Funding’s Froth Factor

 

New investors, tools and markets:
Funding ‘22 is astir with action.

Start with one large, well-performing market. Add a profusion of investors oozing liquidity, and mix in a shortage of available transactions. Sprinkle in a pinch of new technology and then season with supply-chain disruptions, the prospect of monetary tightening, and an overdue capex expansion. Whip it all together, and you have the frothiest funding environment since before The Great Recession. 

As a lead in to the 2022 ELFA National Funding Conference, we spoke with experts about the funding landscape and what’s in store for the year ahead.  

Tom Forbes, Executive Vice President of Wintrust Commercial Finance, elaborates on the current market: “Excess capital has been chasing fewer deals since about 2017, when returns began to fall relative to the risks incurred. Although many larger institutions sold out of their portfolios to lighten their balance sheets during the early phase of the COVID pandemic in the second quarter of 2020, those same institutions adopted a book-and-hold strategy for 2021—again making deals scarce even as liquidity remained exceedingly strong.” 

Because the investment-grade space is now hyper-competitive, Forbes says a growing number of institutions are expanding their credit box to meet volume targets. The results: wafer-thin margins and growth challenges amid swirls of change and activity—and that’s just the beginning.  

“We want to be poised to seize opportunity, and there are momentary niches of real opportunity now.”

—Robert Moskovitz, Verdant Commercial Capital LLC

Furies Beneath the Foam 

Sera Oliver, Director of Capital Markets at Key Equipment Finance, also reports the market robust with lenders flush with liquidity and cash on the balance sheet. “We definitely have money to deploy and we’re finding that a lot of investors do, too,” she says, and then adds this footnote: “We’re also seeing that many investors’ budgets are higher this year than last, and this drives even further competition.”  

Leif Grundahl, Senior Vice President of Syndications at Wells Fargo Equipment Finance, sees credit requirements loosening as deal-hungry institutions begin looking to the single-B credit space for transactions. “Due to the oversaturated market for better credits profiles, there’s an increased demand for larger single-B-rated credits with institutions focused on higher returns,” he says. 

Adding spice to the brew is the prospect of rising interest rates. Despite the Federal Reserve Bank’s announcement in late January that it would leave the federal funds rate at 0 to 0.25%, the Fed has said it plans to raise rates up to three times this year. Meanwhile, the agency is reducing its bond purchases to reduce liquidity and could stop them completely sometime in March. 
 
Robert Moskovitz, CFO at Verdant Commercial Capital LLC, says leasing rates typically move directionally with the market, but that can take a while to happen. “There can be short-term squeezes,” he observes. “Your cost of funding goes up, so you naturally try to increase your lease rates, but you also have to stay competitive. It’s a balancing act.”  

Oliver agrees. “Rising rates mean our cost of funds will increase, and that increase will flow through to customers in the rates we’ll have to charge,” she says. “From our perspective, remaining diligent with regard to pricing will be key this year, because when it’s this competitive and companies are trying to bring in deals, they have a tendency to lower their rates. Especially on the longer tenured deals, we want to stay diligent to meet our targeted levels.” 

“We were able to maintain pricing discipline and still hit our target for 2021,” notes Forbes. “[But] there is an abundance of transactions in the market that have been completed recently where the return doesn’t reward the risk. As inflation continues and the economy softens, this will have a negative impact on the profitability of many industry participants, particularly for those who don’t match-fund.” 

Then there’s the industry’s shift away from using LIBOR as a pricing index. The former standard interest-rate benchmark was scuttled by regulators after scandals involving manipulation or attempted manipulation of the reference. Says Grundahl, “Over the years, many equipment finance companies have indexed over LIBOR swap rates. But now that it’s going away, some have already transitioned to indexing over the SOFR swap, and I would expect to see more make the change over the course of 2022.”  

SOFR is the Secure Overnight Funding Rate produced by the Federal Reserve Bank of New York and based on transaction data, not estimates. Other indexes in play are the Ameribor (American Interbank Offered Rate) and the Bloomberg Short-Term Bank Yield Index, or BSBY. But Forbes says the decision to switch to SOFR or another pricing index is no easy task. “We’re learning that the credit spreads in these benchmarks differ from institution to institution, so it becomes an apples-to-oranges discussion,” he explains. “You have to be able to ask the right questions.”  

”Renewables energy financing is likely to increase, particularly with the restoration of full tax credits for this space...”

—Tom Forbes, Wintrust Commercial Finance

Market Moves 

Despite the changes brewing, experts who spoke for this story expect funding availability to remain steady and demand to increase. Moskovitz predicts growing demand for funding in trucking, logistics and construction as new infrastructure projects launch. Verdant Commercial Capital finances heavy equipment nationwide via relationships it has with capital equipment manufacturers, distributors and dealers, and Moskovitz says the marketplace has been growing over the past year. “There’s always competition; that doesn’t change,” he says. “But we want to be poised to seize opportunity, and there are momentary niches of real opportunity now. To take advantage, we’re in the process of adding to our capital and expanding our lines of credit at attractive rates. Because our assets perform, the Verdant story has been well received by investors and banks.” 

Forbes expects an increase in financing opportunities for manufacturing facilities and equipment as manufacturing comes back to the U.S. “Austin and Frisco, Texas are attracting a ton of transplants, and Atlanta, Charlotte and the Research Triangle are attracting new and more manufacturing,” he says. Example: Texas Instruments has announced plans to build a $30-billion semi-conductor plant in Texas that will employ up to 3,000 people. 

Further, he thinks financing for the fossil fuel industry will remain scarce as institutions maintain a wait-and-see approach, given the current administration’s focus on green energy. ”Conversely, renewables energy financing is likely to increase, particularly with the restoration of full tax credits for this space coupled with direct pay, rather than tax equity offsets,” he adds.  

