An ocean of liquidity has sellers surfing and buyers swimming against the tide.
Ricardo “Ricky” Rios describes the current state of funding
in a single word. “It’s opportunistic,” says the COO of Commercial Equipment Finance, Inc., an Independent that originates transactions and funds them on balance sheet and through a variety of borrowing and syndication arrangements. Funding is a top issue for Independents and, as Rios says, “Low interest rates are allowing us as an industry to access sources of capital we wouldn’t have otherwise considered, such as new bank facilities and securitization.”
He also notes that low rates are causing an increase in payoffs at his company, and that it’s too early to tell if this will lead to a corresponding rise in refinancing. “But we’re seeing a large amount of liquidity in the system and a big focus on economic growth,” he says. “In 2020, everyone was putting the brakes on buying transactions, even though there was great interest from companies that don’t originate. This year, a lot of buyers are looking to purchase portfolios.”
The scenario is different at First American Equipment Finance, an RBC/City National Company. Mike Clune, Director of Capital Markets, says that in his experience, changing buyer patterns coming off 2020, consolidation and extreme competition are the primary forces shaping the 2021 funding environment. “We’ve seen a decent amount of buyers changing their focus after COVID, as well as consolidation over the past few years, mostly by banks,” he says. “This means, for example, we could have two funding sources turning into one, and we’re waiting to see what comes of it.”
At the same time, Clune says the buy side of capital markets is the toughest he has seen in years. “We’re focusing on pockets where we can provide the most value, and we’ve still been able to buy meaningful business this year,” he observes. “But unlike last year, the economic outlook has improved, and now there’s a high demand for transactions. For buyers, it’s incredibly competitive.”
Bob Blee, Global Capital Markets Leader at GE Healthcare Financial Services, sums up the situation: “Specific to the U.S. and capital markets, it’s a seller’s market, and there’s strong liquidity for purchasing both investment-grade and non-investment grade transactions. We’ve seen banks become more aggressive in their underwriting and more flexible on terms and conditions. This should continue as the U.S. economy expands through this year and into 2022.”
Scott Kiley concurs. As Capital Markets Leader at Fifth Third Bank, Kiley oversees syndications and indirect originations, or buying from institutions. He also works with the bank’s leasing group, which does business with Independent equipment finance companies. “After the COVID-19 disruptions, there’s still plenty of liquidity in our space if you have a good equipment lease or loan that needs to be syndicated,” he says. “But corporations aren’t borrowing as much as usual or doing separate equipment-purchasing transactions, and because of that, demand for transactions outweighs supply. As a result, pricing gets competitive and interest rates become aggressive.”
“We’ve seen a decent amount of buyers changing their focus after COVID.”
First American Equipment Finance, an RBC/City National Company
A Fragile Buoyancy
Despite a primed market and waves of activity, then, winds are blowing that could toss both buyers and sellers off their boards. One such squall is continuing disruptions to global and domestic supply chains. Blee says the resulting delays in equipment deliveries “have been a chronic problem for equipment finance companies this year,” and Kiley agrees, noting that companies’ finance volume “is reliant on those deliveries.”
Industry analysts expect many supply-chain issues to diminish toward the end of this year—but the shortage of microchips probably won’t be one of them. The boom in personal-computer sales during the pandemic has made chips in such short supply that the Institute of Electrical and Electronics Engineers says, “It could take much of 2022 for the chips [made in late 2021] to work their way through the supply chain to products.” To that end, Kiley says production on all Class 8 trucks “cannot meet current demand for the remainder of this year,” and several car manufacturers are reporting the same. Thus, customers who order vehicles now may not see delivery until sometime next year.
There is an upside to the situation, however: Some manufacturers are now looking to place more reliance on U.S. suppliers. A 2021 report on the state of North American manufacturing by Thomasnet.com, an industrial sourcing platform, says 83% of manufacturers indicate they are likely to “reshore” parts of their supply chains, compared to 54% in 2020. Says Kiley, “We’re seeing this already in the increased demand for manufacturing equipment, forklifts and material-handling equipment.”
“We’ve seen banks become more aggressive in their underwriting and more flexible on terms and conditions.”
GE Healthcare Financial Services
Other tempests threatening U.S. economic growth and thus, funding, include variants of COVID-19, which if unchecked could erode the recovery made to date. Additionally the growth of inflation, which hit 5.4% in July, could cause the Federal Reserve to take more aggressive action on interest rates and taper its asset purchases, reducing liquidity. For now, though, Blee points to banks’ need to grow assets, which results in fewer deals in the secondary market. Says Blee, “Fewer transactions have intensified the competition among buyers.”
