Susan L. Hodges 2017-03-10 06:38:30
Funding prospects are brightening
The 2016 funding environment looked and felt much like the one before it.
Liquidity hung thick as a storm cloud, darkening the landscape and pelting the best deals with a shower of bids. “On the buy side, it was a tough year,” says Sera Oliver, Vice President, Capital Markets, for Key Equipment Finance in Albany. “Rates were low and the deals weren’t there, partly because competition was up, but also because [equipment-finance] companies were retaining a lot of business to grow their own portfolios.”
Anthony Sasso, President of TD Equipment Finance, a Cherry Hill, N.J.-based subsidiary of TD Bank of Toronto, had similar observations. “What I saw in 2016 was an abundance of liquidity in the U.S. finance market, with the economy experiencing slow-growth status,” he says, adding, “Most of us experienced margin compression, because there was more supply than demand. It was a common theme last year, and I see it going into this year, too— an ample amount of liquidity through a variety of funding sources.”
The slow-growth, low-interest-rate environment has kept many funding sources on edge for several years now. Under pressure from parent companies, stockholders, low interest rates and lean margins, these sources are looking to put their money to work in funded assets that will produce solid returns. As challenging as that goal seems, some funding executives express hope and optimism for 2017.
One reason: Rays of opportunity began to peek through in early January. Whether businesses had delayed equipment acquisitions until aft er the elections or were simply roused by the Fed’s November interest-rate increase, no one knew for sure. But companies began to acquire more equipment, producing an uptick in deal flow. Says Oliver, “Both our syndication and our buy sides are feeling positive about 2017. We think it will be a better year.”
Lindsey McLorg, Executive Director, Structured Finance, for Norwalk, Conn.-based Hitachi Capital America, also expects a sunnier 2017. She thinks the new Administration’s promise to boost infrastructure spending, along with public expectations for an improved business environment generally, “could lead CFOs to make capital equipment decisions and commitments they were reluctant to make previously,” she says.
Banks are still reluctant to lend to high-risk borrowers, so competition for each high-quality transaction will remain just as fierce as it was in 2016.
McLorg believes the possibility of further increases in interest rates this year could prompt additional acquisitions. “Accelerating the equipment acquisition can work as a strong hedge against rising interest rates,” she says, “and some businesses will decide to lease rather than use their cash reserves.”
Interest Rates and Cost of Funds
But interest rate movement cuts both ways. Even if businesses flock to replace older equipment in the face of rising rates, equipment-finance companies will see their own costs of doing business rise with each interest-rate increase. But rate increases aren’t expected to stop banks from growing their equipment portfolios for two reasons: First, many view equipment financing as a foot in the door to sell other products. Second, it’s no secret that equipment financing showed remarkable resilience during the Great Recession.
Even so, a transition from variable-rate to fixed-rate products has already begun. “In a rising interest-rate environment, fixed-rate equipment finance products will be increasingly attractive to bank clients,” says Alan Sikora, CEO at First American Equipment Finance, a City National Bank company in Fairport, N.Y. “So despite increases in the cost of borrowing, 2017 is likely to be a year of growth for the equipment-finance industry as businesses expand.”
Sikora thinks competition will increase even further as more banks and non-bank lenders enter the equipment-financing arena. He thinks existing bank lessors will look to grow their equipment-finance businesses as well. “Many banks view the equipment-finance industry as attractive,” he says. “They’ll pursue growth by both originating directly with clients and by serving as a funding source to new entrants.” Either way, Sikora expects competition to remain high and margins to remain compressed—for financial institutions at least—for the rest of 2017.
Anthony Sasso is not so sure. “To right-size expectations about the cost of funds, we have to remember that each bank has its own cost-of-funds methodology,” he says. “Many include a component of swap rates, so there’s anticipation that we’ll see the cost-of-funds rates come up on borrowing rates. Even floating rates are going up. So the expectation that one would see a rise in the cost of funds this year depends on the company’s methodology.”
Balance-sheet health also weighs in, Sasso notes, so that for banks with strong, healthy balance sheets, the effect of rising interest rates will be somewhat muted. Nonetheless, Sasso feels good about the equilibrium he’s seeing. “First we saw swap rates rise, then we saw floating indices rise as well, so I think we’re on a good playing field, with the expectation that the economy is doing well, and cap-ex spending will increase,” he says.
