ELFA/IMN Investor Conference: High Investor Demand Breeds Competition, Consolidation and Innovation

by Rita E. Garwood May/June 2015
Spirits and confidence in the equipment finance sector were high at the 14th Annual Investor Conference where panelists concurred that equipment—no longer an “esoteric” asset class—has reached a new level of familiarity and desirability with investors. While high investor demand is creating a competitive landscape and fueling innovation, many investors cautioned that competition could lead to loosening of standards.

Competition was the reoccurring theme of the 14th Annual Equipment Leasing and Finance Association/Information Management Network (ELFA/IMN) Investor Conference, which was attended by more than 300 industry professionals on March 12, 2015 in New York City. With a flood of new players entering the space, another large focus of the conference was the emergence of alternative lending, high demand for equipment ABS and lending to startups.

“I see 2015 as being a really phenomenal year for independent finance companies,” said Andrea Petro, Wells Fargo executive vice president. “I see equipment finance as probably having the most favorable trends of almost any sector that we finance currently.”

Petro cited two main reasons for her positive outlook. First, since banks are having a more difficult time delivering capital to small- and medium-sized businesses due to regulatory constraints and cost of compliance, this role is now being assumed by independent leasing companies. Second, small businesses—a market segment that was hit disproportionately hard by the Great Recession—have finally recovered and small business confidence has reached an all-time high since the recession.

Ralph Petta, COO of the ELFA, presented another encouraging trend during an overview of the equipment finance sector, in which he examined the cycle of the asset class since 2008. “We have reached a recovery point and have hit our bottom in terms of charge off and delinquency,” he said, referencing recent stability and slight peaking in receivables.

From a ratings perspective, Du V. Trieu, senior director of Fitch Ratings also presented a positive outlook for the industry. “Going forward, the equipment leasing space is relatively strong,” he said. “There’s potential for growth there. From an assets perspective we have a stable outlook.” However, Trieu reminded attendees that any setbacks within the economy or any significant increases in interest rates may impact ABS performance.

Competition Brings Looser Standards

Trieu also discussed the increasing amount of competition within the industry, referencing the resurgence of small leasing companies tapping the ABS market. While this trend is promising overall for the sector, he cautioned that increased competition could create a loosening of underwriting standards, which could result in weaker asset performance.

BMO Capital Markets director Jeff Merchant also mentioned concerns regarding the growing market. “Some structures can be construed as more liberalized,” he said, adding that rating agencies continue to be diligent in structuring and rating these transactions to ensure the structures adequately mitigate deterioration and underlying credit performance of the assets.

“Banks are becoming less conservative in their underwriting of debt for equipment loan and lease companies, but are obviously still making prudent decisions on the heels of the financial crisis,” Merchant continued. “But there is definitely a loosening of underwriting terms.”

Chuck Weilamann, DBRS senior vice president, concurred. “We’ve seen a loosening of standards,” he said. “It’s something we’re trying to be vigilant about.” Weilamann noted that this trend, coupled with demand from the term side and additional growth in originations that some parts of the industry are experiencing have led him to wonder if the industry is at a very important precipice for ensuring that the view on risk is consistent with the actual risk in the transactions.

Regulatory Updates

Bob Rinaldi, CEO of Commercial Industrial Finance briefly discussed the non-economic, external factors that could be a cause for concern within the industry, including tax reform, impending changes to lease accounting and regulation. He stressed the important role the ELFA plays in monitoring and reporting on these issues.

Providing an overview of regulatory developments, Tom Howard, partner with Chapman and Cutler, explored the three major initiatives of Basel III: risk-based capital requirements, leverage ratio requirements and liquidity ratio requirements. Howard also addressed small differences in adoption of Basel III in the U.S. and Europe, noting the foreign banks may have an advantage when dealing with highly-rated products since ratings are not taken into account in the U.S. Howard believes that, over time, the differences will become increasingly normalized.

Positive Outlook for Capital Markets

In a panel on capital markets and funding, Merchant said the ABS market is off to a fast start this year. For equipment specifically in 2015, ABS issuance volumes are projected to be between $13 billion to $14 billion. He explained that more issuers are accessing the market more frequently and many new issuers have entered the space over the past few years. In fact, nine new players have come to the market since 2012 (see chart) and new names are expected to join the list this year, particularly in the large ticket space as newly established platforms have begun to season and are looking to diversify their funding sources. This increase in supply is anticipated to be met with an increase in demand from the investor community. “Familiarity with the asset class has definitely bred some additional comfort which as translated into additional demand,” he added.

