The Time of Capital Investment

by Michael Gay 2014
Good times for equipment finance are just around the corner. Looking at the number of banks and their leasing affiliates that recently jumped into the market, one might conclude that good times are already here. NXT Capital's Michael Gay asks, 'Are they really?'

Financial media, from Bloomberg to The Wall Street Journal, predicted that 2014 would be the year of renewed capital investment. In March, the Equipment Leasing and Finance Foundation’s Monthly Confidence Index reached a two-year high of 65.1%, with steady numbers throughout the summer into the most recent September report, coming in at 60.2.

Good times for equipment finance are just around the corner. Looking at the number of banks and their leasing affiliates that recently jumped into the market, one might conclude that good times are already here.

But are they really? Structural changes created by the financial crisis may have severely limited the industry’s ability to take advantage of this golden moment. They may even weaken the industry’s long-term relevance.

Banks Now Dominate

Since the financial market collapse and the Great Recession, the equipment finance industry has been dominated by banks. Traditional commercial finance lenders, specialty finance companies and independents that were once major players lost access to capital markets. Banks, with a little help from the government, were the only providers left standing and are today’s primary funding source.

However, with Basel III, new leveraged lending guidelines and a stricter regulatory environment, banks are limited to financing only companies that meet tighter underwriting requirements. As more banks compete for opportunities within this smaller group, increased pressure on spreads and lessee-friendly structural concessions are making equipment finance products virtually indistinguishable from bank term loans.

Widespread Cap-Ex Demand

With the economy approaching some semblance of health, the need for capital investment isn’t limited to companies that fit bank underwriting guidelines. Many companies with elevated financial leverage and credit ratings deeply below investment grade will continue to have difficulty finding capital. The pace at which these companies need to replenish older, less efficient assets will far outpace the rate at which banks can loosen their credit criteria.

Banks simply will not be able to meet these companies’ demands. Yet these are the very companies that offer the industry the most likely path to the growth it so desperately desires.
Many highly leveraged companies have stretched their assets far beyond normal replenishment cycles. Furthermore, growth is the only way out of their highly leveraged positions after years of aggressive cost-cutting. Improving economic fundamentals combined with a more tempered political environment offer these companies the best opportunity in years to invest in growth.

But who in the equipment finance industry will be able to respond?

Meeting the Need

Today’s equipment financing landscape calls for a new type of provider that can address the needs of below investment-grade companies — yet navigating this market demands specialized expertise. Highly leveraged balance sheets, complex capital structures and tight cash-flows require seasoned credit professionals with acumen and experience structuring transactions for these below-investment-grade companies. It also requires significant funding capacity so a provider can fund and hold transactions, as there will be few opportunities to syndicate.

Industry-Wide Opportunities

Although banks cannot fund large-ticket financing for most highly leveraged companies, they can still serve this market. As bank equipment financing platforms have proliferated, they are likely touching a large population of companies with significant pent up cap-ex demand, as well as high leverage and lower credit ratings.

Banks need not turn away from these clients. Rather, banks should look to their in-house syndication groups to seek providers who have the expertise and capacity to fund into these situations.

Serving highly leveraged companies offers banks two valuable benefits: First, it creates higher syndication desk fee opportunities that can offset ongoing pricing pressure. Second, it allows a bank to manage clients and prospects through the credit cycle rather than waiting for them to improve, when it will once again face hyper-competitive pricing.

To date, few banks have taken advantage of this opportunity. But the equipment finance industry and banks that dominate it should recognize that developing viable alternatives for more companies is the key to our growth and long-term relevance.

The equipment finance industry has a well-deserved reputation as a smart, creative, flexible form of alternative capital. Maintaining that reputation calls for offering meaningful financing to companies that fit the bank model and to companies that don’t.

If the industry can’t find ways to serve a full range of companies that need cap-ex financing, the consequences may be severe. Initially, we will lose the opportunity to fully benefit from what we all hope will be the year of capital investment. Longer term, we risk losing the fundamental attributes that have differentiated our industry – and ultimately, our relevance.

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