Cost of Funds Floats Low, But…
Low interest rates help keep the cost of funds low, and Clune says the biggest driver of rates now is funding’s competitive environment. “It’s natural for buy-sides to want growth, and we noticed in the 2020 market, which came off strong for buyers, there was more commercial paper to be bought than we expected,” he says. “But when you get to the budgeting stage, hoping to grow purchases the following year and the dynamic flips, that’s really tough, because you don’t want to grow at the detriment of profitability and margins. It’s all a balance of maintaining volume versus maintaining yield, and that’s a healthy discussion for every funding source every year.”
Yet, Kiley says that for both buyers and sellers, spread compression is exactly what’s happening. “An acceptable spread over the swap rate can go lower because of the alternatives banks have with their excess liquidity,” he explains. “And since banks have to deploy that liquidity, we can be willing to live with a lower spread, just to have a particular asset on the books.”
“Private equity groups, hedge funds, corporations and family offices are more interested this year in investing in the equipment-loan asset class.”
Fifth Third Bank
Islands of Opportunity
Nevertheless, those who spoke about funding for this story are solidly optimistic. From a geographic perspective, Rios says Texas and Colorado are undergoing considerable economic expansion, due in part to the migratory trend from California. “And as for industry segments, we think housing needs and the pending infrastructure bill in Congress will make for a very liquid construction market for the next two to three years,” he says.
Clune believes liquidity for lessors is ample and that customers are starting to take advantage. “Now that the outlook is a bit more certain, it seems reasonable to expect pent-up spending,” he posits. “All the data points I’ve examined indicate that there will be a good amount of capital spending over the next six to 12 months.”
Blee describes the funding environment for healthcare as “full steam ahead,” and Kiley feels similarly about the overall situation. “When we look at the Independents we serve through banking channels, we see they have good access to lines of credit and non-recourse debt funding, and that conditions are fairly robust for solid middle-market investment grade credits,” he says. But at the same time, he says the amount of liquidity lessens for transactions further down on the credit curve. “In the middle-market sub-investment space, for example, buyers are more selective, and there are fewer of them,” he clarifies. “But there’s a home for every deal. You just have to work harder to find it.”
Save the Date!
The 33rd Annual National Funding Conference will be held
April 12-14, 2022 at the Palmer House Hilton in Chicago.
Fifth Third originates large equipment loans and facilities for clients, and Kiley says the bank brings in funding partners to manage its credit or asset exposures. “There’s typically a partner we can find and an investor who’ll help fund those deals in the less-than-stellar credit lines,” he says.
Like Rios, however, Kiley sees shifts in alternative funding sources that increase funding availability. “Private equity groups, hedge funds, corporations and family offices are more interested this year in investing in the equipment-loan asset class,” he says. “We’ve seen several Independent leasing company clients sell a majority interest in, or contemplate offers for, their companies because private equity groups are viewing the industry favorably and want to get into it.”
“If you’re an Independent with a solid stream of good-quality originations, this is a very good time to be who you are.”
Commercial Equipment Finance, Inc.
Partnerships Add Balance
At the same time, Fifth Third maintains solid relationships with unregulated financing companies, and Kiley continues to see more of them entering the marketplace. “As a result,” he adds, “we have alternative funding sources when selling non-investment-grade transactions, because unregulated players have more flexibility to invest in these than do banks.”
Not surprisingly, funding partnerships are highly valued and sought-after in 2021. As equipment finance companies continue supporting the economic recovery of their customers while hunting for safe ways to grow amid what pundits have called “the pre-post-pandemic,” these relationships with trusted buyers and sellers are critical to success.
Clune says funding partnerships at First American Equipment Finance are “stronger than ever, having endured the shock of the pandemic and bounced back with consistency and stability.” First American supports customers of City National Bank, the Royal Bank of Canada and RBC’s investment bank and wealth managers in the U.S. It also has a vendor group buy side and a large direct-originations platform of more than a dozen verticals. “As a result, we see deals ranging from small-business banking to large corporate,” he says, adding, “Things were tough for all of us for a while last year. But we got through it and now we’re really pleased to have these relationships, and to be able to continue our originations growth. We value all of our partnerships on both the buy and the sell sides, and it’s been a great year so far.”
Rios adds positivity for small Independents: “If you’re an Independent with a solid stream of good-quality originations, this is a very good time to be who you are,” he says. “The market is primed and active with liquidity, and you have access to a multitude of capital sources that weren’t available last year.” –Surf’s up, everyone!
Don’t miss your chance to discuss funding and participate in funding-related sessions at the 2021 ELFA Annual Convention, including:
• Capital Markets Review: Syndication and Origination in the Digital Age
• Transforming Process and Perception with FinTech Innovation
• Financing the Intersection of the Circular Economy and the ESG Revolution
Learn more at www.elfaonline.org/ac.