Dale Kluga President, Cobra Capital LLC

Curt Lysne Chief Sales Officer, Balboa Capital

Curt Kovash SVP/General Manager, U.S. Bank Manifest Funding Services

Ed Sproull SVP Leasing Americas, HSH Nordbank AG

Fred Van Etten President, Popular Leasing

Last year, by most estimates America’s financial industry was riding the wave of economic boom in a market flooded with capital. While a diminishing housing market led to a slump in residential building, commercial construction remained steady. Meanwhile sales of Class 8 trucks hit record highs and the Federal Reserve reported broad-based advances in the production of commercial aircraft, information technology products and business equipment.

But simultaneously fiscal policy makers were expressing worry that the economy was growing too fast, leading to inflationary pressure and prompting the Fed to embark on a tightening campaign the likes of which are rarely seen.

In 17 consecutive meetings the Fed raised interest rates from 1% in June 2004, to a peak of 5.25%. They finally stopped for a breather in August 2006, but left open the possibility of further tightening should they find it necessary. So far they have not.

In a recent speech before the Senate Banking Committee, Fed Chairman Bernanke extolled the fruits of this effort, expressing optimism for the coming year while conceding that, “imbalances may continue to impose modest restraint on industrial production during the early part of this year.”

Yet others fear the Fed’s fiscal policy may have put too much pressure on the economy and say the results will be felt in 2007, particularly in the output of goods.

The National Association of Manufacturers (NAM), for instance, expects to see a marked slowdown in manufacturing growth and a drop in business spending. Elsewhere, a survey of leading CEOs conducted by Business Roundtable suggests the nation’s chief executives too are predicting below average growth in 2007.

As 2006 turned to 2007, many analysts were no longer asking if the economy would bottom out, but when and how hard.

Follow the Money
Though it’s impossible to predict exactly what course the economy will take, one way to start looking is to follow the money. In the first quarter of each New Year, the Monitor asks leading funding sources to offer their take on the past year, as well as what the next 12 months promise.

So far, sources of capital say they are continuing to see healthy growth, though they add that the industry appears to be refining itself accordingly.

Dale Kluga, president of Cobra Capital, says that while he’s seen the quantity of broker business diminish since 2005, the quality of broker deal flow increased substantially last year. Kluga credits his staff with better educating prospective borrowers about his company’s lending parameters.

“We saw less indirect business in 2006 because our sources better understood the types of deals we fund and sent us fewer but more qualified deals,” says Kluga. “In the end, our funding ratio increased substantially during 2006, which is our primary goal.” The result, adds Kluga, was that 2006 saw the highest level of funding approval in Cobra’s history.

There’s a message in this irony. As the economy settles, the cream rises to the top, and funding sources are finding that focusing on quality rather than quantity is a winning formula. A key to seeing this through is understanding the nuances of a vendor’s business. To successfully put capital in play, it’s vital to know how and where it will be put to use.

“Lack of knowledge about your vendor is a key area that can cause a deal to stall,” says Curt Lynse, chief sales officer of Balboa Capital. Lynse says business from Balboa’s broker channel in 2006 was almost 40% higher than 2005. “A large part of our growth was the expansion of our broker customer base, refinement of our service offering and the introduction of new product offerings along with technology that makes it easier to do business,” he adds.

According to Lynse, technological advances have been a key driver in his company’s programs development. “From our technology investment we have access to a tremendous amount of data,” he says. “This helps us manage our business through good forecasting models and profitability models as well as supplying our brokers with solid data on their contribution to our success.”

On the other hand, says Kluga, technology, for all its merits, still has limitations. Kluga suspects all the forecasting models in the world can’t compare to the intuition of a qualified credit analyst. “We’ve found that a traditional and human approach to credit has not only resulted in above average portfolio performance, but allows us to focus on those companies that deserve to be funded in the most competitive way for amounts greater than most technology scoring systems can ever possibly justify,” he says.

Curt Kovash, senior vice president and general manager of U.S. Bank’s Manifest Funding Services, says his company too had a record-breaking year. “We developed new products in 2006 that helped our customers close more sales and assisted in the growth of our customers,” he says. “We also evaluated our internal processes and worked extremely hard to create efficiencies within the company that allow our customers to be more successful in the marketplace.”

For Manifest the changes relied heavily on technological innovation designed to streamline the lending process including application-only funding up to $100,000, credit scoring to $75,000 without bank and trade information, and online credit scoring in which customers receive a 30-minute turnaround on applications.

Still, not everyone said they experienced the same level of growth in 2006. For others we spoke to, last year presented no special opportunity from the broker community. “Our broker activities last year were flat compared to 2005,” says Ed Sproull, a senior vice president at HSH Nordbank. “We didn’t notice that the community controlled any more opportunities than in prior years.”

Where he does see potential, says Sproull, is in small but growing leasing companies. “Smaller leasing companies offer the broadest set of needs and, therefore, the greatest opportunity for our own growth,” he says.

Others say they are just beginning to explore working with brokers. “Last year was a discovery period for us,” says Fred Van Etten, president of Popular Leasing. “We only recently began to evaluate the possibility of accepting business from third-party sources. We now see this as a viable origination source and will pursue strategic partnerships with extremely well-qualified lease brokers.”

