Susan L . Hodges 2016-03-14 17:07:39
SO MUCH MONEY, SO FEW DEALS. It’s a normal part of the cycle in equipment finance, but the factors combining to prolong the seller’s market this year are more numerous than ever. The sale of major parts of GE Capital, mergers among banks due to problems generating asset growth and the decline of oil and gas markets are among trends making high-quality transactions scarce.
At the same time, the continued flow of new entities into the market, burgeoning liquidity and finance and banking firms’ need to grow their earning assets have created enormous demand for deals. Add to the mix declining growth in China and falling commodity prices as they affect U. S. manufacturing, and it’s not surprising whole business sectors are hurting while investors from Beijing to Boca Raton clamor for safe places to put their capital.
In advance of ELFA’s Funding Conference, April 19–21 in Chicago, Equipment Leasing & Finance magazine spoke to members of the Funding Exhibition Planning Committee regarding the state of funding. Despite the situation, the funding professionals we spoke with are guardedly hopeful about the rest of the year. They say if finance firms remain disciplined about credit structure, the industry should be able to push through current challenges and emerge intact on the other side.
Individual Influences
Eric Staczek, Senior Vice President of Capital Markets at MB Equipment Finance in Hunt Valley, Maryland, believes a lot will hinge on outcomes from the sell-off of most of GE Capital. “I’ll be very surprised if we don’t see one or two new equipment finance firms started this year by former GE Capital executives,” he says.
“There’s still pent-up demand from last year. People are looking to buy more business, and some have nearly unlimited funds.”
–Eric Staczek, MB Equipment Finance
And since new companies often look to build portfolio by buying business before their own sales forces hit the street, Staczek expects the influx of new firms to add further to liquidity and strengthen competition for middle-market deals. “GE Capital was such a meaningful and consistent player in the middle-market segment, helping other companies build portfolios,” he says. “Someone needs to replace them on the origination side.”
Companies that originate good-quality paper— and firms that buy it— will set the gold standard for funding in 2016
MB Equipment Finance is trying to do its part, Staczek says, by shifting marketing efforts to the direct-lending side of the business and increasing its front-end direct-origination force. “Early on, we focused on buying business,” he says. “Then as MB Equipment Finance grew and achieved its revenue goals, we began to focus our efforts on new channels and driving additional business. We evolved and took advantage of market opportunities that strengthened our position as a solid equipment finance company.” He adds, “I think you’ll see a lot of firms evaluating what the industry looks like without GE and how they can capitalize on it.”
“We’re feeling bullish about this year, and we have a clear mandate to add assets to our portfolio.”
–Lindsey McLorg, Bank of the West
To that end, Staczek references established firms that bought entire platforms of GE Capital’s business. “Will these firms continue to originate deals that they sell to the market, or might they have overlapping customers, prompting them to sell part of their exposure to manage that?” he mulls, adding, “It will be interesting to see how this plays out. We may see some shifts in strategy among market leaders. It will be a trend-setting year.”
Lindsey McLorg, Vice President, Secondary Markets, for the Equipment Finance Division of Bank of the West in San Francisco, anticipates seeing an increase in deal flow “as a result of a balancing of lessors originating transactions to hold for their own portfolios and a rise in syndication since those same lessors also have a need for fee income,” she says. McLorg thinks competition for quality deals will continue to be intense and that pricing will continue to be thinner than most investors would like. “But that’s a function of the high volume of liquidity,” she observes.
“We’ve seen liquidity in the secondary market, but the flow of newly generated deals seems to have diminished. There simply needs to be more deals to feed all the mouths.”
–Steve Gray, BB&T
Steve Gray, Senior Vice President of Capital Markets at BB&T in Towson, Maryland, thinks the lack of product will continue to put pressure on spreads. “We’ve seen liquidity in the secondary market, but the flow of newly generated deals seems to have diminished,” he says. “There simply needs to be more deals to feed all the mouths.”
Blips in Cost of Funds
Gray thinks funding for all transactions will continue to be widely available. “It’s a matter of determining which of the deals in the market meet an investor’s specific investment profile,” he says. At the same time, though, he sees more investors watching their cost of funds and how their cost assumption behaves in relation to market rates, such as swaps. Says Gray, “Liquidity premiums can make or break an investor’s ability to purchase a transaction that would otherwise have all the attributes of a perfect fit for that investor.”
Liquidity premiums are amounts that bank treasury departments add to an index, such as swaps. The sum of swaps plus the liquidity premium is designed to be a proxy of a bank’s cost of funds. “Some institutions pay close attention to liquidity premiums because that’s how these banks fund themselves,” explains Gray. But other banks do not. He says, “There can be a wide competitive advantage or disadvantage, depending upon a bank’s specific cost-of-funds policy.”
Staczek and McLorg mention liquidity premiums, too. “We’ve seen an increase in the bank market during the past year, with liquidity premiums charged for deals of 72 months and more,” says Staczek. Adds McLorg, “If a bank’s cost of funds is rising, it stands to reason the bank will pass on those costs to customers. I know our cost of funds is set by our bank treasury, and there’s been an up-tick in our liquidity premium since the first of January.”
Liquidity premiums don’t worry Henry Frommer, Senior Vice President & Managing Director of Wells Fargo Equipment Finance, in New York City. “If anything, funds will be even more available than last year,” he says, “and the cost of funds will again be reduced to meet the market, assuming banks want to increase their earning assets—and I think everyone does.”