At Key Equipment Finance, cost of funds is holding the line. “I don’t see costs increasing now and I don’t expect them to change dramatically this year,” says Oliver. Besides, she adds, “Our sell desk says there’s a lot of pent-up demand in the market, and now that the election is behind us, they don’t think rates will go up enough to change investors’ spread requirements.”
That could be the case. At its February 1st meeting, the Fed left its benchmark interest rate unchanged at 0.75%.
Whether rates rise or not, McLorg sees them as what they are: just one part of the equipment-finance equation. “Rising rates and the cost of funds haven’t affected our ability to win new business,” she says. “We like to think our value proposition is based on being a flexible, reliable and responsible funding source. We do a fair amount of customizing with our customers so we can be a true partner.”
Availability Angles
But new funding sources have continued to move into the market, seeming to widen availability and deepen competition even further. The situation is not that clear-cut, however. “We’ve seen a lot of new players, [but] some are in the higher-risk category, which is not where we play,” says Oliver.
On the sell side, Oliver says potential investors for the deals the bank has are abundant, due in part to a number of smaller banks that have entered the market. But these smaller banks are also pursuing some of the same deals as Key Equipment Finance. Says Oliver, “A couple of them started a capital markets group, and they’ve been some of our biggest competition lately. They don’t have much exposure, so the world is their oyster, and they’re gobbling up deals.”
Oliver also sees some competitors going down-market and doing selective B-credit transactions. “We’re not doing that,” she says. “We have not loosened our credit box at all and are holding the line at credits that meet our requirements.”
Sikora thinks most banks will exhibit similar discipline for the rest of 2017. “Banks are still reluctant to lend to high risk borrowers,” he says, “so competition for each high-quality transaction will remain just as fierce as it was in 2016.”
29th Annual National Funding Conference Set for April 4–6
Learn more about the funding landscape at the ELFA National Funding Conference, the annual forum for connecting funding sources with leasing and finance industry organizations looking to establish relationships to fulfill their funding needs. See www.elfaonline.org/events/2017/NFC/.
Looking for a Funding Source?
In addition to attending the National Funding Conference, check out ELFA’s online Funding-Source Database. Search by type of company, types of lease structures, funding programs, equipment types and/or credit criteria: https://apps.elfaonline.org/Directories/FundSource/
Standing Out from the Crowd
Given the abundance of liquidity, though, Sasso expects to see more finance firms working to differentiate themselves in a crowded market. “I know we strive to be trusted advisors and to deliver best-in-class service,” he says. “These priorities helped us tremendously last year, and they’ll be priorities again this year. Until we see cap-ex spending rise, I think this will be an important goal for many companies in our industry.”
A fair amount of differentiation is already occurring. Among funding sources are companies that operate within their own strike zones and pricing thresholds, and those with specialties, serving particular industry segments that others don’t. “But I think every organization in the finance space is looking to deploy capital and acquire funded assets within a certain pricing parameter, and most of the players I see have been able to achieve that,” says Sasso.
A fair amount of differentiation is already occurring. Among funding sources are companies that operate within their own strike zones and pricing thresholds, and those with specialties, serving particular industry segments that others don’t.
Hitachi Capital America could serve as an example. McLorg says the company has a strong appetite for clean energy and sees a good market for lighting retrofit projects. The firm also specializes in managed-service financing, and McLorg says the niche is a major strength. “I think as an independent, we have an appetite for a broader band of credit and structured transactions than bank funding sources,” she says. “And if we can get comfortable with a transaction, we won’t go strictly by the numbers, although we’ll certainly maintain our standards for quality.”
McLorg believes the company’s growth this year will come from customized deals and those attached to rebuilding the nation’s infrastructure. “As a funding source, we need to rely on differentiating ourselves—which we do by offering quick decisions, simple processes and certainty of execution—and that’s what we’re all trying to do,” she says.
The firm’s willingness to consider specialized transactions could help fill a vacancy that Oliver has noticed from her spot. “We don’t see a big market for smaller credits, and we’re struggling to find homes for these,” she says. “We see companies considering larger, single-B credits that have been in business a while, but smaller credits are still an underserved market.”
Relaxed regulations on financial institutions could change that. “Regulatory changes have caused banks to book capital against particular types of transactions more than usual,” says Sasso. “But capital is expensive, and you have to achieve a certain return. We hear other banks talking about the need for transactions that would meet or exceed certain return expectations, and I know a reversal or relaxation of regulations would help achieve that. Any change that would lessen some of the regulatory requirements for capital could benefit the funding environment.” Stay tuned.
Susan Hodges writes about equipment finance and other business topics from her office in Wilmette, Ill.
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