The Equipment Leasing and Finance Foundation’s February 2016 Monthly Confidence Index for the Equipment Finance Industry registered 48.3 equipment finance market confidence, the lowest mark recorded since September 2011’s score of 47.6. In an ELFF press release, Financial Pacific Leasing President and CEO Paul Menzel explained some of the apprehension, saying “a flat domestic economy, muffled by presidential election uncertainty, will subdue growth in our industry for 2016.”

Monitor caught up with Menzel to get a feel for what the industry can expect in the year ahead when it comes to deal flow, funding sources, credit quality and potential challenges.

Key Drivers & Concerns

Strength of the economy will be the number one concern for the equipment finance industry in 2016, according to Menzel. Another area of obvious concern is the energy sector, although the level of concern will correlate to a lender’s exposure to the sector. Because Financial Pacific’s exposure is mostly small businesses in the general economy, Menzel believes low energy costs are actually a benefit to his clients and customers.

“We think it’s going to be a positive impact on the credit strength of our clients; it’s going to be beneficial to their cash flow and profitability,” Menzel says. “Obviously, the big risk is any asset exposure directly in the energy sector itself.”

Increased Deal Flow

When it comes to originations, Menzel sees growth in the year ahead. “We’re budgeted for substantial growth,” Menzel says, citing Financial Pacific’s 40% year-over-year growth last year. Though he is not expecting growth to be quite that strong in 2016, Menzel says it could happen.
Menzel attributes 2015’s growth to higher activity in Financial Pacific’s core small ticket business due to pricing and a widened credit window, launch of a vendor group and growth in its direct commercial middle market group in support of Umpqua Bank’s activities.

Traditionally, Financial Pacific’s niche is small-ticket and second-tier credit. “We’ve been part of Umpqua Bank now for two and a half years, which has allowed us to price more competitively and move into the A credit sector,” Menzel says. “We have continued to see a lift in originations in that core business because of the pricing and because of the wider credit window. That has attracted more business from existing TPO’s [Third Party Originators – brokers and leasing companies]. We are also buying portfolios in that sector.”

Menzel also expects growth from Financial Pacific’s other two origination channels. The first, through Umpqua Commercial bank, provides middle-market leasing. The second is a vendor group that was established toward the end of 2015, also in support of Umpqua Bank customers. “We’re expecting the growth to be primarily in the direct middle-market and vendor sectors, because they’re small at this point,” Menzel says. “In terms of the general economy, we’re looking for growth. There could be a decline in capital availability to non-banks, and we could benefit from increased market share as a result. I think the liquidity that’s been so high up to this point is starting to become restricted in the marketplace. But because we are a bank, we don’t have those restrictions. I think that will give us a competitive advantage.”

Less Liquidity

For what seems like ages, industry experts have been talking about the abundance of liquidity and the resulting competitive environment. Menzel says an environment of plentiful liquidity won’t be around much longer. “The liquidity crunch, when it occurs, will affect the independent competitors,” Menzel says, adding that Financial Pacific will be in an advantageous position because of its ties with Umpqua.

Why the sudden squeeze on liquidity? “Already securitization is tightening up and getting more expensive,” Menzel explains. “If you’re not a bank, then you need to borrow from a bank or you have to securitize or use your own equity.” While capital from all of these channels has been available in abundance, Menzel says these sources are shrinking in today’s environment.

“There have been more players in our space. With regional banks getting involved, a lot of independents have been growing rapidly,” Menzel says. “But I think with liquidity tightening up, that won’t be as much of a factor in 2016. You’re going to start to see some consolidation in our industry, and we’re already seeing some of that with GE as an example. But you’ll continue to see more consolidation.”

Menzel believes that independents might look to sell or merge in the year ahead. “We’ve had an expanding economy and a bull market for seven years now, so typically that is when there is consolidation, because people are trying to get out before the next recession hits,” he explains.

Skinny rates have been another environmental challenge, more likely to plague independents than banks. “We have probably the widest credit window in the industry, which gives us an advantage there,” Menzel says. “We’ve been able to maintain our spreads pretty effectively. Since we’re associated with a regulated bank, we do not pursue aggressive structures and credit profiles.”

On the credit side, Menzel says Financial Pacific has enjoyed a very strong credit environment and portfolio performance, both of which are at historically low levels. He believes delinquency and losses are bouncing along the bottom of the cycle range. “I would expect that we will see delinquencies and losses start going up slightly, but I don’t see any major disruption or major volatility,” he explains. “We probably aren’t going to enjoy as strong of a credit environment as we have over the last few years.”

Getting the Deal Done

Despite all the changes in the industry, Menzel says the fundamentals of getting a deal done as a TPO haven’t changed much. “In my mind, we’re a service industry,” he says. “The TPOs are a service that provides capital to their clients.” Menzel explains this positions TPOs as intermediaries that must service two partners: a client and a funding source. Brokers who pay close attention to detail, have strong follow-up skills and do not take shortcuts have a better chance of closing a deal. “Say what you will do, and do what you say,” Menzel says. “Trust and integrity have to be their mantra, both with their clients and with their funding source.”

Looking Ahead

Overall, Menzel says it is important to realize that regulation will not be retreating. “It’s going to invade our lives more and more, and that includes the small operators, TPOs and independents,” he says. “It remains to be seen what the impact of the Consumer Finance Protection Bureau (CFPB) will be on our industry. Even though we’re commercial lenders, that line is going to be blurred so everybody has to be aware that we’re not going to be able to fly under the regulatory radar to the degree that we have in the past.”

Menzel says complaints and record keeping will become bigger issues. “The manner in which TPOs and brokers serve their clients is going to be monitored by the funding sources, the banks and the regulators,” he says. “So if there is a dispute, it is going to become a big deal all the way up the capital chain. Regulators monitor an industry by tracking complaints. Reputational risk, in that regard, is going to be important with anybody that is subject to regulation and compliance, and that concern will get pushed down the food chain to the independent broker.”