by Joyce Gemperlein on Wednesday, April 07, 2010
What's the status of funding?
Better but still challenging, say a sampling of elfa members
The doom-and-gloom conversation regarding funding is shifting to one that’s — no, sorry, not giddy — but decidedly about movement in the right direction. And change. With some exceptions in the first months of 2010, “challenging but improving” and “hit bottom” are being uttered more frequently than last year’s “uncharted territory” and “hellish.”
To eavesdrop on the chatter, we posed a series of questions about the current funding situation to members of relevant ELFA committees — Funding, Capital Markets and Business Council Steering Committees.
Those responding are Joseph Terfler, chief financial officer and senior vice president of Great America Leasing Corp.; Eric Hanson, managing director, Lazard; Mark McCall, managing director, SunTrust Equipment Finance & Leasing Corp.; Crit DeMent, chairman and CEO , LEAF Financial Corp.; John Dale, chief operating officer, FirstLease Inc.; David D’Antonio, managing director, Diversity Capital LLC; and Daniel Marino, founder and managing member, Lavallette Capital LLC.
Here’s a condensation of what they said in conversations during February 2010:
Q: What’s the current climate for funding an equipment finance company?
MARINO: I’d say it is still challenging but has improved gradually over the past months as the supply of financing begins to increase.
HANSON: As far as bank funding, liquidity is improving. Six months ago, [there were] only the big players — JPM, Citi and Wachovia. A
number of banks are back, and there are several new entrants.
DeMENT: Speaking from an independent’s perspective, funding from banks and major institutions that invest in this space is still constricted … as they figure out how they are going to play as the credit crisis ends. They aren’t jumping in and doing a lot of business in our area.
McCALL: The climate is challenging, but moderately improved.
DALE: We have loosened up somewhat. We have changed our criteria; unfortunately, not a lot of leasing companies can now meet our criteria. We are looking for much more collateral that we are funding than we did two to three years ago, because we know we may have to take it over someday.
D’ANTONIO: It’s not very good. I wouldn’t call it a negative climate. I’d call it reserved or limited.
TERFLER: It is still a challenging funding climate, but there’s positive momentum. But for companies with strong track records and strong portfolios, there is the ability to access funding. It is certainly not like it was three years ago, when funding sources were constantly knocking at the door.
Q: What specific changes have you seen in the last six to 12 months?
TERFLER: In early 2009, things were certainly very challenging. Around the middle of 2009, things began to improve, and they are continuing to improve. Financial institutions appear to be looking for opportunities to grow their earning assets and to add some very good organizations to their customer list. Another thing that has helped is that traditional investors in the ABS [asset-backed securities] bond market have returned. This is providing another source of capital that had temporarily dried up. It also is helping the banks get more comfortable lending, as they see that the assets and organizations they finance have other liquidity alternatives.
D’ANTONIO: Things have begun to look a little more possible. Six to eight months ago, funding was dead. Now we are seeing lenders start to tiptoe out. They’re starting to investigate opportunities, but there hasn’t been any big interest in lending to this niche, but this is global in scale; it’s throughout all niche lending sectors. Within this industry, there’s a lack of expertise, and many lenders have exited. I question if we will ever see the same level of expertise return to the markets.
MARINO: There seems to be a greater willingness in the past months on the part of certain banks to increase their senior lending activity. Some of these banks were active in the market a few years ago and scaled back as a result of the credit crisis, while others are relatively new entrants to the senior financing market. In specific cases, institutions that have either formed or purchased banks are now able to access a low-cost deposit base that allows them to provide an attractive lending product to specialty finance companies.
DeMENT: Twelve months ago, funding was almost nonexistent. It’s coming back a little. We will start to see deals done … but nowhere back to normal. Normal won’t ever be quite the same.
DALE: A year ago we were doing nothing. Six months ago we began to look at new business again, and we did new deals in the last three
months. But, like I said, a lot of companies we’d like to do deals with don’t qualify.
Q: Would you say there is still a credit crunch?
DeMENT: Yes, but it is not as severe.
DALE: Yes, but it has certainly moderated.
TERFLER: For us, there is not a credit crunch. We’re not back to the way things were in early 2007, but we have quite a few very good alternatives available to us. I’m not sure all organizations are having that same experience. Our performance during this economic recession
was very strong. For organizations whose performance was more negatively impacted, access to funding is likely more challenging. There are still reasons to be a little bit cautious. The markets aren’t as stable as you’d like them to be and there are some other issues, such as accounting and regulatory changes, that could impact the availability and the cost of credit. Additionally, I’m not convinced that all of the banks’ internal performance issues are behind them. As these issues get resolved, there might still be some bumps in the road.
Q: Is liquidity more available?
D’ANTONIO: Yes, but it is only available to the top tier and is expensive and restrictive. But it is out there!
DeMENT: It’s more available because, to a certain degree, people have worked through their own issues and are in a position to think
about moving forward.
DALE: It is certainly more available than it was a year ago, but not anywhere close to what it was three years ago.
Q: What are the challenges now of funding independents vs. captives vs. banks?
DeMENT: It’s a whole new, very difficult world for independents.
