Seeing Clearly: 2017 Provides Improved Clarity for Equipment Finance Landscape

by Phil Neuffer September/October 2017
With more than half of 2017 in the books, Ralph Petta and Anthony Cracchiolo provide an update on the equipment finance industry from the ELFA’s perspective. They discuss struggling sectors and the 2016 election, improved performance in 2017 and what the association is working on and expecting in the next year.

There are few people in the world of equipment leasing and finance who know the ins and outs of the industry like Ralph Petta, president and CEO of the Equipment Leasing and Finance Association, and Anthony (Tony) Cracchiolo, current chair of the ELFA and president and CEO of U.S. Bancorp Equipment Finance.

As two of the most prominent members of the ELFA, Petta and Cracchiolo have a unique perspective on the events that unfolded in the industry in 2016, how the industry has fared in 2017 and where it is going in 2018.

Reviewing 2016

According to ELFA’s Survey of Equipment Finance Activity, new business volume rose by 2.5% in 2016. As with most statistics, that number can be used to argue both the good and the bad. On the one hand, by growing in 2016, the industry experienced its seventh-straight year with improved performance. On the other hand, the reading was a drastic decrease from the 12.4% increase reported in the 2015 survey.

Much like the data shows, there were ups and downs for equipment finance in 2016, but when shown in the broader context of the U.S. economy, the positives outweighed the negatives, with the 2.5% growth rate out-pacing the estimated 1.6% growth of the U.S. economy.

But a drop of nearly 10 percentage points in new business volume growth can’t just be wiped away with a simple explanation. There were reasons for the dip, including some struggling sectors, more replacement than expansion and the effects of a contentious election.

First, the difficulty faced by the agriculture, energy, oil and gas, mining and rail industries put a damper on the gains made by other sectors.

“If you take into account the sluggish energy and agriculture sectors in 2016, it’s not hard to understand why we didn’t see any real breakout growth in the equipment finance business,” Petta says.

The difficulties faced by those sectors had another effect, mainly on captive finance companies, which saw a 5.9% decrease in new business volume in 2016. With captives committed in large part to their respective industries, they must be viewed through a different lens than, say, independents, which happened to have a 12% volume increase in 2016.

“In those sectors where you have manufacturers that are producing those assets, their related finance arms are going to experience the same difficulties that the manufacturers do,” Cracchiolo says. “As the economy picks up, these captives’ businesses will as well, provided the asset class that they’re in is also picking up.”

The plight of some sectors took a back seat to the event that hung over the entire country in 2016: the presidential election. The equipment finance industry and the companies it serves were not immune to the effects of a year of political turmoil.

“The other wild card that occurs to me is the fact that during a presidential election, there were a lot of companies deferring their purchase decisions until the political picture got a little clearer,” Petta says.

“Businesses rarely invest when they don’t know what’s over the horizon,” Cracchiolo says.

Lastly, with uncertainty rampant and a number of sectors struggling, companies took a more conservative approach to acquiring assets, choosing to replace outdated equipment rather than acquire additional pieces.

“2016 was not a very strong year for equipment finance in the sense that while we did see better than average activity, it wasn’t in an expansion economy,” Cracchiolo says. “It was more aligned with what we call the replacement economy.”

Evaluating 2017

By the beginning of 2017, there was some clarity on the political side of things, with the presidential and congressional elections in the rearview mirror.

“Since the election, I would call it a 180-degree turn in clarity,” Cracchiolo says. “I’d say the landscape is clearer from a political point of view, and the direction that we’re going in is clearer as well. The only question is time and execution.”

In 2017, with a better picture of the landscape, industry performance has improved, as have the metrics of the U.S. economy. Petta says in July, volume as reported by the association’s Monthly Leasing and Finance Index (MLFI-25) was up 13% compared to July 2016, while year-to-date volume was up 6%, with Q2/17 continuing a positive trend from the first quarter of the year.

“The industry seems to be performing better thus far this year and industry volume overall strengthened in the second quarter. There was strong CAPEX in the prior quarter so I think the second quarter just built on that momentum,” Petta says. “We are still in a low interest rate environment. The labor markets are doing well. We have 4.4% unemployment. The equity market is still very strong. The basic economic fundamentals are there.”

