Proceed With
Cautious Optimism
At the ELFA/IMN Investors Conference, the message was clear: equipment finance is not at risk for a meltdown.
By Bennett Elliott
“B
eware the Ides of March.” Especially if
you’re given to panic over events that may
or may not eventually affect you. Many of
the more than 400 attendees of ELFA and
IMN’s sixth annual Investors Conference—the largest ever Conference
attendance—could have used this piece of advice as they mingled
nervously in the lobby of the Manhattan Marriott Financial Center on
March 15, turning over bits of gossip and speculation as they waited
for the day’s activities to start. The recent meltdown in the sub-prime
market was the cause of conversation and, to no small extent, worry
among participants of the conference. With predictions of other
markets potentially experiencing a spill over or contamination from
the recent sub-prime meltdown, attendees found themselves besieged
by an onslaught of rumors that gave rise to just as many concerns.
Would the leasing market take a hit as a result of the upheaval in
sub-prime? And how would the market react to such an event? Most
importantly, what would it mean for each attendee’s company?
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LT • May 2007
Reasonable
Predictions
From the outset, efforts were made
to ease attendee tension and unwind
some of the pressure of coincidence,
hearsay, and justifiable concern with
a rational assessment of the equipment leasing industry. Opening the
conference, Ken Kremar, principal,
Industry Practices Group, GLOBAL
Insight, provided a market overview.
Breaking the Industry down sector by
sector and segment by segment, Kremar helped dispel predictions of any
sort of all-encompassing gloom and
doom phenomenon, even as he noted
estimates suggesting a cooling in the
overall domestic demand for machinery over the next four years.
Addressing individual industries
within the market, Kremar pointed
out market segments with a potentially troubling upcoming year
(medium and heavy trucks) as well as
segments projecting a strong calendar
year (agricultural equipment). Even
with a notoriously volatile and currently declining segment like freight
cars, he took time to parse out and
highlight promising divisions, such
as hopper and tanker cars, each currently experiencing a boom from sub-
stantial production backlogs despite
the start of a moderation in ethanol
production levels.
Underscoring that there was “nothing to suggest the bottom falls out of
the entire industry,” Kremar’s careful
division and comparison of market
segments illuminatedan industry with
stable to declining operating rates and
projected lackluster profit growth—
but not an industry anywhere near
the brink of collapse. This overview
would prove to set the tone for the
day, providing an oft-repeated subtext
for the remainder of the sessions and
casual conversations throughout the
day: even when you cannot remain
optimistic, REMAIN CALM.
The Source of
Discomfort
Following the Market Overview, the
day’s breakout sessions began, drawing a sizable cross section of panelists
and attendees from across the spectrum of the leasing industry—public
and private companies, specialists
and generalists, all ticket sizes—as
well as analysts, investors and other
stakeholders. Despite the variety of
participants and subjects covered, the
same subtext for Kremar’s overview
would be both explicitly and implicitly repeated in numerous instances
and forms.
Whether brought up by panelists,
moderators, or audience members, the
abundance of liquidity in the leasing
market and exactly when and to what
extent it could or would violently
contract were recurring themes and
concerns in almost every session.
Some perceived a “pride-before-the-
Panelist Hugh Connelly addresses the questions of an attendee on the issue of raising
capital in a market awash with liquidity during a breakout session.
fall” attitude in the sub-prime market
prior to the meltdown, and feared a
possible contamination of the equipment finance market.
