ELFA Equipment Leasing & Finance - Jan/Feb 2013 : Page 10
Forces Shaping The Year Ahead 10 JANUARY/FEBRUARY 2013 EquiPmEnt LEasing & FinanCE magazinE
8 Forces Shaping the Year Ahead
IF YOU TAKE A MOMENT TO REFLECT ON THE RECENT PAST, it’s hard not to conclude that the equipment finance industry has been on quite a roll. Despite some structural shifts within the industry, aggregate equipment finance volumes are at all-time highs, the return on assets is at a five-year high and the charge-off rate is at a five-year low. During the climb back to previous peak finance volumes, the equipment finance industry has reaped the benefit of double-digit growth in equipment investment and a favorable interest rate environment. Will the good times continue?
To answer this question and many others, the Equipment Leasing & Finance Foundation commissioned IHS Global Insight to update the Foundation’s 2007–08 research study on the size and expected growth of the U.S. equipment finance market. By cross-referencing various public and proprietary databases, the resulting U.S. Equipment Finance Market Study 2012–2013 provides an in-depth review and analysis of equipment financing volume. Included in the analysis is a custom survey of businesses that purchased equipment in 2011. Respondents were asked to convey key current and historic data concerning their firm’s industry classification, revenue, size, value of equipment purchases and financing tendencies by equipment type. The respondents also shared their opinions on the key drivers of the equipment investment and made forward-looking statements regarding their intent to increase investment.
So what does the future hold in store for the equipment finance industry? Expect the road to get a bit bumpy before we see a return to double-digit volume growth. The weight of evidence from the U.S. Equipment Finance Market Study suggests that the equipment finance industry will find the next 12 to 18 months to be more challenging overall. Businesses faced with rising uncertainty over the economy, export markets and regulatory policies will be more cautious about spending on equipment and software, as well as taking on more credit. The silver lining to this cloud is that technological innovation and equipment replacement needs should spur rapid growth in volume in late 2014 and beyond.
While the U.S. Equipment Finance Market Study reveals many attractive opportunities in select industries, equipment types and geographies, eight key trends to watch that will shape the future size of the industry are revealed as follows.
1.The propensity to use credit is on the rise.
Since the 2008–09 recession, the Fed has kept interest rates near all-time lows and, as a result, a higher proportion of companies are drawing on credit for their equipment acquisitions. This trend was apparent in the Foundation’s study sample, where 72% of firms used at least one form of financing (excluding credit card use) to fund equipment acquisition. Companies with revenues less than $1 million were the least likely to use financing, but even this segment saw an increase from 45% of respondents in 2007 to 49% in 2012. The hands-down winners in terms of drawing upon financing for equipment acquisition were companies with revenues between $25 million and $100 million. This segment used financing in 86% of their acquisitions, a noticeable jump from the 76% figure observed in 2007.
2.Financing is taking a larger share of investment spending.
Not surprisingly, with more companies utilizing credit markets, the dollar volume of equipment financing is rising as a share of total equipment investment spending. The credit crunch that gripped businesses five years ago has eased considerably. Among the borrowing market segments studied, large firms (those employing 1,000 or more workers) showed a significant increase in finance volume as a share of investment spending, rising from 52% in the Foundation’s 2007 survey to 70% in the 2012 survey. There is some risk that this trend will stabilize or even revert back to a lower level if credit conditions deteriorate. Recent bank lending surveys suggest that banks are still easing lending standards, but the percentage doing so is nearly offset by those holding steady or tightening standards. This is a trend to monitor closely in the months ahead.
3.Banks are taking on a larger role in the industry.
In the wake of the financial meltdown, banks have capitalized on their cost of funds advantage over many independent and captive finance companies. Between the Foundation’s 2007 study and 2012 study, banks’ share of equipment financing rose from 47% of total equipment finance volume to 57%. The new study confirms that banks were the primary lenders across all equipment types, with the smallest penetration in trucks and trailers. When comparing the two studies, it also appears that banks actively moved their new financing volume to companies with lower risk profiles. The share of bank financing of highly profitable companies rose from 26% to 47% between 2006 and 2011, while the share of bank lending to unprofitable companies declined from 65% to 53%.
