THE LONG VIEW: A Q&A with the Top Banks in Equipment Finance
The participants in our Q&A represent some of the biggest banks in equipment finance, which fund everything from agriculture to healthcare services and anything in between. Bill Mayer, Joe Pucci, Mike Romanowski and Tom Rutherford offer their viewpoints on 2019 so far and their outlook on the months and years ahead.
Since it’s about mid-year, how have the actual 2019 results compared to forecasts at the start of the year? Have results been higher or lower? What seems to be working and why?
Bill Mayer: New business volume in 2019’s first half was below expectations across many of our businesses. Conversely, new business spreads, while still on the low end, have improved across our entire platform. In particular, our businesses that experienced pricing compression due to rising interest rates through much of 2018 have benefitted in 2019’s declining rate environment. On the revenue side, performance has aligned with our original forecasts, and we have benefitted from continued benign credit loss activity. We continue to heavily invest in both regulatory compliance activities and technology. Overall, Wells Fargo Equipment Finance’s financial performance has met expectations even though the path has differed slightly from the original forecast.
Joe Pucci: Beneficial Equipment Finance (BEFC) year-to-date results are in line with expectations, and our core markets are stimulating growth. We have little vendor attrition, and our 2018 vendor acquisitions are also augmenting our 2019 volume. The economy and stable interest rates are providing the catalyst for equipment purchases in our markets, which we expect to continue through the remainder of 2019.
Mike Romanowski: We’re presently tracking to budget. In the major sector that we serve — agriculture — customers are cautious and investment is muted.
Tom Rutherford: It’s been a very busy year for us — in good way, as we’re running about 40% ahead of our original forecast for fiscal 2019. Primary contributors have been an increase in our indirect originations, as we opened up that channel a little wider at the start of 2019 (and will continue to expand that in 2020), and we’ve seen and closed more FITC deals (specifically solar and fuel-cell) than originally planned.
Has the risk/reward balance changed during 2019? Are lessees pushing for more relaxed credit structures than in 2018?
Mayer: 2019’s competitive financing environment has been marked by a long-lived, low-loss expansion cycle. Customers and prospects are demanding more from their primary bank relationships, both from structure and pricing perspectives. Market competition has driven pricing compression on upper middle market and corporate bank customer transactions and requests for proposal. However, returns on loans under $1 million have improved over previous years. On the structure side, we are being pushed for things like longer tenures, larger balloons/residuals and on the small end of the market, for no personal guarantees.
Pucci: We believe there has been a push for relaxed credit standards and structures. We’ve stayed the course with our credit philosophy and approach to credit underwriting, with very little changes or modifications. We align our underwriting strategies with the markets our vendors serve and our pre-determined risk tolerance.
Romanowski: We’re not experiencing demands for relaxed credit. That said, we are working with our partners to meet the needs of customers with balance sheets that have been hampered by consecutive annual loses but where we believe the customer is a prudent operator and will survive the current agriculture recession.
Rutherford: I think lessees are always pushing for more relaxed credit structures. From our perspective we haven’t changed our risk/reward metrics, but pricing has been drifting down as interest rates have declined, so that’s good news for our lessees.
We’re hearing a lot about the adoption of blockchain and smart contracts. How has the rapid pace of technological advancement affected your new business activity?
Mayer: Our customers want the same customer-centric experience on the business-to-business side that they experience as individual consumers. We have seen the industry — both large traditional players and new, emerging fintech companies — building and creating new systems and technologies to meet this demand.
Over the past several years, Wells Fargo has dedicated tremendous resources towards enhancing our technology systems to provide this convenient, quality experience.
Our new business volume ties directly to meeting our customers’ technology expectations. Wells Fargo’s primary goal as a financial services provider is to add value for our customers, helping them increase top-line growth and operational efficiencies. As we continue introducing these technological enhancements, customer satisfaction and loyalty increases.
Pucci: We have not adopted blockchain technology but remain interested in its perceived benefits. Delivering seamless products and improved efficiency is a requirement to drive down administrative costs and provide a best-in-class customer experience. The merging of Beneficial with NewLane Finance creates a platform built on advanced technologies and allows for additional enhancements to BEFC customers.
