Allan Levine Chief Operating Officer, Madison Capital

Mike Coon Executive Vice President, Enterprise Funding Group

Dale Kluga President, Cobra Capital

Scott Woodring VP, Sales & Marketing,  Dakota Financial

Peter Davis Chief Financial Officer, Financial Pacific Leasing

If there was a singular moment when the impact of the credit crisis on the broker-funder relationship became apparent, it was probably last September at the United Association of Equipment Leasing’s Annual Conference in Denver (the last one before UAEL merged with the EAEL to create the National Equipment Finance Association — NEFA).

While participation was high, the activity was noticeably lopsided. Glancing across the conference floor, it wasn’t difficult to tell where the funding sources were located. All you had to do was follow the groups of brokers as they wandered from booth to booth, congregating in packs around the smattering of funders in attendance.

As one funding source said of the traffic at his booth: “It’s been nonstop the whole show.” That day represented a paradigm shift for both the broker and funder communities, and it brought to light a new reality for the equipment leasing industry.

Since then the U.S. economy officially entered a recession, a new president has taken office and more than $1 trillion has been earmarked to bring first the financial sector — and more recently American industry — 
back from the brink of economic collapse.

For funding sources in particular, the economy has been a double-edged sword. On the one hand, everyone is suffering from a lack of available cash; and yet at the same time, funding sources have suddenly become the people in the room everyone wants to talk to.

At the beginning of February, the Monitor spoke with five executives representing a variety of funding sources and asked them to reflect on the past year. Everyone agreed that with available credit increasingly scarce, many funding sources have adopted a different approach to originating new business and, in most cases, it’s the broker community that’s feeling the impact.

Allan Levine, chief operating officer of Maryland-based Madison Capital, says one result is that funding sources are more careful about the kind of business they book. “Even well-capitalized funding sources are looking harder at transactions and want to use their funds for solid approvals that yield the appropriate returns,” says Levine. “Brokers are obviously looking for funding sources. It’s the financing sources that are pulling back.”

“Funding sources are ceasing to fund indirect originations or are leaving the market entirely and many of those that remain are reevaluating their broker relationships,” adds Mike Coon, executive vice president of Enterprise Funding Group, based in Grand Rapids, MI. “This has trickled down to the broker community.”

Nevertheless, both say their companies are still doing deals, but for Levine, this has meant concentrating more heavily on direct origination. “Our business was always more direct than indirect, so there really is not a major policy change,” he says. “However, we are now more discriminatory in our broker relations and the types of transactions we review.”

That sentiment carries across most funding sources these days, with many reporting they are depending less and less on brokers to book new business and are relying more on direct sourcing. “New business activity from our indirect sources dropped in 2008,” says Dale Kluga, president of Illinois’ Cobra Capital. “But this revenue segment decline has been more than offset by an increase in our direct business; that said, while our direct sources continued to grow in 2008 it was at a much slower pace than in 2007.”

But not everyone is so focused on direct funding. Scott Woodring, the vice president of sales and marketing at Dakota Financial — a California firm that relies heavily on broker business — says his company has seen a 6% decrease in broker funding in 2008, with noticeable fluctuations in activity. “What I have noticed most is the inconsistency, month-to-month, from a funding standpoint compared to previous years,” he says.

To adjust, those who book the bulk of their business through brokers have had to employ a new set of working guidelines designed to filter out the deals that will be most fruitful and leave the rest behind. “Our challenge has been how to control volume responsibly,” says Coon, whose company only books indirect business. “Our approach with our existing relationships has been to focus on those originators that best meet the criteria of our programs, and which are the most efficient for us.”

Peter Davis, chief financial officer of Financial Pacific Leasing, based in Washington state, says that during the past year his company experienced a significant increase in broker application volume. But, he says, “We undertook a series of credit tightening measures aimed at mitigating the impact of the economic downturn, and as a result, our approval rate has declined.”

Meanwhile, Coon says that Enterprise Funding has experienced its own reductions in fundings from its sources, which notably reduced the amount of business it could book in the second half of 2008. “Enterprise is primarily funded through facilities provided by banks. As their appetites, requirements and covenants change, ours must change in response,” he says. “Liquidity has dried up significantly due to declining bank capital, deteriorating creditworthiness of borrowers due to the economic downturn, and the closing of the asset-backed finance market.”

His experience is far from unique. At the beginning of February the Federal Reserve released the results of its monthly survey of senior loan officers for the previous month. What they found is of little surprise to anyone in the leasing business that has spent the last year struggling to fund deals.

“The market remains very competitive for both funding sources and the broker community, for much the same reason,” says Davis. “Financing for leasing companies is extremely difficult to access because, at this point, banks have not been willing to extend the credit facilities currently in place and are less willing to offer new lines of credit.”

