As we turn the corner into the fourth quarter, the financial picture looks similar to last year as the economy slowly moves forward. Achieving smart growth, while balancing risk and reward, is an everyday part of doing business. The competition is fierce for customers as well as the talent needed to serve them. The expectations of technology continue to grow and change along with the employees and clientele who expect lenders to make increasingly better use of it. Whether you work for a bank, a foreign affiliate, a captive or an independent, there is a wall of challenges to scale. We asked four equipment finance leaders to share their insights into today’s marketplace.

“With interest rates holding stable, you’d think the balance between risk and reward would start to find some equilibrium,” says Ryan Collison, president and COO of Hitachi Capital America. “You have to know how badly you want to build assets for the future versus how willing you are to sacrifice profitability. As with any company, I have to consider what my stakeholders and parent company want. I need to balance short term versus long term and match that to where we are on the list of needs at any single point. We don’t want to be so shortsighted as to provide less and less service to our manufacturer partner.”

“As the captive for the Volvo Group, our strength is our consistency around pricing and deal structures,” says Tom Guse, president of Volvo Financial Services USA. “We want our dealers and customers to know what the answer is going to be when they ask for financing. As a captive finance company, our understanding of the brand’s products and our relationship with the brand puts us in a unique position to develop exceptional financing solutions that third-party lenders cannot. In effect, our full understanding of customer’s needs and the brand’s product offerings helps the brand sell vehicles and equipment.”

“Banks have capital and look for opportunities to use it to help companies invest in their businesses, hire employees and expand their markets,” says Byron Payne, executive vice president at Wells Fargo Equipment Finance. “Wells Fargo takes a calculated risk approach. We’re committed to responsible behavior and lending policies.”

“Each transaction seems to carry more elements of risk while the rewards are diminishing,” says Rich Doherty, president of PNC Equipment Finance. “More specifically the risk of credit quality, residual realization and regulation provide the perception that the rewards — that is, the margin compression — are out of balance.

The opportunity to maintain a healthy reward-risk balance clearly exists when capital providers focus on the things they do best and are cautious about stepping outside their normal playbook.”

Cautious Capital Expenditures

The September 2016 ELFF Monthly Confidence index fell to 53.8 in September from the 54.8 reading in August. Everyone agrees that the current mood of U.S. businesses is to hesitate when it comes to acquiring new equipment.

“Over the past seven years, businesses have been very cautious in their capital expenditures,” Payne comments. “Rather than replace their equipment during the recession, businesses used and maintained their existing equipment. Since 2013, we have seen a replacement cycle, because the equipment had worn down past the point of usefulness. The replacement cycle has passed, and that contributed to the drop in the index. As a result, we are competing aggressively for what is, in reality, a slightly declining market.”

“Most industries have been impacted by the challenges facing the energy industry as well as the effects of renewable energy production on companies with historical appetites for equipment financing, such as coal mining and rail,” Doherty says. “When you add in the manufacturing cost advantages of taking your production off shore, companies are hard pressed to invest capital in domestic operations. The totality of these factors has limited new capital equipment acquisitions.”

“It varies widely according to industry segment and geography,” Guse says. “For instance, our over-the-road Class 8 business is very uneven and may be off by 20% in unit sales over the previous year. That decline is mostly driven by current freight levels, used truck values and, to some extent, uncertainty around the outcome of the presidential election. Business remains very good for our construction equipment business and for vocational trucks such as cement mixers and dump trucks. The quantity of very large infrastructure projects occurring across the U.S. is good for this business. Commercial and residential real estate is very good, too, and that bodes well for vocational type business. On the flip side, anything related to commodities such as oil and gas has been negatively impacted by the price of those commodities.”

“We still see hesitation across small- and medium-sized businesses, even though the stock market is at record highs,” Collison says. “Some of these businesses are unsure of Brexit’s impact, and they are taking great care before they invest. We also see that hesitation in the vendor business where our customers tend to be medium-sized businesses. On the other hand, in our big-ticket business where we work with large, high quality credits, we don’t see as much hesitancy to invest.”

If the economy hasn’t changed dramatically, what explains the 10-point variation in the confidence index over last year? Payne attributes the variation to the end of the replacement cycle. “Most businesses have replaced the equipment needed to maintain their customer base, and much of that equipment is long-lived. A year ago, the index reflected the replacement trend, but now we see that businesses are still not confident enough to finance new equipment.”

“I believe there are two major factors that may have negatively impacted the confidence index,” Doherty says. “The first is domestic and global uncertainty. A major driver of that uncertainty in the U.S. is the presidential election that has impact on business investment decisions. The other major factor affecting confidence is the significant number of new competitors that cause raised concerns about maintaining market share.”