The questions raised and the
answers to those questions differed
in terms of focus and approach. But
there was consensus on at least one
key issue: the current sea of liquidity
is due to a combination of current Fed
policies and excess capital from Asia
and elsewhere being invested over
the breadth of the U.S. market. In
addition, delinquency and market actions emerged as broadly agreed upon
metrics capable of judging liquidity
in the market, with special emphasis
placed on the debt market. Yet there
was no consensus prediction of how
long before leasing market liquidity
would tighten—few even went so far
as to speculate on such an event at all,
feeling that such predictions could do
much more harm than good to the
market.As Neil Rudd, managing
director of strategy and business
development at Merril Lynch, noted,
“Liquidity is good, except when it’s
bad.” And while other markets are
clearly experiencing the “bad” side of
liquidity, equipment finance, for the
moment, appears safe. Despite all the
nervousness, most observers seem to
know this. The statement, repeated by
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LT 37
By the evening cocktail reception, most of the fears surrounding the sub-prime meltdown had subsided.
numerous panelists, that delinquency
and loss stats in leasing are totally
unlike those in the sub-prime market took few attendees by surprise.
And as Piper Jaffray Senior Research
Analyst Robert Napoli and Jefferies
& Company Vice President of Equity
Research Richard Shane pointed out,
while there are some markets, such as
buyout lending and leverage finance
that qualify as being vulnerable to
sub-prime contamination, equipment
finance, at this juncture, does not
rank as a major cause for concern.
According to one panelist, one reason
this happens to be the case is that,
“Credit behavior is driven by millions
and millions of factors, while liquidity
is determined by a very small number
of people who, for better or worse,
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aren’t any more informed that the
average observer.”
However, the large question remained: what if a consumer market
choked with liquidity eventually
trickles down to even the most insulated market segments of the commercial finance industry? How does
one go about safeguarding from such
a situation?
There was no shortage of suggestions. John Fruehwirth, managing
director, Allied Capital Corporation,
emphasized “spending a lot of time
on risk assessment and talking about
credit toughness policies,” and “diversifying both origination sources
and a strong balance sheet to face the
impending cycle.” The range of answers to this pair of questions varied
broadly from panelist to panelist and
session to session in terms of specifics, though the gist of each—even
the ones that seemed contradictory—was summed up in the advice of
Goldman Sachs & Co.’s vice president of the Special Situations Group,
Gauray Seth: “Proceed with cautious
optimism.”
Yet there are apparently some companies out there showing anything
but caution. Several panelists who
advise leasing companies mentioned
attempts to buffer clients from potential liquidity evaporation and pitching
defensive ideas, only to be met with
repeated interest in much riskier ventures. Why? The current environment
in leasing is very competitive.
Keep Your Management Team Closer
To prepare for and guard against a
market shock, panelists suggested
an array of sometimes conflicting
tactics. But there was one widely
agreed upon approach for increasing security in the event of any
potential downturn of fortunes, and
in ensuring long-term profitability:
good management teams. In a session
involving six panelists, four of the
six would mention, if not openly
discuss, the importance of management teams. “Management teams are
Would the leasing market take a
hit as a result of the upheaval in
sub-prime? And how would the
market react to such an event?
crucial,” Mericap President and CEO
Craig Weinewuth affirmed, noting
that, “70-80 percent of private equity
group decisions are based principally
on trust in the management team to
come through.” A respected, top-
notch management team can ease
investor nerves more than almost any
other factor, allowing companies to
persevere in even the worst conditions. And that team must be proven,
its strengths carefully selected and
May 2007 •
LT 39
The current sea of liquidity is due
to a combination of current Fed
policies and excess capital from Asia
and elsewhere being invested over
the breadth of the U.S. market.
Moderator Mark McCall and panelist Quentin Cote listen as Crit DeMent discusses
beating obstacles for raising equity and debt in the private market.
then distilled to match a business’s
projected strengths. “You have to
show growth and quality of your
management team,” said Weinewuth.
Strong, established teams unwilling
to compromise credit quality in an
attempt to achieve steeper growth,
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LT • May 2007
that look for defensible niche,
recognize long term trends, and do
not forget underwriting make the
difference—especially in the case of
startup companies.
