John McQueen President & CEO, Wells Fargo Equipment Finance

David Merrill President, Fifth Third Leasing Company

Walter Rabin 
SVP, Capital One Equipment Leasing & Finance

Kenneth Turner President & CEO SunTrust
Equipment Finance

Adam Warner President, Key Equipment Finance

Last September’s Monitor roundtable of leasing executives focused on the sluggish economic recovery and the threat of a double-dip recession. The housing market was slumping and loan demand was soft. Overall industry confidence was waning, yet these leaders were optimistic in adjusting to the new economic environment, and they looked to 2011 to be a stronger year.

As we again discuss the state of the industry with a select group of leaders, two things remain unchanged: The economy is still struggling to rebound, and they remain optimistic even in this slow-growth environment.

Industry Confidence
According to data from the Equipment Leasing & Finance Foundation’s Monthly Confidence Index for the Equipment Finance Industry (MCI-EFI), optimism is losing ground. The MCI-EFI for September 2011 was 47.6, down both from the year-to-date high in March of 72.4, and last September’s reading of 56.9.

However, Walter Rabin, president and CEO of Capital One Equipment Leasing & Finance, takes a practical approach to analyzing confidence data: “What we are seeing here is the classic optimism that is inherent in the leaders of this industry trying to come through while we have a lot of other economic factors that put us a little bit on tilt. Despite these negative factors, people in the industry are generally upbeat — maybe that week your team won a bunch of deals, you closed a big transaction and you’re hearing good things from the field — and that is what puts you back in an optimistic mode.”

Adam Warner, president of Key Equipment Finance, notes that there was a lot more optimism about an economic recovery in the first half of this year, but with waves of bad news this summer, the tide has changed. “The events going on in Greece and other struggling nations have caused a significant amount of pressure on the EU. When you couple that with the U.S. government barely avoiding default by raising the debt ceiling at the eleventh hour, the market and the global economy went into a tailspin. Since then there has been more talk about a double-dip recession and slowing economic growth again. Things have almost come full circle in a year.”

Fifth Third Equipment Finance’s president David Merrill agrees that the ongoing stream of bleak economic news erodes industry confidence, noting examples such as Federal Reserve chairman Ben Bernanke proclaiming significant downside risk to the economic outlook and the International Monetary Fund’s director and chair Christine Lagarde announcing drawbacks of global growth estimates from 4.5% to 4% and U.S. growth estimates from 2.5% to 1.5%. “Over the past year it’s been two steps forward and one step back. It’s starting to feel a little bit like the Washington policy makers have used up all their chips,” he adds.

Nonetheless, Merrill has hope for the equipment leasing and finance industry, “I think for our sector there are some bright spots out there. We have the benefit of forced replacement cycles in certain asset classes and the prospects for bonus depreciation to continue. If you look at the growth estimates for our industry, they range from 5% to 8%, so we are well positioned relative to other sectors. But, realistically we have to recognize that it’s going to be a slow growth environment for the next couple of years,” he says. Merrill adds that remaining optimistic is buoyed by his group’s portfolio, which has held up well through the downturn.

At Capital One, Rabin remains upbeat, “You feed off of positive customer experiences and what your business development people in the field bring back to you about how they are feeling. We’ve had a solid year through all of our business channels. We have very experienced people who have gone through up and down cycles and acknowledge that this is a unique one in terms of length of time and the depths. But, we think the worst is behind us even if we are experiencing some instability. No one here feels like we are heading into a ‘Great Recession’ like we may have felt at the end of 2008 or 2009.”

SunTrust Equipment Finance president and CEO Kenneth Turner says he doesn’t believe we’ll have a double-dip recession but foresees slow growth for the next 12 to 18 months. “It doesn’t surprise me that the confidence index is down, but when I talk to people I don’t hear that. The bottom is behind us. We are moving up. We are not moving up fast enough though, and that’s frustrating. But, portfolios have not been better in years. Charge-offs are down. Delinquencies are down. Companies’ balance sheets are looking stronger. Credit applications based on the last report that I saw are slightly up year over year.”

