Scott Schauer VP Direct/Large-Ticket Asset Management,   Key Equipment Finance

Kimberly A. Esposito AVP/Equipment Management, M&T Bank

Phil Cooper, ASA SVP/Asset Manager, Regions Equipment Finance

Dennis A. Bolton II Manager/ Corporate Aviation/ RCBO/ USCB/ Equipment Management, Wells Fargo, EF

James P. Grace SVP/Equipment Management, Banc of America Leasing

Each February, as the new year begins and much of the U.S. is mired under the weight of winter, the foot soldiers of the leasing industry gather — typically someplace warm (no surprise there) — to take stock of the past 12 months and learn about the latest trends in their field. I’m referring here to asset managers, those specialists on the industry’s frontline, who — unlike their colleagues in, say, credit or originations — focus their attention on leveraging margins from the leased assets going into, and coming out of, the field.

The gathering? The Equipment Leasing & Finance Association’s (ELFA) Annual Equipment Management Conference, of course. As this issue of the Monitor goes to press, equipment managers from across the country are preparing to travel to Tucson for the 2010 installment of the ELFA’s yearly event.

In anticipation of the conference, the Monitor reached out to five of the industry’s leading asset managers — including the chairperson of this year’s conference planning committee — to see what the past two years have been like, what people will be talking about in Tucson and what’s in store for 2010.

The timing of this year’s event is summed up nicely in the conference’s official theme: Equipment Management at the Crossroads.

“To me, asset managers always seem to be at a position between a boom or bust market,” explains Phil Cooper, senior vice president and asset manager at Regions Equipment Finance, when asked what the theme means to him. “We are either trying to protect the portfolios we manage from too risky proposed business, or we’re working to protect against, or at least minimize, losses in a downturn economy. As an economic recovery may be at hand, the question is: are we at the crossroad between boom and/or bust or someplace else?”

For the entire finance industry, that’s the $64,000 question. As the economy begins to slowly stabilize, the sector as a whole finds itself at something of a transition point. With the lessons of the past two years firmly planted in people’s minds, many in the leasing industry are taking time to reassess approaches to the market that prevailed during boom times while at the same time they remain attentive to when the market will “recover” and how best to capitalize on it.

To be sure, the industry remains in a precarious situation. Despite inklings of a turnaround, the most recent Beige Book survey released by the Federal Reserve shows the finance sector still lags the overall economy in stabilizing. According to the Fed, loan demand continued to decline or remained weak in most Fed Districts, and most reported that credit quality continued to deteriorate. Almost across the board delinquencies were on the rise, albeit at a slower pace than 2009.

Meanwhile, the consensus among analysts is that the economy will begin its turnaround in the first half of 2010; but how and where that recovery will be felt in the equipment finance industry depends on a number of factors — including who you ask. As February marks the first official gathering of asset managers since the end of the recession, the conference promises to be equal parts reflection and conjecture as seen through the eyes of this unique industry segment.

“We certainly hope that the recession wanes in 2010, however, many segments appear to be experiencing significant challenges well throughout 2010 and in some cases beyond,” says Scott Schauer, vice president of large-ticket asset management at Key Equipment Finance. “Most of the banking and financial services [institutions] are significantly more stabilized than one year ago, and that should result in a gradual increase of equipment finance in a number of market segments.”

Kimberly A. Esposito, assistant vice president of equipment management at M&T Bank Corporation, thinks that in spite of the stabilizing economy, companies — particularly smaller firms — will continue to struggle to get credit; and that could be a good thing for the leasing industry.

“Customers will look for the smallest capital outlay to keep cash flow, and leasing is often a good solution,” says Esposito. “Lessors in 2010 should have more negotiating leverage on lease terms, using affordable access to capital as the lever.”

But, she adds cautiously, on the flip side, “Lessees have gotten savvier over the years, and are paying closer attention to maintenance and return provisions, fees and other parts of the lease that were once untouchable standards.”

Regions’ Cooper thinks the turnaround will ultimately be a slow one, at least until demand has substantially increased. “Historically, as the economy begins to improve, one would expect an increase in demand in borrowing and financing, but I see not only the financial sector moving at a slower, more cautious pace, but borrowers not moving too quickly to spend on capital improvements until they have orders in hand,” he says.

Dennis A. Bolton II, a manager in the Equipment Management Group of Wells Fargo Equipment Finance, is a bit more optimistic. “In any recovery, we have traditionally seen the equipment leasing and finance sector benefit as companies work to manage their capital structures and seek tax-efficient financing alternatives as part of their acquisition of capital equipment,” he says.

Still, not everyone is convinced opportunity is right around the corner. James P. Grace, senior vice president of equipment management at Banc of America Leasing, says he expects 2010 to present many of the same challenges that 2009 did — at least for most equipment managers.

“Equipment values are likely to stay depressed and demand for used equipment will begin recovering from the current low point,” he says. “Residual gains will improve somewhat, but still lag well below industry norms.”

Grace says leasing companies will be challenged to replace these returns with income from better spread business or by selling deals from out of the portfolio. “This is all typical, effective portfolio management,” he says.

If the past year is any gauge, the asset managers we spoke to have had plenty of practice thinking creatively about these kinds of challenges. Our roundtable participants all agreed that the recession highlighted the need for effective loss mitigation and risk management, as well as imaginative resale strategies.