“Startup companies” stressed
Anthony Nocera, director of Stan-
dard & Poor’s, “are made or broken
by the strength of the management
team. New competitors that have not
put together a management team of
seasoned pros are likely to be hurt
by the fact that they have a limited
operational history and data.” Ability, although an abundance of it may
be present in an unproven management team, cannot entirely make up
for experience. As Noreca asserted,
“the difference between proven and
unproven teams lies in knowledge
of the competition, not ability,” or as
American Capital Strategies’ Managing Director Bob Gruenwald put it,
“It’s easiest to underwrite a proven
management team. Period.”
No one summed up the importance
of a strong management team’s role in
the current market quite like keynote
speaker Dean Graham, president and
CEO of Capital Source Finance, LLC.
Graham drove home the importance
of the experience provided by proven
management. Successful investment
teams know “that down cycles exist
and admit they can’t predict where,
when, why, and how a cycle will
turn, and they do not forget past lessons, engineering models to weather
bad periods.
“We can’t control the actions of
business cycles” Graham emphasized, “but we can control our reactions to business cycles.” In a market
awash with liquidity, there is more
money chasing less business, creating a loosening of credit standards
to win deals. Some companies are
competing in this tough market by
lowering overhead to produce attractive asset growth, but tough times,
Graham insisted, may mean these
institutions don’t steer their own
destinies due to a lack of control
of underwriting and investment
management. “Targeting high risk
loans for high returns” Graham said,
was also not advisable. Companies
should instead “target loans that
achieve high returns by controlling
all aspects of loan management.”
Control of three key aspects—originations, underwriting, and portfolio
management—is essential to enabling
companies to soldier through even
the most difficult periods. An efficient
management team, and in turn its
company, should, Graham explained,
operate like a veteran crew team,
constantly at the oars and moving
briskly and consistently in a chosen
direction. “If we put our own oars
in the water,” he emphasized, “we
can be the ones choosing our own
course.” Even though there is a cost
to controlling all three, he pointed
out that it was worth it, providing a
degree of efficiency that would yield
“superior credit outcomes and attractive returns.
“And true efficiency” Graham
asserted, “is fielding the leanest
operation possible pertaining to
one’s specific approach to business.”
Management teams that heed this advice while (simultaneously)cautiously
embracing the underserved middle
market despite liquidity and risks,
specializing and diversifying, retaining as much control of the three aforementioned aspects as possible, and
maintaining discipline during market
swings would be able to ride out any
cycle and achieve fairly consistent
growth. As in all things discipline is
the key. But, “the simplest and most
Management teams are
crucial. Seventy to eighty
percent of private equity group
decisions are based principally
on trust in the management
team to come through.
obvious truths are” the hardest to
live by,” Graham noted. Following
these simple, even somewhat obvious guidelines of good management
through tightened control of key
aspects however, could be the difference between continued profitability
and obsolescence. Self-Fulfilling
Prophecies
Historically speaking, the 15th of
March, 44 B.C. was bad news for
Julius Caesar, but, in the long term,
not for Rome. Worried about the
future stability of the Republic, a
collection of panicky leaders from
the Roman government stabbed
Julius Caesar to death. As it turned
out, they were right to be worried,
since their own action created more
panic and vicious infighting in the
government. It was a self-fulfilling
prophecy…in the short-term. But
as any history major, high school
graduate, or casual Russell Crowe
fan can confirm, Rome did not fall
with the death of Julius Caesar,
thanks in no small part to the collection of level-headed, far-sighted, and
prepared senators, military leaders,
and future emperors that remained
calm enough to fix the results of others’ self-fulfilling prophecies of terror
and woe. And when the dust settled,
those that had stood prepared were
still standing, while the panicked
were…well, they were forever cured
of their panic attacks.
It’s safe to suppose that more than
a few Investors Conference attendees walked away with a less violent,
subject-specific version of this two
millennia old lesson: if the markets
look rough, be prepared, and if the
markets actually get rough, remain
calm. After all, predictions, whether
accurate or inaccurate, tend to focus
solely on events yet to happen, on
actions you cannot control. Reactions, on the other hand, things that
you can control and foresee, are left
to you. Bennett Elliott is assistant editor of ELT.
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