John McQueen, president and CEO of Wells Fargo Equipment Finance, notes that the industry has been well positioned compared to other bank businesses because of a rebound in demand thanks to an 18-month replacement cycle. However, he predicts slow demand growth over the next 18 months because the replacement cycle is slowing. “Companies that normally would have replaced equipment in 2008, 2009 started to replace it later in 2010 and 2011. We’ve seen a nice rebound in a very slow economy, but I think it’s more a replacement cycle more than a demand cycle driving the volume,” he explains.

Warner adds, “I am optimistic about our upcoming election in 2012. No matter what happens, there needs to be some type of change with the interaction between the administration and Congress. The current gridlock situation is somewhat crippling to the economy and quite frankly it’s tiring on businesses and consumers.”

Loan Demand — What’s Hot and What’s Not
According to the Federal Reserve’s September Beige Book, demand for business loans since the July report remained unchanged or weakened in the New York, Chicago, Kansas City and San Francisco districts, but was moderately stronger in the Philadelphia, Cleveland and St. Louis districts.

Merrill agrees with the report’s mixed assessment. “Some of the industries we support have shorter replacement cycles, like IT and trucking. You can only take the technology or equipment so far.”

Rabin says he has seen an increase in loan demand since last year in transportation, infrastructure-related construction and municipalities. However, he explains, “An increase from where we were a year or two years ago is not hard to achieve, but I think we are approaching a more normalized demand level supported by the need for replacement equipment rather than the need for increased capacity.” Areas remaining soft during the slow recovery include the printing industry and retail-oriented businesses, according to Rabin.

Turner predicts that industry loan demand is going to continue to be slow with growth in the low to mid single digits. He sees opportunity in healthcare, technology and the municipal space, as well as energy, particularly solar and wind. The most challenged markets continue to be construction and aircraft, he says.

Merrill adds, “In the sectors that have short replacement cycles, we’re seeing mid to high single-digit growth prospects out there. Industries that don’t have those short replacement cycles, perhaps manufacturing where it’s really demand driven and you can really extend the life of the equipment if you need to, I think it’s going to be low single-digit growth.”

According to McQeen, Wells Fargo Equipment Finance runs up to 12 different industry business lines and is seeing demand across all of them. He adds, “The transportation business, especially trucking, is up substantially. The construction business is up slightly. Medical is up year-over-year, although it’s a complex industry to get numbers on. We’ve seen a nice rebound in manufacturing over the last 12 months. And we’ve seen some growth again in materials handling.”

At Key Equipment Finance, some of the most active areas are technology infrastructure, hardware and software, both in the commercial and government leasing sectors, according to Warner. Areas slowing down a bit are some of the larger healthcare and energy installations. “There’s a lot of activity in regard to wanting to acquire equipment, but purchase dates are being pushed out into 2012,” he explains. “The issue now is purely demand and not liquidity. Key is in a position of significant excess liquidity and would love to put it to work. The reality is that we need people to want to borrow money to be able to lend it.”

New Business Volume
Based on findings from the Equipment Leasing and Finance Association’s Monthly Leasing and Finance Index (MLFI-25), overall new business volume for August was $5.7 billion, up 33% from volume of $4.3 billion in the same period in 2010. August volume was unchanged from July. However, compared with June volume of $7.3 billion, there was a 22% decrease in July. Year-to-date cumulative new business volume in August was up 25%.

At Capital One, Rabin anticipates a meaningful year-over-year increase in new business volume in 2011. “We think our relative new business origination growth is strong in an economy that is still trying to get its footing, but we have seen growth across all of our business segments. We anticipate 2012 volume growth at similar percentage levels, albeit at larger absolute dollar basis because our portfolio is bigger,” he explains.

At Wells Fargo Equipment Finance, McQueen notes, “Our business had an excellent first half and third quarter in new business volume. From an overall performance standpoint, we’re forecasting an excellent 2012 because our portfolio has returned to a strong position, and our asset quality costs are in the lower part of the range where we expect them to be. So, there’s strong profitability from our revenue. The challenge is how to continue to grow volume and evaluate what’s creating that demand.”