For Van Etten, this means working with well-established brokers that have long-standing relationships with vendors and are experts in their respective markets. “Brokers need to be seen as partners in business and our job is to provide them the infrastructure and support to allow them to focus on generating new sales opportunities,” he says. “The key is to cultivate this relationship.”

That seems to be a consistent theme. All of the funding sources we spoke with emphasized the special relationship that exists between brokers and funders — a mutually beneficial give-and-take in which quality far exceeds quantity. “For us it is all about the relationship,” says Lynse. “We believe both parties to the transaction need to benefit from the relationship and work in harmony with each other.”

According to Kluga, realizing this harmony sometimes requires sacrifice, and rethinking the “winner takes all” approach that is evident elsewhere in the financial industry. “We take a relationship approach with companies by opting to mitigate credit risk rather than increase the cost of the financing to the client,” he explains. “We find that by taking less return, we legitimately build a closer relationship with our clients.”

Kovash agrees. He says lenders need to be more aware of the needs of the broker community. “Our sales and marketing team is out there talking to customers everyday about helping them grow their business,” he says. As a result, Kovash says Manifest has been able to create more than 180 customized finance programs for individual customers.

Furthermore, with the increased competition for deals that has characterized the previous year, an individualized approach can act as insurance in hard times. “There are many more companies competing for broker/lessor business than ever before and this has driven down price points,” says Kovash.

For funding sources, building unique relationships and solidifying these alliances is one way to mitigate risk. “All of us in this industry provide more than just financing,” says Kovash, “and in the end it comes down to the people who drive the entire process.”

But this atmosphere of trust and camaraderie needs to be balanced with a dose of healthy skepticism.

In an industry that has seen its share of high-profile fraud cases, lenders have to remain vigilant in conducting due diligence, taking care to never let their guard down. Furthermore, funding sources need to do their homework and understand the industry in which their vendors are involved. The lesson: if something doesn’t feel right, it probably isn’t.

“In order to limit risk, brokers and lessors should always know how the transaction was originated,” says Kovash. “When things are not clear, take some extra steps to ensure the transaction is legitimate.”

“Common sense is the most proactive solution to determining if a prospective client deserves your time,” says Kluga. “Don’t allow a client to treat you as an order taker. Be a problem solver.”

Think Globally
Throughout 2006, it was impossible to ignore the globalization of the financial industry. Talk of the convergence of international accounting standards has reached a crescendo, while financial regulatory bodies move towards a single approach for assessing capital under Basel II.

This global movement has some funding sources looking ahead. Sproull, who heads up the American lease finance operations of a major European bank, is concerned about the big picture — like how Basel II will affect the way he conducts business. “We are a bank and therefore focused on Basel II requirements,” he says. “Successful implementation of those requirements will require gathering enormous amounts of data.”

Sproull worries that the new rules, which will modify the way credit risk is assessed, will create a disconnect between business and market realities. Success will depend on adaptability. “Basel II is coming,” he warns. “Brokers should be sensitive to the changes that will come with the new regulations. What worked this year may not work next.”

Without specifically mentioning Basel II, Kluga agrees that excessive oversight is a worrisome trend and one that has the potential to hamper the industry. “Increasing regulation only serves to satisfy politicians and bureaucrats while making it more difficult to run a business and generate reasonable returns,” he says.

Taking a broader approach, Van Etten says that the real challenges lie in the unknown, such as where the economy is heading and when and how hard a slowdown might come.

It’s easy to understand his concern. Already, the transportation sector is feeling the heat from new EPA diesel standards that went into effect in January. In the months leading up to the change, new orders flowed like a river, only to slow to a trickle with the New Year. Recent statistics from the Federal Reserve indicate that the auto industry pullback is having a significant impact on manufacturing growth; a trend Lynse says is likely to have repercussions.

“I foresee some challenges in everyone’s portfolio for 2007,” says Lynse. “The industry has enjoyed a strong portfolio performance over the past few years but I expect to see some deterioration coming.”

In the end, how each company approaches these challenges will define their place in the market. Sproull says the answer lies in versatility. “We provide a broad array of financing and are not limited to one or two types of financing,” he says of his company. “Instead of searching for a particular specialist, brokers are better served finding a lender that can accommodate most of their needs.”

On the other hand, Lynse sees the merit in finding ways to better serve the clients he has. “For 2007 we will move into a discounting relationship with some of our larger, well-established relationships while refining our credit and funding standards,” he says.

In their advice to brokers, however, one message rings clear: communication is key. Kluga advises brokers to be upfront about the weaknesses of a deal to avoid problems later and help maximize efficiency. “A candid understanding of risks disclosed early in the underwriting process means we can focus our energy on mitigating weaknesses rather than uncovering problems,” he says.

Kovash agrees. “It’s critical that brokers/lessors and funding sources develop a relationship based on shared successes,” he says. “This will drive a healthy portfolio as well as innovation, quality service and program development that in the end responds to the needs of the customer.”