“2009 was a year where equipment managers had an opportunity to showcase their worth,” says Cooper. Among other things he says the recession forced asset mangers to think outside the box by supporting new transactions, and by researching market trends and the near term sustainability of equipment values.

Esposito makes a similar point, noting that the recession offered equipment managers an opportunity to show how they are able to help protect the bottom line during difficult economic times. “[The recession] magnified the importance of equipment management mainly in mitigating losses through negotiated repairs and sales of returned and repossessed assets,” she says. “More equipment inspections and customer visits were done by equipment managers. This was not really a modification of the job, but a spotlight was put on the department as being an essential leader in loss mitigation.”

On the resale side, Grace says the economic downturn challenged equipment managers to find the best avenues to sell equipment and presented the additional question of whether to hold an asset for a more normal secondary market by placing it in long-term storage or putting it out on short-term lease to keep it earning income, or by selling it for whatever the market would pay. “The economic recession tested the fundamental soundness of the equipment manager and the leasing company’s portfolio,” says Grace. “Equipment manager’s skills were tested to see how effectively we could remarket returned and repossessed equipment to maximize income and minimize losses.”

For his part Cooper says he doesn’t necessarily believe the recession had an impact on the way equipment managers do their jobs beyond bringing to light the value of robust risk management. “There has always been a fine line for the equipment manager to manage risk while at the same time support transactions,” he says. “I think what the recession did was to bring more light to the risk associated with a proposed transaction.”

Bolton agrees. “The market downturn resulted in a change in focus from new business generation to risk management and loss mitigation,” he says, adding that the experience gained during the recession will be “invaluable” to the development of well-rounded, experienced asset managers.

“Consistent with the financial industry as a whole, equipment managers have been faced with some of the most significant market changes in our lifetimes,” says Bolton, who calls the impact the recession had on many industries “unprecedented.”

Bolton, who chaired the 2010 ELFA conference committee, says this year’s event features a new agenda that includes a general panel discussion to discuss these changes as well as the best practices that helped some companies thrive, or at least survive, while others did not.

“Some [leasing companies] didn’t differentiate themselves from competition through creative structuring and by providing a true value proposition to their clients and [instead] competed solely on price,” he says. “As a result, many wound up with debt returns on equity risks.”

Over the past two years there has been a lot of talk from veteran lessors about the importance of going back to the basics — that is, sticking to time-tested processes and approaches to the industry that are easy to stray from in robust markets.

“The recession tested how well we priced our portfolio when we placed the business in our portfolio,” says Grace. “Did we price our residuals assuming a perpetual strong market, or based on a stick-rate play? Or did we assume it could come back at expiration possibly in a down market?”

“I think the most important takeaway [from the recession] is that all industries in which we finance equipment are cyclical — some with very harsh peaks and valleys,” says Schauer. “It is important to always remember it’s likely to be in a different phase when the transaction matures.”

Esposito says it’s common during boom times for lessors to lose sight of this, bidding higher and higher residuals to “get the business.” She adds, “Most recently it was rail. Everybody was playing, which made it highly competitive, drove up residuals, shortened lease terms, gave the lessee a great deal, and shifted the risk almost entirely to the lessor,” she says. “Money was cheap for everyone, so it made competition extra fierce.”

Echoing Schauer, Esposito says that in boom times, future value estimates tend to get skewed. “The basics of equipment management have traditionally been to evaluate residuals on a ‘normalized’ basis, because we’re estimating future value,” she says. “This gets harder when a particular market is booming, because recent secondary market information used in research is skewed higher.”

“It is critical to price residuals to normalized historical resale values,” adds Grace. “Every industry experiences cyclicality. Markets heat up and they cool off. So do values for equipment. As lessors, we can price residuals assuming equipment values will continue to increase or experience volatility. Equipment managers should fully understand the equipment’s market dynamics.”

We couldn’t end our discussion without asking our participants to opine on what sectors are poised to rebound first in 2010. Almost across the board the one industry that everyone saw as having potential is healthcare; and on the flip side, just about everyone saw the trucking industry as the sector that will lag the longest.

For her part, Esposito points to information technology — particularly anything medical related — as an area to watch. “Mid-sized companies are starting to use cloud computing and other firmware-based equipment that can multiply network capacity using the same number of servers,” she says. “If the healthcare bill passes, large amounts of firmware, enterprise servers, workstations and auxiliary computer equipment will be needed to administer a national patient database.”

Cooper agrees: “With healthcare a huge national topic one would expect that segment to continue to be a hot spot of activity,” he says.

“Manufacturing assets should be the first to begin experiencing a recovery in 2010,” says Grace. “Companies will need to increase production capacity as consumers begin consuming more goods.”

At the other end of the spectrum, both Grace and Esposito say transportation — particularly trucking — will be one of the last sectors to recover from the recession. “The demand for corporate aircraft, rail, and trucks and trailers will take some time as historically high used inventory balances will take some time to burn off,” Grace says.

Grace says in the aftermath of the worst recession in half a century, the leasing industry needs to examine the vital role equipment managers play in keeping the leasing industry strong and viable.

“Equipment management is at the crossroads of its importance within a leasing company,” says Grace, echoing the ELFA convention theme. “Given the incredibly challenging economic times and the critical nature of leading the leasing company into the future, there’s never been a more critical time for equipment management to provide its leadership to the company. Equipment management must step up to make sure the processes employed are best practices, the new business is quality and essential to its clients and must position the company for success in the right markets for the long term.”