EQUIPMENT FINANCING: Commercial Finance is a Marathon, Not a Sprint
By: Jeff Brannon
All signs point to another good year for the equipment finance industry, and the leasing product is still the most viable financial solution for companies in the market for equipment. Jeff Brannon provides an industry outlook and discusses the importance of delivering the right product for each credit type.
As we embark on a new decade, most indicators point to strength in the economy. Coming up on a decade removed from the late 2000s mortgage crisis, the U.S. has completely rebounded in terms of confidence in the economy and growth. Although some economists think we have reached an apex, all signs point to another good year for the industry.
Equipment leasing has always been a sector that performs well in a robust economy regardless of its relationship to rates. In the mid-2000s, the prime rate was as high as 8.25%, and the leasing community flourished. Today, we have a robust economy and prime at 4.75%, and the industry has the best of both worlds.
Key Statistics for Equipment Finance in 2020
As we look forward, some key statistics, provided by the Equipment Leasing & Finance Foundation, will drive the state of the equipment finance product in 2020:
- • The U.S. economy grew at a moderate 2.1% annualized growth in Q3/19, driven primarily by a healthy consumer spending at an annualized growth rate of 2.9%
- • Business investment contracted in Q3/19, dropping two consecutive quarters for the first time since Q1/16.
- • In addition to declining business investment, other economic headwinds include a continued slowdown in global manufacturing and further deterioration in the global economy.
- • A robust labor market and solid consumer base are top economic tailwinds.
- • Additional economic factors to watch are unresolved tensions with China, political uncertainty and a sustained homebuilding rebound.
- • New business volume growth reported in ELFA’s Monthly Leasing and Finance Index is still on track to beat 2018 levels. In October, new business volume grew at a 13% pace year over year — the fifth month in 2019 with double-digit year-over-year growth.
When the U.S. economy is growing, confidence in business investment typically follows suit. However, due to global trade concerns, business investment declined for two consecutive quarters. This could be considered an anomaly as the trade negotiations and proposed tariffs on Chinese goods was an outlier in the nor- mal economic cycle. I am confident that business investment will have increased in Q4/19 when the numbers are published.
Labor markets are always pegged as a leading indicator of the economy, and they remain very strong. Some economists believe we have reached an econom- ic apex due to the prices of stocks and homes, so a pullback (or small recession) is in the cards for 2020, but the data doesn’t support this theory.
The equipment leasing product is still the most viable financial solution for companies looking to procure equipment. The presence of merchant cash advance lenders has taken a small segment of the market as MCA brokers promise fast approvals and quick fundings. While the cash is quick, it is not the best financial solutions for these scenarios.
As we continue to grow as a community of solutions providers, the equipment leasing product needs to be at the forefront of our mind when we are working with borrowers looking to procure equipment. Asking “what is the money for?” will provide all the answers necessary for brokers to put their clients in the right financial product.
We see multiple transactions each month in which the borrower was steered in the direction of an MCA loan for purchasing equipment. It’s important to keep in mind that a borrower is losing money every month if they purchased the equipment using an MCA. It is only when the MCA is paid off that the economics benefit of the equipment outweighs the cost.
Lending Programs for All Credits, All Equipment
In today’s economy there is a wide divide between A tier credits and start-ups/cautionary industries. Brokers should try to look for lenders that have the capacity to fund all credits, all equipment. Growing a relationship with a lender is about knowing their products and marketing to those products.
Here is a brief snapshot of the credit/asset types that are going to be relevant in 2020.
A Credit: These borrowers will always be attractive to lenders. They are typically bankable or just below bankable due to credit scores over 700, time in business and revenue/net income. These credits require low rates and, from time to time, flexible payment structures. Quite frankly, these companies have earned that. Good vendor relationships focus on high volume and low-to-moderate margin per deal centered on A credits.
B Credit: These companies have credit scores above 675, have been in business for three to five years and report revenues of $1 million to $5 million, breakeven or small loss. This category will probably request A-type rates but need to be educated on their credit profile standing.
C Credit: With credit scores above 620 and two years in operation, these business owners often do not own a home. Rates for this category start to tick up. The client must be educated about their credit profile and may get some sticker shock when they initially see the terms.
D Credit: This category is difficult to traverse. Typically, not rate sensitive, but also not adept at paying their bills on time, this category will often require “structure” to get deals done. In these cases, large down payments and/or additional collateral (in the form of free and clear equipment or real estate) are common. Just like A tier credits, D credits have also earned their standing. These transactions can be risky, but with risk comes opportunity. In these cases, asking for a PFS/Facilities is a good practice. Knowing what to look for to strengthen a “D” deal will set brokers apart.
Cautionary Assets: In certain cases, cautionary assets have more of an effect on the terms of a lease/loan than the credit. Over-the-road trucks and cannabis/hemp related equipment will continue to be viewed as cautionary in 2020. In these cases, the credit profiles must be strong, but the pricing may end up in the C range due to industry/asset.
As we move into a new decade on strong economic tailwinds, the equipment leasing industry is poised for another great year. As we consider our approach to business development in 2020, we have a bevy of products at our disposal. Whether in good times or bad, we must remember that fundamental business development principles apply. Understand your clients’ businesses, understand their needs and the economic benefit of their capital use. Always consider the full array of financial products, not just the easiest or the most profitable. Commercial finance is a marathon, not a sprint. Do right by your clients.
“Equipment leasing has always been a sector that performs well in a robust economy regardless of its relationship to rates.”