For the U.S. economy and the equipment finance industry that provides capital for fixed assets, 2019 may seem like a generation ago. Industry leadership faced the multifaceted fallout from the ongoing COVID pandemic. When we emerge on the other side of this crisis — immunized and with masks off — we will be looking upon the scattered remains of an unprecedented perfect-storm set of circumstances.
David Wiener, Managing Director, The Alta Group
Yes, 2020 Is Different from 2019
Sales representatives continue to encounter lower demand for many equipment types they have traditionally financed. Credit underwriters have directed their organizations to cease financing indigent industry sectors that have been especially hard hit through various state-mandated lockdowns. Portfolio managers have been balancing forbearance and work-out requests at an unprecedented pace. The staff within corporate treasury departments have scrambled to ensure adequate liquidity. Asset managers are just beginning to handle repossession and remarketing of returned equipment from obligors who have thrown in the towel.
More broadly, executive leadership has been challenged to reactively redesign their organizations on the fly to be sustainable within the new work-from-home staffing model. Maintaining a corporate culture that echoes the company’s mission statement requires communication adaptation in the use of Zoom, WebEx, LoopUp and other video conferencing tools including Microsoft Teams and Slack.
The technology platforms that operate all aspects of equipment finance functions have been stress-tested like never before. Many organizations had instituted back-ups and redundancies as part of their short-term disaster recovery initiatives, but no organization could have anticipated the long-term requirements for company-wide staff access to critical data and work process queues from each employee’s home laptop.
Eleven years ago, I wrote about the subtly changing economic landscape that was seemingly going unnoticed within our financial services community until we were startled awake during the liquidity crisis that triggered the Great Recession. The warning signs of financial engineering problems went undetected until a full financial panic ensued, requiring massive federal intervention. That article, entitled “Frog in the Kettle,” was published in the Nov/Dec 2009 issue of the Monitor magazine.
The onslaught of this 2020 economic downturn is vastly different than the frog in the kettle syndrome of 2008 and 2009. The change of fortune in 2020 was fast, and the effect was immediate. No growth economy lasts for decades. The inevitable economic downturn anxiously dreaded for the past several years had finally made landfall. But it made a surprise entrance triggered by the arrival of a contagious virus birthed at a wet market in Asia.
The Unique Perspective of the 2020 Monitor 100
Our 2020 financial state of affairs is historically unique. For the first time in history, any armchair economist could confidently declare in the first fiscal quarter that the year 2020 would register a decline in GDP and corresponding fixed asset sales.
The 2020 Monitor 100 leaderboard that we are viewing now on our laptop screen will precisely mark the exact peak of this record-long 11-year economic expansion. Never in the past 30 years could we look at a Monitor 100 listing in real time knowing that the next year will present lower new business volume and smaller portfolios.
As new business originations will look markedly lower when the 2021 Monitor 100 for fiscal year 2020 is published, it may be tempting to dismiss the 2020 Monitor 100 given the current year’s seismic plate-shifts underfoot. Despite a somber year that continues to unfold with more surprises, leasing history offers many lessons that can be utilized as a competitive advantage.
The four years prior to the Great Recession of 2008 showed average annual compounded growth of 7.7% among the Monitor 100 companies, peaking at $228 billion of new business originations in 2007. This was followed by a 18.9% compounded decline from 2007 to 2009. The most recent four years showed a renaissance of growth, with the 2016 to 2019 annual new business origination volumes following a pattern quite similar that of 2004 to 2007.
While recession-driven economic corrections can be steep, growth can often resume with a market reset, particularly with proactive federal intervention. Well- positioned equipment finance companies will address issues and remain battle ready, poised to seize upon growth opportunities as the tide turns on this economic cycle.
The largest equipment finance companies dominate the Monitor 100, with the top 25 alone holding a commanding market share that exceeds 80% of all new originations. It may not be apparent that these top 25 companies tend to be the most adversely affected by declines in equipment finance demand unless one views each of the recent Monitor 100 lists. The volume for the equipment finance firms ranked below the top 25 did not suffer the same dollar volume contraction during the recession.
This offers promise for mid-sized equipment finance companies. Smaller, less bureaucratic organizations can be more proactive in their ability to digest and adjust to market changes. Absent an internal corporate demand for immediate scale, mid-sized finance firms can quickly test opportunities as they explore new market segments. Being nimble does have strategic benefits.
Common Market Characteristics in an Economic Downturn
When faced with uncertainties resulting from a recessionary economy, companies instinctively retreat to their core competencies. This was apparent in the 2008 to 2010 Great Recession. Many equipment finance organizations faced challenges ranging from absence of capital to portfolio scrutiny, which triggered a sabbatical from the traditional demands of ongoing portfolio growth. C-suite-issued declarations to exclusively serve core clients was widespread. Many banks retreated from the national market and were only willing to assist customers in their bank branch franchise area. There was a marked departure from purchasing indirect third-party transactions. In this 2008-2010 timeframe, manufacturer captives stepped up to bridge this unfamiliar financing vacuum and support parent company sales efforts. Captives began taking proactive responsibility for financing a greater share of their own equipment for their customer base. As the economy recovered and market share competition returned, the chase for achieving volume targets incited renewed pricing competition in the 2013 to 2019 timeframe. Serving core customers became insufficient to meet origination volume goals. Once again, many looked to indirect / third-party transaction providers to extensively supplement core business volume originations.