As the industry gets a boost and the U.S. economy continues to strengthen, there has been a corresponding slight shift toward expansion mode for companies.

“There’s some anecdotal information we are receiving that indicates companies are expanding their operations and acquiring new assets,” Petta says.

Anecdotal evidence is not all the ELFA can point to when painting an increasingly positive picture of the current industry status, with Cracchiolo noting that both data and optimistic thought are in correlation and that people are buying.

The optimism is fueled, in part, by the improving performance of sectors that have struggled a bit more in recent years. Cracchiolo points to construction, manufacturing, healthcare, mining and oil and gas as industries that “took it on the chin” and are now showing positive activity.

But not all industries are benefiting in 2017, with the agricultural sector still stuck in the doldrums while the print business continues to struggle.

Issues and Initiatives

For all the increased clarity 2017 has brought on the political front, there are still concerns that the ELFA is firmly focused on. Two of the most important ones are reforming the tax code and dealing with financial regulation, specifically Section 1071 of Dodd-Frank.

On the tax side, Petta stresses that it is extremely important that companies continue to be able to deduct business interest and for Congress and the new presidential administration to deliver on this issue.

“The ability to deduct net interest expense is critical. Unencumbered capital really forms the life blood of a lot of companies and the raw material that they use to go to market,” Petta says. “It’s incumbent upon the Congress to get the message that to continue to deduct business interest is paramount for the overall economy to perform properly and for finance companies, in particular, to continue to provide incentives for businesses to acquire assets.”

Petta is equally concerned about Section 1071, which he says places an administrative burden on finance companies of all kinds, not just those in equipment finance.

“We’re not the only ones concerned about this. Anybody who extends credit is going to have to collect additional sensitive demographic information about borrowers and report it to the government. This information is supposed to be walled off from the underwriters in the finance company so they don’t use the information in a way that biases the extension of credit,” Petta says. “That’s a big issue for our members and anybody that extends credit.”

In Cracchiolo’s view, while regulatory compliance continues to be a challenge, larger institutions are better positioned than most to address it. Smaller companies without scale will have a much more difficult time addressing these requirements.

“When you go to a two-person company that’s building or selling a service and you’re asking for this kind of information, this presents a problem,” he says. “It probably will have a negative effect in the small-business environment. In other words, counter to what we’re trying to do by growing the economy.”

One of the ways the ELFA actively addresses this, and other issues facing the industry, is through its federal and state advocacy programs, which provide education at both the federal and state levels about the importance of the equipment finance industry to the national economy. It’s an area Cracchiolo says the association is “laser focused” on.

In addition, the ELFA continues to expand its Emerging Talent Advisory Council to encourage industry employees to get involved in the association earlier in their careers. It has developed a Women’s Council to increase the engagement of women. These two programs work hand-in-hand, as the ELFA attempts to bolster its membership and workforce as the industry evolves.

Speaking of evolution, the rise of e-leasing is an area the association is monitoring closely, and it launched an initiative to expand the use of electronic chattel paper in equipment finance.

“A good number of transactions are now occurring electronically in the absence of paper,” Cracchiolo says. “We have a working group on that from a legal as well as industry focus, and we’re making progress on positioning for this type of activity.”

While that may make for an already full plate, the ELFA is also releasing a new compensation study, continuing to develop educational resources on the new lease accounting standard and working on providing a digitized version of its annual Survey of Equipment Finance Activity.

Back to the Future

As evidenced by many of the initiatives underway, Petta, Cracchiolo and the rest of the ELFA team are already focused on next year. But what does 2018 have in store for the equipment finance industry?

“We expect that a lot is going to depend on the economy. Here we are in the eighth year of an economic expansion, and there’s no guarantee that this expansion will continue indefinitely,” Cracchiolo says. “But what we do know now seems to indicate that, but for some unforeseen event, positive industry performance should continue into 2018. Overall, our industry has proven to be resilient and adaptive. These qualities characterize this industry and are responsible for its success over these many years.”

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