through public limited partnerships and last year he explains, the company raised $50 million that way. The benefit to LEAF is that it is not controlled by one source. The advantage to the investors is realized in predictable and consistent income distributed monthly, rather than an equity position in his company. He adds the product is received well and he projects significant growth this year over last year.

Surviving in the Industry
One panel was charged with describing the winners and losers, but in such a fragmented industry, that is not easy. Robert Rinek, of Piper Jaffray, notes the better question to ask is, “Who will be the survivors?” Beyond good management and good returns, winning companies have strong credit cultures, robust systems and an ability to identify new origination opportunities. Those are the investor attractions.

Susan Carol is a niche communicator in equipment leasing and finance, technology and healthcare, who has provided freelance reporting for the Monitor since 1989. She can be reached via e-mail at [email protected].