Partnership in the Trenches: It Pays to Pick a Lender With Sector Expertise

by Eric Miller Monitor 100 2015
In a marketplace flush with borrowing options, a lender with sector expertise stands above the shoulders of generalists. Eric Miller, group head and managing director of CIT Capital Equipment Finance, examines the worthy approach of seasoned lenders — those who know the ins and outs of an asset class while understanding the importance of cyclicality and flexibility.

One of the most common complaints I hear from midsized business owners is that their lending partners don’t understand their business. It’s no secret that credit is more available today than it was a few years ago. As we start to see the financial crisis in the rearview mirror, the number of financial institutions looking to lend grows.

This renewed interest on the part of new or returning lenders is playing out in the equipment leasing and financing space. Equipment and software investment grew at a healthy 5.8% clip in 2014, and the ELFA Monthly Leasing and Finance Index reveals that the industry’s new business volume was up 12% in the first four months of 2015. This increased investment is luring lenders who were once reluctant to extend credit in industries where they have little familiarity. Banks, for instance, are jumping back into equipment financing because historically low interest rates are pushing them to find markets with higher margins.

Just because more lenders are active in equipment financing today doesn’t mean they make good lending partners. A lack of expertise across a wide variety of sectors exposes general lenders to bad decisions on both ends of the credit spectrum. On one side, they are more apt than seasoned equipment financing companies to turn down credit applications that don’t fit into the specific box they’re targeting. On the other, they are more likely to pull the plug on financing — or change the terms — at the first sign of trouble.

Understanding Cyclicality

The problem is the approach a typical lender will use to render a decision on equipment financing. Most of these institutions have defined criteria for making credit decisions. One parameter may be how leveraged a company is, or the amount of debt relative to cash flow the business generates. A crane equipment company, for example, requires far more leverage than a food processing firm, but they both look the same to a general lender. It doesn’t matter if an industry is highly levered — if a lessee’s ratio doesn’t fit in that box, they’re out of luck.

Borrowers may also need to look elsewhere if their industry has experienced tough times recently. Consider the California-based food manufacturer trying to obtain financing right now amid one of the worst droughts in the state’s history, which has caused the company’s raw input prices to jump. While the unseasoned lender won’t look twice at such a request, one with expertise in the food industry will dig deeper and ask important questions. How is the company positioned to weather the higher costs? How did it fare during past episodes of a similar nature? What specific steps did it take to mitigate losses, obtain materials from other sources and return to profitability?

Asking these questions is just as important when business is booming. The lender who signs off on an equipment loan or lease without considering such issues is much more likely to be taken by surprise — and repossess the assets — if the market faces challenges. Lenders who know an industry will be in a better position to work with clients through the next downturn because they already have a plan for it. Not only will they help a borrower survive the challenging period, but they will facilitate its growth when market conditions improve.

The experienced equipment lender not only understands that most businesses and industries are cyclical in nature; they know what’s driving those cycles. This information makes them much more inclined to extend financing where others hold back.ange the terms — at the first sign of trouble.

For example, a quick scan of the headlines reveals that printing companies are facing fresh challenges due to the digitalization of information. But a deeper look reveals that demand is pretty constant in other areas of the industry, such as the need for labels. This is the kind of analysis that eludes lenders who are only looking for financials that fit a cookie-cutter mold.

Asset Awareness

Many new entrants to equipment financing cut their teeth in the construction and transportation industries and try to apply that experience to other sectors. One of the shortcomings of this approach is that assets vary widely between industries. Obtaining the residual value of a piece of equipment in, say, the marine or manufacturing sectors, isn’t as simple as checking the Kelley Blue Book. Many industries don’t have thriving secondary equipment markets, and values are much more difficult to assess.

Very few pieces of equipment are shared across sectors, and assets depreciate at different speeds. Understanding the factors that drive the value of a specific piece of equipment helps a lender gain comfort when deciding to lend and then developing terms.

The media and broadcast industry provides an example of how assets that would seem to be at the end of their lifecycle can still retain value. For about 50 years, all television broadcasts worked off the same format before giving way to high definition and the rapid transformation that technology brought with it. First, there was 720p progressive scan, then there was 1080i, and now there’s 1080p. The fact that broadcasting technology is aging rapidly, however, doesn’t necessarily mean that older equipment is obsolete.

These days, most major networks broadcast in high resolution, but a niche market still exists for standard definition broadcast trucks. In many cases, this equipment has achieved a new lease on life by supporting high schools and small markets broadcast sporting events. That level of demand, though a step down from before, means that the equipment still carries some value.

Knowing where secondary markets are likely to exist is a factor that a sector-focused lender will work to understand before approving or declining a financing application. Even when those markets don’t exist, there still may be plenty of residual value to be recognized in a bankruptcy proceeding.

Flexibility Over Rigidity

When a borrower signs on with a lender to finance their equipment needs, they want to partner with someone who values flexibility. Rather than approach a financing request with a pen looking to check boxes, a lender should start working from the get-go to understand the business in order to find the perfect financing solutions. The right lender will have a full range of financing options to consider, not just a single product it is pushing at that moment. For example, if a business is seasonal, a loan that offers seasonal payment terms may be a better fit.

A great lender should also work proactively to come up with customized, innovative solutions that align with the borrower’s business model. One way an experienced partner can support a growing business is by helping to tap hidden sources of liquidity within the business’ existing asset base. Equipment often retains more market value than is left on the loan as it ages. In some cases, companies in good financial standing can obtain a secured loan against that equipment’s advanced value, which gives them access to new funding that might help them grow faster than previously projected.

Often, a lender that rolls up its sleeves and digs into the business can find new reasons to go forward with a financing package. At CIT, we recently agreed to finance a marine company that was levered at a high rate. As we got to know the company, we realized that an investment-grade firm had guaranteed more than half of its debt through a long-term agreement. This additional information changed our calculus for executive the loan and enabled us to help provide the funding that the company needed to grow its business.

What can a lender do to ensure a borrower believes that they are signing on with the right financing partner? Ask the right kind of questions. Lenders who fixate on why one quarter’s worth of financials weren’t in line with the rest of the year probably don’t know much about the business or industry. Lenders who approach a deal much like a proxy for a board member—understanding business fundamentals and growth strategy—will typically exceed the expectations of a prospect or customer because their interests go beyond the scope of the financials. Astute lenders will be focused on what a company is doing now to ensure success in the future.

When a borrower finds the right lender, they will be wise to hold on to the relationship. That type of lender will be there through thick and thin. When challenges appear, borrowers are relieved to have a partner who is committed to staying in the trenches with them, rather than someone scrambling to get out.

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