Industry Leaders Brace for a One-Two Punch: Issuers Must Consider New ‘What-If’ Scenarios
by Susan Carol May/June 2008
At the recent ELFA-IMN investor conference, many leasing and finance industry professionals talked about the market’s current status while those now operating on the investor side noted they’ve never seen anything like what the industry is now facing. All that anyone can do is consider new scenarios as they present themselves.
The equipment leasing and finance industry’s investor conference was a wake-up call. Reports about the economic downturn’s effect on the industry were sobering — especially those made by leaders who’ve successfully navigated through past crises at the helms of major finance companies. Former leading equipment leasing executives who now operate on the investor side, such as Tom Wajnert and Rick Wolfert, said they’ve never seen anything like what the industry was facing on March 11 at the ELFA-IMN investor conference in New York.
We are experiencing a “market dislocation of historic proportions,” Wolfert said. In a keynote address, he showed downward pointing arrows on slide after slide, causing many of the more than 350 senior executives to squirm in their seats. He said one should not be confused between liquidity and availability. The industry is facing both tightening lending standards and increasing prices, in spite of injections of liquidity by the federal government.
“It is a double whammy hitting quickly,” said Wolfert. In fact, one slide was titled “Rolling Thunder,” showing the downward spiral of falling home prices, to subprime securitization crisis, to loss of confidence in other assets and now the frozen credit markets. He pointed to rising delinquencies and charge-offs, a leveraged loan market that has “shut down,” and a dramatic drop in asset-backed commercial paper and middle-market investment grade CLO issuances.
Wolfert said the frozen credit market has produced a “$144 billion global equity write-off in terms of just subprime and that takes $1.7 trillion in global lending capacity from the market, and this is just one asset type.”
After five years of strong economic growth, Wolfert advised that the equipment finance industry better prepare for what he described as “dislocation” that will be with us for awhile, “18 to 24 months” at a minimum. (See the Q&A with Rick Wolfert)
Wajnert, a senior advisor with Bear Stearns Merchant Bank (BSMB), said the massive deleveraging throughout the world will have a long-term and profound impact, noting it could be several years before a recovery. He explained that he is anticipating a recession and expects companies will sell units that aren’t core to their businesses and return to a more conservative business model.
(Following the conference and responding to the news that JPMorgan Chase would rescue Bear Stearns, Wajnert pointed to a WSJ.com blog on March 18 stating that Bear Stearns owns only a minority stake in the merchant banking arm and that BSMB “could likely function as well without the bailout.” He also noted that Alter Moneta, the independent leasing and finance firm that he chairs, is doing fine.)
Concerning the much-anticipated contraction in the industry, Bruce Kropschot, a well-known industry M&A advisor, said stronger companies may hold off on selling, waiting for a better price but, at the same time, they will need to develop better economies of scale. He noted that the industry will see an increase in the sale of distressed companies that don’t have enough funding to weather a long-term economic storm.
Mike Fleming, a former Equipment Leasing and Finance Association president and now an Alta Group consultant, said that although he and Joe Nachbin, an Alta principal, spoke about due diligence last year at this same conference, it was different now because due diligence must be far more future-oriented. It must now also include looking at recovery plans and corrective actions. There’s going to be more interest in origination platforms and models, to see if they are scalable. In fact, Fleming said most companies will have to change their whole business model and better manage risks.
John Callies, a general manager of IBM Global Finance (IGF) and a self-described “IBM lifer,” said IGF expertise in managing risks enabled the company to continue providing a profitable return to shareholders. He said its biggest opportunities — and challenges — are in supporting parent company expansion in emerging markets, and adjusting the business model from hard assets to more software financing.
The annual conference (now in its seventh year) connects investors and issuers who share insight on the criteria that investors use to evaluate potential issuers and vice versa. The program generally provides an economic overview from the industry’s perspective. Last year, various investor panelists spoke about their interest in securitizing select asset categories.
This year they spoke more favorably about companies that had the ability to sustain growth organically and build into various spaces with robust platforms and systems that are designed for future opportunities. They are looking for companies that can sustain themselves through the downturn, such as the fortunate ones that over capitalized when infusions were faster and cheaper.
Debbie Adami, vice president, Securitization Finance, AIG Global Investment Corp., is looking for double-digit returns. She provided the following advice:
Choose your bankers wisely, those with experience in your asset class
Demonstrate your company’s performance
Show incremental costs
Drill down to historical data
Show that the company can support itself without securitization
Rian Emmett, vice president, Key Equipment Finance Lease Advisory Services, said the company is looking for a deep information base, underwriting policies, corrections, proven systems, solid financial strength, diversified funding strategy, collections, policies and documentation, as well as good primary and secondary management, when evaluating opportunities.
“It is not just lunch anymore — there may be several days of exploration,” added Tom Glanfield, an independent consultant. He estimated that some 40% to 50% of people who wanted to come to market were unable to show well this year and “drive the right type of performance in their assets.” They were unsuccessful on the liability side because they had nothing to show. “When you go that first time [for funding], you need to be well organized.”
Craig Weinewuth, CEO of Mericap Credit, said he would access the term marketplace this year and put facilities in place for this, but his company had not put excess liquidity in place, so he added: “Now, we are knocking on doors of banks and looking for that excess capacity.”
Some funding sources are sitting on the sidelines, while others are advancing conversations with leasing and finance companies, but delaying decisions.