Captives acquiesced some product financing to the low-priced players in the market, and their market share normalized from one-half in 2010 settling back at the more customary one-third of all equipment financed in the U.S. Should an abnormal market economy persist, expect captive finance companies to control their destiny and ensure no interruption of parent company sales by again engaging in a more active financing strategy.
The delivery of equipment finance products with consistent quality is paramount in any season of disruption. The ability to provide an unfailing customer experience with no loss of speed in delivering proposals, credit decisioning, documentation and funding in the face of work from home is paramount to preserving market share and being poised to benefit from the economic recovery.
In every past economic correction, several companies were unprepared and failed to survive. Equipment finance firm casualties abound from the combination of underdeveloped strategies, inadequate controls and poor execution. The onset of a recession works to accelerate such companies’ demise — resulting in the company’s sale or portfolio liquidation.
In the aftermath of the Great Recession, we witnessed GE Capital stumble. Atop the leaderboard since the 1991 inception of the Monitor 100, GE Capital faded from the general equipment finance field. With their 2009 request for federal assistance, GE was rewarded by being branded a SIFI (systematically important financial institution). As this event was unfolding, Ken Bentsen, past ELFA president and former Texas congressman, remarked, “Rue the day you make the federal government your partner.” GE struggled to adapt their entrepreneurial business model under the watchful eye of bureaucratic bank regulators’ oversight. By the middle of 2015, GE had divested itself of their general equipment, vendor finance, and transportation finance platforms, choosing to focus only on equipment finance offerings complementary to the medical- and aircraft-related equipment they manufactured. GE has come full circle, now operating as a captive—an echo of how they started in 1932.
The freefall of GE Capital presented multiple white knight opportunities for large acquisition-hungry banks with strong balance sheets and ample liquidity. This one event dramatically changed the equipment finance landscape forever. With the sunset of the GE Capital era, U.S. banks now represent nearly 50% of the new equipment finance volume within the Monitor 100—almost double their market share of a decade ago.
With the sunset of GE Capital as the perennial top equipment finance company, banks and captives have grown to a combined 84% market share, up from 58% in pre-recession 2007.
Unlike the post Great Recession sell-off, here in 2020 there are no apparent large equipment finance companies that may be potential prime targets for acquisition on the order of a GE Capital five years ago. But some mid-sized equipment finance operators privately face either liquidity challenges, portfolio mitigation distractions or origination underperformance because of problems in the markets they were designed to serve. If their portfolio quality is stabilized, they could seek a merger partner. In the meantime, these companies likely will have some level of dissatisfied customers who could be solicited and courted — offering competition a short-term window to poach customers and grow market share at their expense.
While market disruption can offer opportunities, failure to adapt will undermine the value proposition in the eyes of customers and work to threaten relevance. When employed at GE many years ago, water cooler banter included the wish for a good recession to bring back sanity in transaction pricing and bring to the surface some suitable acquisition opportunities to accelerate growth. The hunter can become the hunted or the victim.
Recessions: A Growth Environment?
Recessions have proven themselves to be fertile times for the launch of healthy start-up organizations. Here are some representative companies that were launched during past economic downturns:
Great Recession (2008-2010): Airbnb, Groupon, Instagram, Pinterest, Slack, Square, Uber, Venmo, Warby Parker and WhatsApp
Dotcom Bust (1999-2001): Salesforce and Google
Great Depression (1929-1933): Disney, Hewlett Packard and Revlon
The Long Depression (1873-1879): GE and IBM
Ninety years ago, one company was on a mission to explore effective ways to support the sales of the products it manufactured. This was the infancy of electricity, and American homes were prime target markets to be wired. But Americans were challenged just to put food on the table, much less be persuaded to afford products that would preserve or prepare food. In 1932, GE Credit was formed as a division of General Electric to offer payment terms for the purchase of GE refrigerators and stoves.
Captive finance products have advanced over the past 100 years from serving consumer customers to serving corporate customers with sophisticated products ranging from leases to cost-per-use to managed service offerings. When an equipment finance vacuum surfaces in each economic downturn, manufacturer captives have characteristically risen to serve the top-line revenue interests of their parent organization.
Hidden in the plain sight of 2020 exists unique opportunities to exploit in the fog of uncertain economic disruption. When the Monitor 100 and Monitor 101 are published a year from now, we will inevitably find a changed leaderboard, discovering healthy equipment finance players that have risen to adapt to a changed landscape and incorporated innovative products and processes to meet a wider array of customers.
Our pandemic economy — and its fallout to the equipment finance community — is indeed a crisis, but it’s not one to cower from. It is dangerous, but it also represents an extremely rare opportunity to assess and distinguish processes and to refine or even redefine the core customer-centric value proposition. Luck does not have to run out. Make this COVID crisis season your own dangerously good opportunity. In the words of Roman Philosopher Seneca in 50 A.D., “Luck is what happens when preparation meets opportunity.”
Take a hard look at this Monitor list. Who are you? Who are they? Are you a poacher? Are you at risk of being poached? Are you a hunter? Or are you among the hunted? Hope to see you moving up on the Monitor 100 leaderboard in 2021.
Business leaders have largely embraced the rapid introduction of home working and digital processes as an inevitable necessity. Though the global lockdown has rapidly accelerated trends in digitalisation, seeing many asset finance businesses moving their operations entirely online in a contracted timescale, the direction of these developments is not a new concept for the industry.