HANSON: For independents, funding is more difficult than for most captives, as captives still have the parent as a source of support, albeit in varying degrees. Deposit funding for banks has resulted in historical wide spreads when risk is adjusted. That said, banks are disproportionately invested in AAA paper and, with the historic low cost of funds, can show earnings. This will change as the Fed ramps up rates.
D’ANTONIO: There’s no difference, quite frankly. Everyone looks at how much capital is in the structure. There certainly are nuances.
Independents have always been the wildcatters. They generally take more risks and have a little bit different venue in terms of how they
dispose of equipment. This makes a difference in how they are looked at. They have to have more capital. I think that will be the biggest factor: How much equity, like capital, can these guys raise or need? The answer is a lot more than in the past. There will be a lot less leverage in the industry.
Q: How is the low interest rate affecting spreads?
D’ANTONIO: That’s a good one. I’m not sure. I do know that it certainly has helped companies. They haven’t lowered rates. There is a
bigger spread. On the other hand, charge-offs and other expenses have risen so high that any increases in spreads have been consumed by the failing economy and the lack of strong performance. It has been kind of a good news/bad news situation with the low cost of capital.
HANSON: Spreads have narrowed. Of course, not as narrow as 2005 to 2007.
MARINO: Spreads charged by banks certainly increased during the credit crisis as supply of senior financing decreased. However, the low interest rate levels of the base indices have generally offset this increase in spreads. In some cases, the all-in cost of funding to the leasing company is not much different than it may have been prior to the credit crisis. However, in some cases banks are also utilizing floors for either the base index or the all-in interest rate, which may negate part of the benefit of the low-interest-rate environment.
McCALL: Spreads in general are improving, but they are still considerably higher than they were before the credit crunch. I’m not sure how to answer how interest rates are affecting spread. They are mostly a function of risk appetite and what price people want to put on risk. They are wider than three years ago because people’s risk appetite has changed. They are narrower than they were recently because people are starting to put money to work again.
TERFLER: Our primary markets remain very competitive, but we are able to originate business at spreads that make good long-term economic sense. The low benchmark interest rates have helped to keep borrowing costs in line, and there hasn’t been as much downward
pressure on yields.
Q: What is the status of the securitization market, particularly with the TALF (Term Asset-Backed Loan Facility) program ending in March?
HANSON: In certain asset classes—particularly various types of equipment, autos and premium financing—non-TALF deals are getting done with improving spreads.
TERFLER: I believe the TALF program did help to jump-start the ABS market at a time when it was clearly suffering. It brought some new capital into the space in the form of nontraditional ABS investors, like hedge funds, that were attracted by the opportunity to get very good double-digit returns on AAA -rated structured bonds. Over time, it also helped to restore the confidence of traditional ABS investors, so they became much more active. When we did our ABS transaction in November, the vast majority of the notes went to traditional ABS investors who were not utilizing the TALF program. The securitization markets are doing much better. I recently attended a securitization conference and, in general, people there were very upbeat. That optimism seemed to be shared by the issuers, the traditional bond investors, and the banks that provide both conduit and nonconduit facilities. The fact that ABS transactions are getting done with strong investor interest and little to no reliance on the TALF program is a very good sign. The general sentiment I picked up from investors and banks is that, as it relates to securitization, the equipment finance space is well situated. Even with the expiration of TALF for our asset class at the end of March, the feeling was that securitization opportunities will remain strong for equipment finance transactions.
Q: Are any new funding products or models being developed? Have you experienced or heard of any successful innovations that addressed the credit crunch?
McCALL: People are trying to be more flexible using things that are already out there. Some people are looking to raise discrete investment
funds that they would externally manage. Other people are selling their originations more than they would have. Everybody is doing what they can, but I am not aware of anything new and different. The SBIC [small business investment company] is something that people chat about: Should we start an SBIC to establish another source of low-cost funding? It’s been out there a long time.
TERFLER: The ideas I’ve heard discussed are similar to what was more commonplace 10 to 15 years ago. Ideas such as more traditional
(nonsecuritization) bank facilities or possibly a direct lending arrangement with nonbank sources, such as an insurance company.
HANSON: Surprisingly, covenant-light high-yield bonds are back for acquisition loans and recaps. This competes with bank funding. And increasingly, bank conduit participants are demanding that the conduit be rated so there is more liquidity when they want to sell.
MARINO: For the most part, banks are reverting to conservative senior secured financing structures because of the lack of senior financing competition relative to pre credit crisis levels of a few years ago. As such, there is little incentive for the banks to develop new products to differentiate themselves from their competitors. The demand from equipment lessors is such that the banks can do as much business as they want while remaining conservative and offering simple bread-and-butter loan structures. As competition for supply of senior financing increases, banks will likely need to become more innovative with regard to structure or terms they offer.
DALE: Financial innovation is kind of taboo these days. People are going back to basics and not looking at trying to create the latest financial wizardry. These days, simple is better when it comes to funding and funding products. People’s willingness to step out on a limb and create some type of fancy structured product is nonexistent. Overleveraging got us into this problem, and only deleveraging can get us out of it.
Re-circulated with permission from the Building on Solid Ground issue of ELT Magazine, March/April 2010, pages 38-40.