According to Warner, the state of the industry is a reflection of the overall condition of the economy. “I still believe the equipment finance and leasing sector is a leading indicator for economic activity and health in the market. Typically, companies that are acquiring equipment are going to be investing in production. This will improve durable goods orders and potentially reduce unemployment. But it all begins with companies purchasing and financing equipment to make that happen,” he explains.

Over at SunTrust, Turner is positive: “We’re going to have a strong finish. We have a growing pipeline, and we see that cascading into 2012. We are forecasting double-digit growth in new originations in 2012.”

In addition, Turner believes that despite concerns about accounting changes, the industry differentiates itself by its ability to manage assets as a lending product. He explains that banks are lenders of money, and equipment leasing and finance specialists are asset experts. And, therein lies the value of the industry. “Whether you’re bank owned or uniquely positioned as a captive, or if you’re an independent and serve a particular niche, there’s a need.”

Lessons Learned
Through navigating their respective companies through the recession and wobbly recovery, these industry leaders are quick to note some positive take-aways.

Explains Merrill, “One lesson is that if credit quality is weak in good times, what’s it going to be like in bad times? If your margin appears too thin for a risk, it probably is. A lot of people in the industry were able to refocus on what their core business really is and exit unprofitable segments or business lines. All in all, we got back to basics.”

Working through the cycle has allowed Rabin and his group to reconsider the kind of customer they want to retain and attract. “It’s given us a chance to refocus where we want to grow once the economy starts to expand, and we actually have been able to execute on that to a large extent this year and focus on companies with larger, more tested balance sheets. Our institution is committed to becoming a large player in the healthcare world, including healthcare equipment finance, so that’s something we see optimistically going forward.”

Turner adds, “We are a lot more focused and strategic in our decision making. We’ve gotten smarter about where we want to play and why we want to play, and we’ve built skills to do that. We’ve taken the opportunity to get more efficient. And, we’ve had the opportunity to bring in exceptional talent due to the industry disruption.”

At Key Equipment Finance, Warner notes that despite the troubled economy, his group has enjoyed some positive outcomes. “During the recession we refined our business model to concentrate on markets where we are determined to be a very relevant and material player to our clients, rather than focus on industries saturated with competition. Candidly, if there were to be a double-dip recession, I think we’re much better positioned than the first time around,” he explains.

Going Forward
Although lethargic economic growth seems to be on the horizon for 2012, our roundtable participants say the equipment leasing and finance industry will survive, if not expand, despite the challenges.

Regarding the industry as a whole, McQueen says, “The competition is different than it was three or four years ago. I expect within the next 24 months for it to return to something closer to normal. Smaller banks aren’t as engaged as they might have been in the past, but I don’t think that’s a trend; I think it’s a short-term situation. They are concerned about their capital levels and lending into this marketplace, so they are not as competitive. The big banks are still looking heavily at their own customer base and larger transactions. That marketplace is very competitive.”

Rabin notes, “As things in the financial sector settle down there is more demand for asset generation including equipment finance. The bigger question is whether customers use cash more than they ever have because they have been stockpiling it. It could have a dampening effect for new business.”

Looking forward, Warner sees Key as well positioned due to its size. Dodd Frank has created some expense challenges for banks but in particular, he explains, small banks may be forced to seek acquisitions or go out of business because they cannot pay for the required activities to be compliant with extensive regulations. On the other hand, the biggest banks continue to be under fire, with many of them being sued by the federal government for misrepresentation on mortgaged-backed securities. “I think that banks in the tenth- to 25th-largest range could be very well positioned because they have the resources to manage compliance with Dodd Frank and other regulations and can provide products and services without being overwhelmed by the regulations coming from Washington,” he adds.

According to McQueen, to build strength moving forward, the industry must do a better job of effectively utilizing technology, especially in fostering customer relationships. “The industry needs to find ways to continue to improve its efficiency through greater automation and use of technology. We have to be more focused on how we improve our interaction with our customers versus how we process a deal quicker inside the business. We’ve talked about it for years, but we have done very little about it as an industry.”

Turner adds, “Our industry is still strong. If you’ve made it through the recession, I don’t know how you can’t be bullish. The issue is we all feel it can’t happen fast enough.”

Lisa M. Goetz is an associate editor of the Monitor.