In spite of a drastic easing of fiscal policy, which has seen short-term interest rates cut to near 0%, banks across the country continued to employ strict lending standards in January, leaving borrowers of all stripes to fight over a shrinking pool of cash.

Among commercial and industrial loans, about 65% of domestic banks reported having tightened lending standards to large and middle-market firms over the prior three months. Among those that are lending, large fractions of banks noted that they had reduced both maximum size and the maximum maturity of loans or credit lines to firms of all sizes. In addition, about 70% of all domestic respondents reported having tightened covenants on C&I loans to large and middle-market firms and about 60% reported having done so on such loans to small firms.

In short, the tap has been turned off. And this has left many funding sources in the same boat as their brokers. Nonetheless, it’s fair to conclude that given the current environment, it’s still a funder’s market. “I do believe the days of a broker saying ‘if you do not fund his, someone else will,’ are over,” admits Levine.

But that’s not to say companies are taking advantage of the situation. As anyone who’s been in the industry for any significant amount of time knows, times change — sometimes quickly and drastically — and so do circumstances.

“Funding sources do have the upper hand, for now, however, everyone appreciates the concept of ‘what goes around, comes around,’” says Kluga. “We believe it is better to be consistent in our business model than to take advantage of temporary market opportunities at the risk of adversely impacting customer relationships.”

Coon makes a similar point. “There is no question that lessening competitive forces have made it easier for many of us to make business decisions that better meet our own objectives,” he says. “But, we believe that long-run success in this business comes from building strong, trusting, long-term relationships with originators.”

Woodring says for a company like Dakota, taking advantage of the down market would only make a bad situation worse. “As a broker-driven funding source, we have to offer a product to our clients that allows them to sell our programs to their vendors and end-users in the field to the best of their ability,” he says. “If we arbitrarily tighten credit parameters or increase buy rates, things will only get more difficult in an already difficult environment.”

Looking forward, there’s little consensus among experts as to how long the economic crisis will last beyond the general belief that things are likely to get worse before they get better. And while it’s too soon to tell what, if any, effect the Obama Administration’s recently passed stimulus program might have on the equipment leasing sector, the funders we talked to seemed to be in agreement that the Bush Administration plan was a failure if its goal was to inject liquidity into the market and spur lending.

“TARP has yet to have any effect on our business,” says Woodring. “Until the banks that have been beneficiaries of this program start lending money again, this will continue to be the case.”

Levine calls TARP a “12th hour desperation move,” adding, “The first round of TARP was a necessary fiasco. There was no accountability and therefore billions were wasted. It bailed out a few and gave some money to acquire other companies, but did little for the overall business community. Actually, liquidity is becoming less and less.”

Kluga pulls no punches when asked if he thinks TARP has had any positive impact on the industry. “Absolutely not,” he says, and makes this prediction: “I firmly believe, despite the politicians’ naïve attempts to print our way out of this current crisis with government spending, the global recession will cause free-market democratic capital rules to ultimately prevail resulting in a massive consolidation in the banking industry.”

For now, our funding sources say they plan to rely on their own experience and business acumen to prevail instead of waiting for handouts. For most, this involves accepting that limited cash flow is a part of doing business and adjusting accordingly. “There are very few markets where it is possible to compete successfully over the long term if your only weapon is price,” says Coon. “Funding sources that can establish confidence and trust with their originators will be highly sought after and pricing will be secondary.”

Woodring agrees. “Pricing will have to take a back seat to solid underwriting guidelines in this environment,” he says. “Right now, there is less competition across market segments because there are fewer funding sources. It is a competitive advantage just to be active and funding transactions.”

“In the current market, success seems to be tied as much to relationships as it does to pricing,” adds Davis. “Having established relationships with your lenders and your brokers helps insure continuity in both your business and your products.

Davis says Financial Pacific is also employing sophisticated metrics to weed out undesirable credits. “Using historical performance data relating to our market segment, we’ve developed proprietary credit scorecards,” he explains. “These cards, along with our seasoned underwriting staff, allow us to quickly identify the type of applicants we are willing to approve.”

For brokers who are struggling to stay afloat, Coon recommends becoming more educated about the credit process and much more thorough in presenting their applications to their funding sources. “Brokers need to differentiate themselves in the eyes of funding sources with successful marketing programs, true vendor programs, industry niches and a loyal customer base,” he says. “Those brokers that simply deluge funders with random applications will struggle to be viable.”

On the other hand, he notes: “Those that step up their game will not only generate more approvals, they will position themselves as an attractive source of business by their funding sources.”

As for the coming year, Levine says that while there is still capital to be had, he expects 2009 will continue to be tight. But all is not lost. “The solid funders will look for good transactions from trustworthy brokers. Be that trustworthy broker,” he says. “A surviving funding source will grow after this mess is over. That company will have had a solid balance sheet that is able to withstand a few hits.”