Romanowski: We’re not presently experiencing asks by our customer for blockchain or smart contracts. Our focus is on producing automated documents and digital signature for our small-ticket channel.
Rutherford: I’m not sure if it’s “blockchain” or “smart contracts”, but certainly the advancements in data analytics and data mining have improved the efficiency and performance of many of our lessees, which translates to more activity for us. It’s actually been fun to work with our lessees to incorporate their improved capabilities into their credit profile and lease documentation to help get more deals closed.
What’s your assessment of the quality of the transactions that you are seeing compared to the past year or two? Can you provide an example or two of a discernable change?
Mayer: Financial industry competition remains intense across all segments. We see aggressive pricing and structure offerings from most competitors. In some cases, there appears to be a risk-and-reward disconnect and a clear focus on growing new business volume. Not surprisingly, customers are playing financing providers against each other in search of even better deals.
This type of environment puts more pressure on us to show the value Wells Fargo can bring to a situation through experience and ability to structure a deal to satisfy our customers’ needs and help them succeed financially. Our ability to use our knowledge of our customer’s industry, the underlying asset, and experience through many cycles, allows us to structure transactions which fit a customer’s need, while at the same time keeps the risk-and-reward equation in balance.
Pucci: No real change in the credit quality of our transactions. Our niche markets of healthcare and veterinary services provide very stable credit profiles.
Romanowski: We continue to see opportunities for large facility build outs as the industry continues to consolidate and agribusinesses and producers manage through a shortage of labor in rural America. These opportunities are coming from forward-looking market leaders.
Rutherford: Considering “quality” as yield, that is down compared to the past year or two, reflective of declining interest rates. From a transaction structure perspective, lease and loan documents continue to evolve as lease structures get more creative/complex and lessees become a little savvier.
What are your expectations for the bank-affiliated equipment finance industry in 2020?
Mayer: For the past 10 years, bank-affiliated entities have provided most debt-profile financing products to the equipment finance market. As banks continue to value loan growth and market share, we expect a sustained, competitive and highly liquid marketplace. While there will be some notable consolidation among our competitors, we don’t expect any reduction in available capital for quality middle market and large corporate credits. Bank-affiliated shops will continue to compete fiercely for customers and will eagerly participate in opportunities offered through capital markets channels, despite pressure on spreads.
Pucci: We believe bank affiliates will continue to grow and expand into the equipment finance industry. Many banks entered the market during the past few years, and we believe new entrants will continue to seek out the diversification and returns that equipment financing provides. The number of bank affiliates will grow and competition for assets will increase.
Romanowski: I would expect cautious growth until the tariff issues are resolved. Businesses don’t like to invest during times of uncertainty. We’re presently in uncertain times.
Rutherford: If we can keep regulatory/compliance hurdles manageable, I think the future is very bright for bank lessors. Whether a bank grows its finance activities organically or by acquisition, the good ones are exploring new products and services, as well as re-assessing (and expanding) their credit box.
Comparing this year to last, can you comment on the credit quality of customers?
Mayer: Our overall credit metrics — i.e. delinquencies, non-performing assets, write-offs — continue to remain at cyclical lows. If you look at our portfolio by segments, credit quality remains solid without noticeable change in the upper end of the market on larger credits. We have started to see stress in the lower end, smaller credits that typically exhibit credit issues earlier in a downturn. Credit quality also depends on the industry. For example, our construction customers, in general, appear to be doing well in 2019, while trucking companies are showing weakness with overall softness in the industry. The same can be said for parts of marine, as well as oil and gas.
On the positive side, at a high level, customers appear to be more prepared for a downturn as they have been careful about expansion and taking on increased leverage. This bodes well during the next economic downturn for both our customers and Wells Fargo.
Pucci: The credit quality of our existing customers is very good. Our delinquency and losses are in line with our targets, and we are not experiencing any degradation in credit performance through the first six months of 2019.
Romanowski: Overall, credit quality has remained stable. We are pleased with how our portfolio is performing given that we are in the fifth year of a low-price agriculture commodity environment.