Financial Federation Corporation CFO Steve Groth said the company is one of the fortunate ones that overcapitalized when capital was more readily available. He advised seeking a whole variety of financial paths with long-term commitments from the banks. He noted “a major drop in securitizations from July through January.”
He said in the past there was complacency in the industry with conduits because they were very available and stable, but renewing them now is going to cost more.
Jeff Hilzinger, CFO of US Express Leasing (USXL), said there is still a strong secondary market for whole leases so those with access to secondary markets will be more liquid, adding that “is an important psychological thing for banks, [the market value of their collateral].”
“Anything unique or novel is working in an issuer’s favor,” said Howard Milligan, a partner with McDermott Will & Emory, LLP. He said securitization thrives on certainty, and there is too much uncertainty. On a positive note, he said the fundamentals underlying these transactions are not being called into question. He said the industry is suffering from the infectious spread of problems from other financial services.
Todd Plotner, a partner of Chapman and Cutler, LLP, representing small- and medium- ticket companies in structured finance and securitizations, said there are still deals getting done, but “more slowly and typically at higher spreads with relationship banks.” He advised spending time on relationships with long-term financial partners, and expanding existing equity.
“Our role has switched to helping our clients on a lot of day-to-day problems that have arisen … We’re hearing more inquiries from borrower-issuer clients about the availability of their facilities and making sure they don’t hit defaults.”
With regard to capital market funding, Evan Wilkoff, a Wachovia director, said his bank is more willing to lend on-balance sheet as opposed to off-balance sheet. He suggested it would be next to impossible for a first-time issuer to access the current market. In his presentation, one slide noted that “as of December 2007, four structured investment vehicles had defaulted accounting for $21.4 billion and another 13 SIVs accounting for $137.9 billion have been moved back onto their sponsors’ balance sheets.”
Hilzinger suggested the broker model would work best for anyone starting now. “The key would be to build a strong origination platform, sell on a whole lease basis and originate in such a way that you don’t have to service them.” He said the company would need to bridge itself financially through this dislocation and build over time, because one can’t raise meaningful debt capital right now.
Frank Cirone, CEO of Velocity Financial, said he had a different approach from other startup executives. Velocity’s strategy was to fill out the entire capital structure. His group of ex-colleagues from Comdisco raised junior capital and also one-off, non-recourse financing with lenders in 2007. When they closed, the markets were starting to “turn sideways,” he said. Nevertheless, he described his company as “sitting on $300 million of dry powder,” and fortunate that it capitalized when it did.
Main Street Bank CEO Tom Depping said his company is originating small-ticket leases in franchise, health and fitness, and other niches. While the company started with capital from high net-worth individuals, it is currently competing for its third equity raise.
Being a bank first gives the company the advantage of stable funding, he said. However, a disadvantage is the regulated environment, he added. “Regulators want to put us in a box and compare us to all the other banks of our size,” but he said the company is quite different because its primary business is leasing.
On a positive note, he said the Texas economy is good with oil prices up and home prices more steady than in other regions. Depping, who was with First Sierra in the late 1990s (sold to American Express in 2001), said that in the 1990s the company had been very reliant on securitization. In fact, Depping completed more than $2 billion in securitized dept financing while president of SunAmerica Financial Resources from 1991 to 1994.
A more stable funding strategy now might be starting with a bank.
Utah Industrial Banks
The Utah industrial bank (UIB) concept was addressed in a new panel at this year’s conference, with the Utah Commissioner of Financial Institutions presenting on the UIB regulatory landscape. The Marlin Business Services application, which began in 2005, was cited. (The application approval was announced several days after the conference.) The delay was due to the investigation of a similar application from Wal-Mart — which received a lot of scrutiny and slowed the approval process for others.
Six more states have industrial bank legislation including Minnesota, Colorado, Indiana, Nevada, California and Hawaii.
Attendee John Semon, founder of industry networking platform Lessors.com, asked, “Whatever happened to the days when we would look at the challenges in front of us, put our heads together and identify how we are going to navigate through this?”
Ken Bentsen, president of the Equipment Leasing and Finance Association (ELFA), said that during much of the huddling between sessions, people were exchanging their outlooks for public and private securitization. “The situation right now is really mostly about confidence,” Bentsen said. “There is still demand and there is still capital. There are still deals being done, he said, though they are mostly on the private side.”
The ELFA had contributed to the language in the federal government’s stimulus plan and Bentsen said he felt that it had a stronger psychological impact than a fiscal one, but he said the Federal Reserve’s actions in March (while not without risk) are appropriate.
Another positive note came from Brent Hall, founder and CEO of Pinnacle Business Finance, who said his Seattle-based company raised capital, grew, diversified and created three channels for origination and four tiers of business. He expressed appreciation for good funding partners and said he feels he is in a good place.
It is uncertain how long the downturn will last. Chapman and Cutler’s Plotner said, “It is a good market class and clearly this market will come back. Once investors get their own liquidity problems under control, we will see a large boom in term securitizations.
“There weren’t many discussions about deals getting done [on March 11] … the markets are too interconnected and too broad … and you can’t simply go into a huddle and work this out… It was a wake up call about how difficult this market is.”
Susan Carol, founder of Susan Carol Associates, is a niche communicator in equipment leasing and finance, technology and healthcare. She has provided freelance reporting for the Monitor since 1989. She can be reached via e-mail at firstname.lastname@example.org.
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