“We’ve seen demand outpacing supply and a search for yield,” Weilamann added, noting that the equipment sector was no longer an “esoteric” asset. “The investor base is growing and they’re very hungry for these assets.” Demonstrating this demand, Weilamann discussed several key investments made in the sector recently, and the important takeaways from each acquisition (see related chart).

Many presenters concurred that the equipment asset class has gained in popularity with investors in recent years. Weilamann cited that the increasing role of private equity in financing equipment has helped to firm up the sector as viable and essential to the U.S. economy, which has reengaged banks and gained access to capital markets. He explained that private equity has been attracted to the sector due to stable returns and relative value proposition.

“The intermediate term of the bonds fills a gap and a need,” Petro added, speaking of investor appetite for ABS bonds. “It appears that there’s certainly a volume of longer term assets that are securitized … that intermediate term–the five to ten years—there isn’t a significant amount of alternatives to equipment.”

A panel moderated by Matthew Perkins, senior managing director of Guggenheim Securities, panelists Stephen Whelan, partner with Blank Rome; Evan Wilkoff, EVP of Capital Markets with Ascentium Capital; Teresa Davidson, VP, Legal and general counsel with Volvo Financial Services; Steven Day, SVP of Investor Development with GE Capital and Karandeep Bains, VP and Senior Analyst with Moody’s Investors Service discussed securitization perception versus reality, specifically addressing the viability of securitization as a funding tool for issuers, the relative value of the commercial ABS sector for investors and the major risk factors that should be considered when investing.

Alternative Financing—Here to Stay

The keynote was presented by Angela Ceresnie, co-founder and CFO of Orchard Platform, a technology company that enables loan originators to distribute their loans to a diverse set of institutional investors through marketplace lending. Ceresnie discussed the ways that marketplace lending can add significant value to businesses by adding efficiency to funding sources (see related sidebar).

In a panel devoted to alternative financing strategies, Charles B. Wendel, president of Financial Institutions Consulting explained that alternative lending opportunities abound today because banks have narrowed their credit box due to credit crunch, regulatory compliance and capital concerns. New competition has also entered the space from companies like Amazon and PayPal who have better relationships with customers. “Companies with insider knowledge of the activities of their customers are lending to these borrowers,” he said. “The bank never gets to see the deal because these companies are anticipating the need and soliciting … it’s a very powerful position to be in.”

Affirming that alternative lending is now part of the permanent landscape, Wendel discussed the rapid evolution that is occurring as lenders pivot from one lending area to another. While this makes it more difficult to chronicle what lenders are doing, he said “It is also indicative of the amount of energy and activity going on in this space.”

Wendel noted two factors that will affect the alternative space in the future. First, while the government has ignored this business so far, he indicated that it could play a “devastating role” in the future. Second, there is not enough volume to be generated cost effectively to support all the players in this space, so he anticipates that there will be fallout ahead as the playing ground changes and consolidation increases.

Rana Mitra, principal with Atalaya Capital Management discussed the six verticals of alternative financing as well as products that might appeal to those in the equipment industry, including merchant cash advance, direct loans and peer to peer financing.

Tom Carter, founder and managing partner of Fountain Partners discussed sustainability within the alternative lending space, identifying the costs of acquisition and funding delivery as numbers that will become unsustainable if they become too high. To Carter, the two characteristics of sustainability are what he calls “skin in the game and cycle,” referring to an originator’s carried interest and the importance of natural cycles. He stressed the importance of incentivizing borrowers to minimize risk instead of just “just hanging your hat on the asset itself.”

Vibrant Environment for Startups

Miles Herman, president of Leaf Commercial Capital, moderated a panel that focused on measuring the potential of startups. Bill D. Allen, president and CEO of LeaseDimensions, presented statistics from an ELFA study indicating that businesses are projected to purchase an estimated $1.5 trillion in equipment this year, which creates a vibrant environment for startup activity.