Oliver says that’s already happening, partly due to rising interest in ESG investing. “We’re finding new investors who want to buy into the green markets, so we’re syndicating our clean-energy transactions to them,” she says. Since 2015, Oliver says, Key Equipment Finance has invested over $300 million in fuel cell technology with one developer and is now actively in the market syndicating such opportunities to other investors. Fuel cells convert natural gas to energy without a combustion process, significantly reducing a company’s carbon footprint. 

Oliver expects no weakening in availability either. “Although oil-and-gas and mining remain lackluster, the technology and transportation markets continue to show strength, and in the municipal space, towns are in a very strong position,” she says. Whether municipalities opt to finance remains to be seen, however. “Some of our municipal customers are delaying financing now that rates have begun to rise. And because they have strong balance-sheet positions, they may choose to avoid financing altogether,” she explains. Nonetheless, she expects new investors and developing markets to help balance any negatives.  

“Our industry is so relationship-driven, and the Funding Conference provides a great venue to connect with peers as well as institutional customers.” 

—Leif Grundahl, Wells Fargo Equipment Finance 



Valerie Gerard, Co-CEO of The Alta Group LLC, is also watching sustainable finance with interest. “Renewable energy has been around for 15 years, and in some ways is the original green asset class,” she says. “Today, institutional investors are incorporating ESG standards into their investment criteria as they expand their socially responsible investing opportunities to include ownership and management of green assets.” 

The result is a large class of investors who want to invest in green assets—and demand is stronger than supply. “This represents a huge opportunity for our industry as a potential new pool of capital looks for established green assets,” Gerard asserts. “Equipment finance and leasing as an industry has a strong track record, not only for financing established classes of green assets, but also in refurbishing and redeploying equipment, which leans into ESG-friendly circular economy models.” 
 
As an example, Gerard cites Dallas-based Trinity Rail Group LLC, which recently completed a securitization of rail-car transactions qualifying as a green bond. “Rail cars have lower carbon emissions than over-the-road trucks, so this meets a lot of green criteria for ESG investors,” she explains. “If other equipment finance companies haven’t thought about it, they need to consider what the assets they’re financing in their portfolios are eligible for that could qualify as green or ESG financing. The ability to qualify as green bonds will bring new investors, new sources of capital, and for some smaller companies, a possible narrowing of their cost of funds.” 

“There are strong balance-sheet positions and funding is robust, but customers are dealing with labor shortages, supply chain issues and Omicron.” 

—Sera Oliver, Key Equipment Finance 

Study Says… 

Gerard should know: she’s a researcher on the steering committee for a study on industry funding, securitization and syndication options being conducted by The Alta Group for the Equipment Leasing & Finance Foundation. To be released in April, the study will provide an industry overview of funding options and clear guidance around best practices. These tools are designed for companies financing transactions of any size to apply in creating the optimal funding program for their situation.  

“When the pandemic hit, the capital markets were shaken, and we wanted to understand the funding implications for our industry,” Gerard says. “We went out early and surveyed CFOs, treasurers and syndicators to ask how the pandemic had changed the ability to secure funding, and we found that transparency was fundamental to returning their borrowing ability to normal.  CFOs and treasurers learned from the 2008-2009 recession that tracking their portfolio more closely and having more frequent and open conversations with their lenders avoided later, potentially damaging knee-jerk reactions by lenders.” 

Gerard says funding strategies will evolve to incorporate more transparent real-time portfolio reporting with lenders going forward, but she adds this note: “I can tell you: Coming out of the global lockdown, funding availability was not a major issue for anyone we interviewed.”  

What’s Next 

Given the abundance of factors at work this year, story sources hesitate to say much about 2022 as a whole. “Currently, institutions are willing to take less margin in order to help grow their portfolios, so we’re essentially back to pre-COVID interest rates now,” says Grundahl. “And while we probably won’t see significant changes in the first six months, impending monetary changes could certainly impact that in the second half.”  

“COVID-19 is still here with the Omicron surge, so we’ll have to see how the year goes,” adds Oliver. “There are strong balance-sheet positions and funding is robust, but customers are dealing with labor shortages, supply chain issues and Omicron. We’ll see where the intersection of these headwinds and tailwinds takes us.” 

“Post-pandemic conditions are pointing to a huge surge of equipment financing needs.” 

—Valerie Gerard, The Alta Group LLC


Moskovitz is a bit more optimistic. “At Verdant, we’ve seen no pull-back to obtaining funding; we’re fortunate to have many avenues for additional capital, should we need it. With interest rates still as low as they are, customers continue to use financing. When rates go up, rates to our customers will go up as well.” But he adds a caveat: “Our portfolio did well throughout COVID. But now that we’re on the backside, capital equipment demand is very strong, and our origination growth is starting to be impacted by supply chain issues. Many of our equipment vendor partners have extended delivery schedules due to logistics problems and part shortages.” 

To compound the problem, Gerard says the U.S. capital expenditure cycle is at an expansionary point. “We were poised to enter this cycle just as COVID-19 set in, and now, as supply chain delays ease and inflation remains in check, many analysts expect corporate capex spending to climb, aided in part by the infrastructure bill,” she says, and then adds a suggestion: “As customers gear up to finance more equipment, their treasury departments may want to think about how to flex up their funding programs to accommodate potentially huge demands for equipment.” 

This could mean talking with your company’s current bank group about increasing the size of your facility, or adding new capital sources. Concludes Gerard, “Post-pandemic conditions are pointing to a huge surge of equipment financing needs, so companies need to ensure that they have the funding capacity in place to support those levels of originations.” 

Clearly, it’s time to stop and smell the coffee.