Collison suggests that it might be the political rhetoric of the presidential candidates and all their talk about a faltering economy. “Some people have a harder time than others separating political rhetoric from economic facts and figures.”

Guse agrees that bad news might be part of the problem. “There are large economic factors that we hear and read about everyday, and that keeps them on people’s minds. Job losses related to oil, gas and coal are an example. This kind of news makes people wonder if those problems will bleed into other parts of the economy, and that causes them to hesitate.”

Looking Ahead

No one can accurately predict what is ahead for the rest of this year, but there are clues and indicators that can provide helpful hints. “Consumer spending makes up two-thirds of the economy and is important to watch,” Guse says. “For the general economy, we look at the inventory-to-sales ratio. If the ratio is high, as it is today, there will be less manufacturing until those inventories are sold off the retail shelves or out of the warehouses.”

“There are things we measure internally that give us an idea of what’s ahead, but, of course, it depends on the segment,” Collison says. “In the transportation business, the number of credit applications is a simple straightforward indication of the demand for trucks and financing. In the larger-ticket business, we look at bid activity and how often we are asked to bid. In over-the-road, heavy-duty trucks, the market watches inventory as a percent of sales. That’s an indicator of how much demand there will be for transportation of product and tonnage. That indicator of usage is also a gauge of demand for new vehicles and the health of customer portfolios.”

Wells Fargo watches the leading indicators, such as housing starts, PMI and retail sales as well as its own internal indicators. “Because Wells Fargo Equipment Finance has deep domain expertise in financing Class 8 over-the-road trucks and trailers as well as railcars, we have a good pulse on freight and shipping,” Payne says. “For the most part, we see that freight is down or very flat. We think that lack of activity portends a slower economy and a softer market. I also watch the strength of the dollar against other currencies. If the dollar weakens, the price of oil would rise. That would stimulate the energy industry and potentially offset some of the softness we see in other markets.”

Doherty’s barometer is based on PNC’s strong client relationships and the feedback it gets through executive conversations. “Decision makers tell us they are currently holding off on acquiring capital equipment due to the uncertain political climate, unless it is an absolutely necessary acquisition. Since we traditionally see a seasonally high level of activity beginning in September until the end of the year, we have to be prepared to accommodate companies that will try to utilize unused capital spending budgets in a shorter timeframe than normal.”

Excluding GE Capital, the Monitor 100 companies projected a 4.7% volume growth rate for 2016, but our panelists had varying opinions about that projection. “With a GDP projection of 2% to 2.2%, an overall growth rate of 4.7% seems aggressive,” Collison says. “To expect volume to grow at more than twice the rate of the overall country’s production is optimistic. That growth rate is on an aggregate basis, so certainly some markets could grow in that range.”

Payne thinks the projection seems about right if not slightly high. “Based on what we’re seeing across our business lines, there is some softness in our transportation and rail verticals. However, I also see this being offset in other verticals such as healthcare and technology equipment.”

“As an industry, I think that is a fair number, but it could potentially be low,” Doherty says. “Originators have a tendency to chase the same business. Companies with a unique value proposition that offer tailored solutions to customer’s capital needs should experience a growth trajectory greater than 4.7%.”

Guse says it varies by business. “For our yellow iron business, 5% seems about right. New equipment sales may be flat, but used equipment is up significantly because businesses have either leased or rented equipment for the last few years. In the case of leases, that equipment has now been returned to the dealer or factory where it is being re-leased or re-sold to second and third users. For Volvo Financial Services, used equipment sales have brought our volume up about 5% in our construction equipment business despite flat new equipment sales. For over-the-road Class 8 trucks, I’d say 5% is way too aggressive.”

Facing the Challenges

Attracting quality people is an ongoing concern for equipment finance leaders. “The greatest challenge is developing the culture to be one where you can attract and retain the best talent,” Doherty says. “Younger generations have new ideas and aspirations. We need to provide them a platform and environment that excites them.”

“Our parent wants us to grow in the U.S., so we need people who understand growth and can drive growth,” Collison says. “Then we need them to work really well together, because growth is hard and puts stress on an organization.”

“My biggest challenge is making sure we have the right people selling the right products and services to match the customer’s demand,” Guse says. “It’s not a sexy industry, and it’s not one that students have at top of mind as they contemplate their career options. Years ago, many banks, captives and third parties ran their own intensive training programs, but fewer companies do that now. Many have substituted technology as a training tool, which has less impact than a training program that allows a candidate to spend an entire year learning all aspects of your business. The lack of formal training makes it more challenging to hire talent.”