4.Software financing is growing significantly.
The financing of software and services bundled with software is a market not to be overlooked. According the U.S. Department of Commerce, software investment totaled more than $309 billion in 2011 and represented the largest single “equipment type” category. Businesses are increasingly financing their software spending, with finance volume in the Foundation’s 2012 survey representing 55% of the category. Many software vendors and independents have expanded their financing programs, offering a broader range of services, including the soft costs of software acquisitions, such as implementation, service and maintenance. Businesses, in turn, are increasingly finding software leasing an effective way to keep their costs low while benefiting from the most up-to-date automation tools and services, such as cloud computing.
5.The construction market is gathering momentum.
Recent economic trends also suggest that certain assets or equipment types are poised for higher growth. For example, the housing market is beginning to show real signs of improvement. Household formation is reviving despite sluggish employment growth, and the recovery in demand is spreading from rental units to the owner-occupied sector. IHS expects housing starts grew 23% in 2012, albeit from a low base, concentrated in the multifamily segment, where pent-up demand is helping the rental market. With housing prices going up and housing starts rising, the construction equipment market is likely to experience a boost in demand, especially in 2014 as the economic recovery gathers momentum.
6.The energy economy is an important driver of equipment investment.
Unconventional energy production is attracting large capital investments. According to a study published by IHS, unconventional gas and oil production above $87 billion in capital investment in 2012 alone. Annual investment will almost double to $173 billion in 2020 and a total of 3 million jobs will be created by 2020. The expansion in the energy sector will help to reinvigorate equipment investment in construction, transportation, computer and other related equipment categories.
7.Short-term risks abound.
The economic recovery can be best characterized as possessing weak momentum that has not ground to a halt. Exports and business fixed investment—two key drivers of the recovery thus far—have run out of steam in the face of global economic headwinds and domestic policy uncertainty. A combination of slower growth around the world and a stronger U.S. dollar is dampening U.S. export growth. Business fixed investment, the second key driver of the U.S. recovery, is also weakening. A deeper Eurozone crisis and a harder landing in China remain the principal global risks. Despite the avoidance of the so-called “fiscal cliff,” the primary domestic risk remains the lack of political leadership to address the long-term changes needed to reduce the U.S. deficit and increase the federal government debt ceiling. Businesses may limit their investment spending until the full ramifications of future spending cuts and tax increases are known.
8.Evidence of pent-up demand bodes well for volume growth in 2014 and 2015.
For many businesses, the slow pace of economic recovery has put a strain on earnings. As a result, equipment that would have been replaced or updated remains in companies’ use. This is demonstrated by Bureau of Economic Analysis research, which shows that the average age of most equipment and software has increased since 2007 (see table, page 12). In fact, only the agricultural sector shows signs of significant replacement of older equipment over the past five years. Therefore, as economic conditions improve and credit flows more freely, there is an opportunity for significant growth.
For equipment finance participants, the immediate future may provide fewer opportunities for growth. In addition to overall investment spending growth slowing down, select segments of the market are expected to adjust their financing behavior. Based upon the findings of the U.S. Equipment Finance Market Study, the financing decisions of smaller companies are especially sensitive to general economic conditions. Even though this segment relies heavily on cash to finance its equipment purchases, it represents a significant share of the overall market. A prolonged standoff on the federal budget could lead to slower economic growth, with a contraction in this segment of the market pulling down overall market volumes.
In addition, the Foundation’s survey findings suggest that it is primarily larger businesses that anticipate increasing their equipment spending over the next 12 months. In the event that earnings growth slows, this segment of the market may have a greater incentive to utilize cash reserves to help finance equipment purchases.
So the headwinds for overall finance volume growth are considerable, and finance volume growth may only be in the low single digits for the next 12 to 18 months. However, as the economy gathers momentum and the path to fiscal stability becomes clearer, there will be a gradual easing of lending standards for large and medium enterprises, as well as an improvement in business credit demand. The equipment financing industry will remain an important source of funding for business expansion and equipment upgrades.
Mark Lauritano is Vice President of Growth Industries-Americas for IHS Consulting.
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