According to Allen, today’s entrepreneurs fall into three major categories: brand new startups on the margin of the traditional equipment finance space, captives or spinoffs launched by existing parent companies and old line manufacturing companies coming to the market with new products. Allen said that while each set of businesses have their own challenges and values, many are technology-based and are focused on customer experience and creating new sales channels. He added that many companies on the margin of the industry are coming to a scale that suggests that they are normalizing, so they will not be on the margin much longer.

Charles Stuard, vice president of Commercial Banking with Genpact, discussed sources of competitive advantage for startups from a strategic perspective including customer experience, market expertise and cost. He said that creating a streamlined customer experience is a main area of focus for many startups because they have the capability to make the application process easier using new integrated technology.

Matt Tallo of Capital One Commercial and Specialty Finance continued the conversation on startups, focusing on key areas to investigate before financing a startup company including: the vision of the company, target markets, type of collateral they are financing, competitive advantage and the entrepreneur’s level of experience and past performance. Tallo also urged investors to look at the company’s existing capital structure and to discuss the anticipated exit strategy to ensure that the lending relationship is built upon a foundation of clear expectations for each party.

Adding a “real live entrepreneur” perspective to the panel, Charles Anderson, CEO of Enverto, said that his company believes that the equipment industry is ready for change. Discussing modernization seen by other major asset classes such as subprime auto and mortgage financing, he said, “They’ve gone from the paper world to a paperless world, they’ve gone from offline to online … it’s inevitable that our industry follows that as well.” Anderson said the world of equipment finance is moving online because people want a more intuitive, simple process.

Todd R. Plotner, partner with Chapman and Cutler, provided an overview of entrepreneurial challenges, noting that there are three things that really matter: relationships, beginning with the end in mind and diversification of capital. He encouraged startups to build multiple relationships and multiple lines of credit, to start doing securitization or marketplace funding, to diversify capital sources and to create an exit strategy.

The final panel of the day, focused on improving the U.S. transportation infrastructure and increasing efficiency, was moderated by Stewart Hayes, SVP of Wells Fargo Capital Finance. Bradley Sohl, senior director with Fitch Ratings, provided an overview of the transportation ABS market, which represents three distinct asset classes: container, railcar and aircraft leases. Sohl indicated that Fitch’s outlook for the market is generally stable, with some increasing issuance over the course of the year, primarily driven by customer demand for yield. Performance was expected to be stable as the trends of competition and yield compression were being continuously monitored. Sohl discussed substantial competition on the aircraft side, with much of the activity being led by Chinese leasing companies that will accept a lower yield on investment.

Sohl also outlined trends in the transportation ABS market, such as the order backlog and replacement risk associated with aircraft, and DOT regulatory compliance for tank cars in the rail class. He also indicated that fuel prices have the potential to affect each class in different ways, being better for airlines and shipping companies, but potentially negative on the rail side. “If fuel prices are low enough that crude by rail users are eventually stressed, that could create an asset supply glut and greater default risk to some of those transactions that carry large concentrations of tank cars,” he said.

Craig Zimmerman with PNC Equipment Finance Corporate Finance Group, discussed the transportation assets held by banks like PNC. He noted that transportation and energy are the two segments that are seeing growth.

Wrapping up the panel, Michael Ruehlman, operating executive of Hudson Clean Energy Partners and president of Sunlight Financial discussed the emerging renewable energy asset class. He expects an increase in interest from utility companies in the future as an “incredible turnover” in the infrastructure in this country is expected to occur as coal is phased out and the grid becomes smarter and more stable. Although the rapid growth seen recently is expected to slow, he anticipates the industry to remain strong despite the fact that solar tax incentives have disappeared at a state level and will be phased out on the federal level by the end of 2016.

Looking Ahead

Although the general consensus of the conference was positive, some lingering doubt remains. “Regardless of what the Fed does, the business cycle is here,” said Petro. “So all of us who have long memories and long careers in this business always are looking for those signs in terms of when does the next downturn happen?” Petro added that she thinks this cycle could go much longer due to extensive manipulation by the Federal Reserve. “We’ve never had this kind of long term manipulation of interest rates,” she said. “No one knows where that’s going to end, so I’m sure we’ll have some interesting times within the next five to ten years.”

Rita Garwood is editor of Monitor.

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