Payne shares similar concerns about attracting talent but also sees challenges around upgrading technology and evolving how we interact with the future customer. “Providing state-of-the-art technology is an ongoing challenge that Wells Fargo addresses with increased capital investment. From a customer perspective, the challenge involves the difference between how baby boomers do business versus how generations X, Y and millennials do business. When baby boomers are deciding who their financial partners will be, they do it in more traditional ways, such as over the phone and face to face. Future customers acquire and develop partnerships via technology. If financial institutions don’t keep up on that front, they risk being left behind. There is also the continuing need to upgrade technology for increased efficiency in all aspects of the business, including keeping up with regulatory compliance demands.”

Collison mentions commoditization as another threat. “How do we avoid simply being a low value-added finance company? We talk about how innovative our industry is, but what I see is more evolutionary than true innovation. One area that is a challenge for our industry is how we finance products for customers who don’t really want to own the product but want the utility of it. The copier business has done this by offering cost-per-copy structures. How do we extend that model into other collaterals so that a customer gets the utility of that product but doesn’t have to borrow money to own it? Can we use that model in the fields of energy production, energy savings or manufacturing products?”

“Depending on the industry, existing inventory levels are also a problem,” Guse says. “It will probably take two to three quarters before inventory is right-sized to the point that dealers feel comfortable ordering more in 2017. Strengthening consumer confidence and getting the election behind us will be part of that solution. Customers need to have a longer-term outlook to assure them that there is work for their equipment so that it will pay for itself.”

In addition to all those challenges, Doherty reminds us, “As competition for product increases, many capital providers display irrational behavior that leads to risk in transactions that they are not equipped to manage in the long run.”

The Pros and Cons of Technology

Technological evolution presents a double-edged sword bearing advantages and challenges. “The greatest benefit of evolving technology is that it gives our customers the ability to access financing where, when and how they want it,” Payne says. “The future customer wants that flexibility, so it’s worth investing in this technology. Technology also brings ongoing cost savings as we gain efficiencies in origination, onboarding and portfolio servicing.”

“Technological advancement allows us to provide better customer service as a result of the information we can provide in the time that they need it,” Doherty says. “Technology is moving so fast, clients and employees want more knowledge and quicker. Providing clients with more information can deliver a better client experience. We need to be thoughtful around the balance of how and what information we provide and how we can manage the risk associated with breakdowns in cyber-security.”

“The power of data is almost endless,” Guse says. “It is so valuable, and we use it for many different purposes. Technology has allowed us to become much faster in meeting customer expectations and responding to their questions as well as in our underwriting practices.”

“Technology helps us be a more collaborative partner, and that can mean anything from cycle time to approval turnaround time,” Collison says. “If we can use technology to help a truck dealer close a deal on a Saturday by giving him more knowledge about the finance product or the pricing or allow that dealer to self-serve documentation, that’s a plus.”

As a caveat, Guse offers a cautious word. “This industry remains a relationship business, and technology has a tendency not to look at the relationships between the finance company and the distributor/dealer or end customer. If we depend solely on automated credit-decisions based on a credit bureau score and what we’ve submitted online, we can miss out. The data can ignore the story behind the numbers, and that can lead to lost opportunities.”

“Not only do we need to figure out how to interface with the new tech-savvy generation, but also technology can reduce the face-to-face business model,” Payne says. “If you don’t have the ability to service all parts of the market from low-touch technology to high-touch relationship-focused channels, you lose opportunities to obtain new and grow existing customers.”

Forging Ahead

Despite the hardships and developments, our panelists are enthusiastic about the future. “One of the most significant benefits of being a leader in this industry is the opportunity to help realize what this industry will look like over the next 10 to 15 years,” Guse says. “It wasn’t all that long ago that we were satisfied with making a credit decision in days or hours. Today, the best finance companies are measuring those decisions in minutes. These types of changes will continue as we move forward, and they will be dictated by customer demand.”

“The equipment finance industry has always been dynamic and continues to change and see change,” Payne says. “That’s what I enjoy the most — keeping up with those changes and developing the products and services that meet the current state of financing capital expenditures. There are a lot of traditional capital assets out there that we will continue to finance, but there are many new things people are looking to finance such as contracts for cloud services and alternative energy.”

“The benefit of being a leader is that you can establish the culture by taking the best of past generations and combining that with new ideas to create a great workplace that everyone can embrace,” Doherty says.

“The great thing about this role is having the privilege, responsibility and authority over the work environment to ensure we’re doing everything possible to sustain a culture of collaboration, respect and energy,” Collison says. “While it can be especially difficult in a high growth mode — where things are changing rapidly — to maintain consistency in hiring, reward systems, training and organizational design, I don’t think a company needs to sacrifice culture for results. If you get the working environment right and attract the right people into it, the results will follow, and everyone can feel good about how they get there.”