Competing Pressures
But Frommer notes that banks’ gross margins have been falling for more than two years, creating tremendous pressure to hold the line. What’s more, recent mergers have made a number of banks bigger, increasing their risk tolerance for individual credits. “So there’s less reason to sell, making for less product out there, and making every type of equipment finance company short on earning assets,” Frommer concludes. The situation probably won’t change soon, he says, “since companies with large capital-ex budgets are likely to sit on their hands until after the presidential election to see how things work out.”
Others see promise in recent economic developments. Gray and McLorg think Congress’s reintroduction of 50% bonus depreciation for equipment placed in service from 2015 through 2017 could stimulate capital expenditures to an extent.
And McLorg believes that while low oil prices will significantly lessen demand for drilling and earth-moving equipment, the need for vehicles and technology used in healthcare, transportation, IT and construction will continue to be strong. “I do think there’s a need for customers to build up their assets in these areas and replace old equipment,” she says. “That momentum should continue to provide for a healthy equipment finance market for the rest of 2016.”
Frommer is more reserved. “Everything I’ve seen leads me to believe the economy this year will be flat,” he says. “Bonus depreciation is nice, but what’s really needed is a fiscal stimulus, and I see none on the horizon. That means that when there are new business opportunities for the leasing industry and paper does come to market, there will again be a feeding frenzy to buy those assets and get them on the books.”
Those possibilities notwithstanding, Frommer has yet to see much weakening of credit structure, and it gives him hope. “It’s tough right now and if banks are stretching, they’re stretching in the investment grade world where there’s little risk,” he says. “They’re not doing so in the middle market because the oil patch has shown it’s very dangerous to stretch on credit. Whatever your normalized requirements are, that’s what you should be doing.”
Staczek doesn’t disagree. But he thinks non-SIFI (Systemically Important Financial Institution) banks, new market entrants and independents could fill the void for middlemarket credits that aren’t a fit for larger banks—and that paper produced by these credits could fit the parameters of what buyers in those markets normally buy.
“There’s still pent-up demand from last year,” he says. “People are looking to buy more business, and some have nearly unlimited funds.” He thinks deals of all sizes and credit qualities will have multiple buyers.
Lesser Effects
Interest rates are another part of the funding equation to consider, but few expect big changes this year. “It’s possible that customers who’ve been on the sidelines showing restraint about equipment acquisitions in light of the rising rate climate may now be more motivated to acquire,” says McLorg. “[But] I see indices only inching up.”
Frommer thinks interest rates could remain flat for the rest of 2016, based on the downturn in the energy sector (and industries allied with energy, such as steel manufacturing) and lackluster retail sales. “Th ese things indicate that all is not well in our economy,” he says. “If the Fed was talking about four rate increases, perhaps there will be only one or two instead, or none. I could see interest rates plateauing.”
If interest rates do continue to rise, Gray thinks leasing could see an increase over cash purchases. “When there’s no benefit to holding cash because you’re not earning much on it, you can just as easily spend it,” he says. “If interest rates go up, on the other hand, you may be able to invest your cash in things that have a higher return than investing in new capex. Because of the transfer of depreciation benefits, leasing becomes an attractive way to acquire that equipment, as it will provide a lower IRR (Internal Rate of Return) than traditional financing.” Depreciation benefits are also worth more when interest rates go up, he notes.
A counter to any uptick in leases over loans or cash purchases could be changes to lease-accounting standards, widely expected to be implemented by the end of this year. “To the extent that companies will be required to place leases on their balance sheets, I think more customers are tending to finance their equipment with loans,” says McLorg. Generally, however, many of the lease-accounting changes are expected to have a neutral impact equipment transactions.
“There will be a bounce-back; there always is. I think what we’re seeing is how interconnected our economy is with the world’s, and there’s no getting around it.”
–Henry Frommer, Wells Fargo Equipment Finance
Despite so many complicating factors, cautious optimism and a certain determination prevail. “Th ere will be a bounce back; there always is,” says Frommer. “I think what we’re seeing is how interconnected our economy is with the world’s, and there’s no getting around it. International trade and a world economy are here to stay, and since there are several unstable areas of the world, that coupled with high liquidity and China slowing down will just make for a tough year in terms of acquisition of earning assets.”
“We’re feeling bullish about this year, and we have a clear mandate to add assets to our portfolio,” says McLorg. “Bank of the West is committed to providing liquidity to the equipment finance market.”
“The industry is resilient,” observes Staczek. “We always seem to rebound and find a way to play, no matter what changes occur.” The state of funding in 2016, then, will be in the eye of the beholder. Originators with solid transactions to sell will find the world their oyster while banks and new market entrants line up, vying for a taste of the meal.
Susan Hodges writes about equipment finance and other business topics from her office in Wilmette, Ill.
New Study Looks at Lender Finance A new study from the Equipment Leasing & Finance Foundation looks at the dynamics of the lender finance marketplace post-financial crisis. Have banks’ appetite to be both a lender and participant in the leasing business changed since the crisis? Will more or less funding be available to independents, in what form and to whom? Visit www.LeaseFoundation.org to download “Lender Finance: How Does the Capital Stack?”
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