Rutherford: In general, I think the credit quality of our long-time customer base has been pretty constant and maybe improved a bit over the last year. As for new (potential) customers, there may be a slight improvement in credit strength when comparing year-over-year financial statements.
What was your biggest concern for the industry at the beginning of the year? At mid-year, has this changed?
Mayer: There are many areas for potential concern, including the increased volume and effects of state laws, new market entrants, customer demands for technology, and ever-increasing competitive price and structure pressures. On top of this are economic factors like trade tensions, an uncertain oil industry and falling oil prices, the political environment at home and abroad and the interest rate environment. These factors are ever-present and impact our results and overall success throughout the year.
With that in mind, one of Wells Fargo’s objectives — at the year’s beginning, midyear, and always — is providing a value proposition for our customers. We constantly work to maintain the reasons customers choose to bank with us.
Pucci: In the beginning of the year, we were concerned about rising interest rates impacting capital equipment purchases and the overall slowdown of the economy. At midyear, our current concern of a stagnating economy has shifted, and we see that changing more towards the middle of 2020.
Romanowski: Our biggest concern is the impact that tariffs are having with our customers resulting in an investment pull back. This concern has not changed at mid-year. Presently, we are disappointed with the progress to resolve trade issues.
Rutherford: We like FMV transactions, and a big concern we’ve had over the last few years was the potential for a decrease in FMV deals as a result of the FASB changes — which has turned out to be the case for us. So our concern hasn’t changed with respect to a decrease in FMV deals, but we accept that’s the new reality, and we’re seeing and processing more capital leases and loans.
How has competition changed between banks, finance companies and specialty lessors? Are you seeing new entrants causing disruptions?
Mayer: Competition across all industry segments remains intense. A prolonged period of low-credit losses resulted in many competitors becoming increasingly aggressive, attempting to win or hold market share. However, there are costs of doing so when considering the entire credit cycle. Finance and specialty lessors that work in niches where they have specific collateral or industry experience continue to hold their positions. This high-level competition makes it difficult for any one competitor to gain market share and creates a period where trading share is the norm.
There are always new entrants to the market. From our perspective, none have caused significant disruption. In particular, fintech — while remaining active — has not threatened longtime players as some industry watchers predicted. Wells Fargo continues to invest in technology that improves service and cuts costs. This helps to set apart our value proposition and ensure long-term competitiveness.
Pucci: There has certainly been more competition in the industry and go-to-market strategies are being challenged by new entrants using the latest technologies. There have been several fintech entrants that, at face value, appear to impact our business but cannot compete with our vendor driven sales model. We use technology to enhance our vendor relationships and service their distinct needs by providing custom solutions.
Romanowski: We are not seeing new entrants. The competition for customers, even those with less than stellar credit profiles, remains intense. We have experienced spread compression to retain and win business.
Rutherford: We are seeing new entrants, as well as a shift in some banks and finance companies to grow/win more volume, so there may be a little competition out there but no real disruptors yet from our perspective.
Is there anything we haven’t covered that you believe would be valuable to our readers?
Mayer: The equipment finance industry is facing a big increase in state laws that affect lessors and lenders. Although banks are typically exempt from state laws, bank subsidiaries are, in many cases, subject to compliance.
Recent examples include:
• A new California law that requires lenders to provide detailed disclosures to commercial borrowers that previously only applied to consumer loans is proving challenging to the financial services industry.
• New requirements for parties entering into certain contracts with New York and New Jersey state agencies to provide detailed demographic and salary information about certain employees.
• Vermont recently enacted the nation’s most-stringent requirements related to automatic renewal provisions in leases.
Frequently, bills that aim to fix a problem unrelated to our industry unintentionally cover equipment leases and loans. To counter this, the industry should proactively work to ensure that state legislators understand the equipment finance business and the unintended consequences that many bills have on our industry. This could limit adverse effects on both customers and financial institutions as such bills become law.
Rutherford: We’d encourage everyone not to let their guard down with respect to fraud; the bad guys are getting better and more aggressive. From high-jacking emails to some pretty creative phishing techniques, it’s amazing what’s popping up, so cyber security and education/training should be a high priority for us all. •