The Credit Landscape: Better, But Not Too Pretty a PictureBy William Atkinson
Article Date: 07-01-2010
Copyright(C) 2010 Associated Equipment Distributors. All Rights Reserved.
Three lender sources explain where they see things now and what the future implications are for dealers.
The tightening of credit over the last couple of years has had a devastating effect on AED members. According to research from AED’s Washington office, there has been a loss of hundreds of millions of dollars of revenue over the last 12 to 18 months due to the lack of available capital to dealers, who are trying to set up floor plans for equipment, as well as for the purchasing power of their customers – even their well-qualified customers.
Has anything changed over the last year, or even within the six months since CED last assessed the situation? Plenty, and, fortunately, most of it is good. We asked three industry lenders to share their insights on what has happened, what is happening, what may happen in the near-term, and what it all means for construction equipment dealers and their customers.
The Changing Credit Landscape
How is the credit landscape changing these days for average AED construction equipment distributors and for construction as a whole?
Since the spring of 2010, Kristi Webb has seen a pick up in applications for new credit. “This is telling us that the construction space is trying to come back,” stated Webb, who is the commercial leader, dealer finance business, for GE Capital Equipment Finance (Irving, Texas) “Some of the retail buyers have restructured their businesses where necessary, and we consider this to be a positive sign.”
GE Capital conducted a survey of CFOs recently, half of whom, according to Webb, responded that they see the current economic “reset” as being more permanent, meaning that they don’t see things returning to the pre-crisis level. “Here, we see things continuing to remain relatively flat this year, but we start to see 2011 looking a little healthier,” she continued.
Dick Wavro, president of the construction equipment finance division of 1st Source Bank (South Bend, Ind.), is well aware that dealers and their customers have come off a pretty tough year in 2009.
“The market activity is showing some improvement because of the stimulus dollars, so that will bring some opportunities to the dealers,” he reported. In preparing for this interview, Wavro noted that he obtained insights from his six sales officers to add to his own observations. “They do a great job of staying on top of the market,” he said.
As Wavro and his sales officers see it, the credit landscape going forward is looking a little better. However, it will still remain somewhat guarded. “That is, the credit people are still going to look for the fundamentals, and they will keep one eye on what is going on in the construction marketplace,” said Wavro. “They will want to know if the dealer has adjusted to the new landscape, compared with what happened in 2009.”
He adds that there are some signs of easing credit, but only slight signs. Again, it will go back to the fundamentals. “If the lender can determine that the dealer has a good solid plan and has made the adjustments, then they should be able to obtain money,” he said.
John D. Crum, national sales manager, Wells Fargo Equipment Finance, Inc., Construction Group based in Tempe, Ariz., also sees things brightening up. “There seems to be more of a flow of credit availability into the dealer space these days, and even in the contractor space,” said Crum.
Lender Priorities and Parameters
What are the top priorities that lenders have these days? And are their parameters still as strict as they were 12 to 18 months ago?
According to Crum, it comes down to the basics in terms of understanding what is happening with the financial picture.
“Obviously, almost everyone has seen a decline in sales, and most of these declines have been pretty significant,” he said. “As such, lenders are going to want to know how much sales are off.”
They will also want to know things such as: How did the dealer react to the decline in sales? Did they adjust expenses themselves? If so, what did they specifically adjust? (employees? locations?) Have the adjustments fully flown through the balance sheet and P&L?
“In other words,” said Crum, “are the results of the changes they have made already obvious?” And, he adds, do they foresee any additional operational changes or adjustments?
In terms of credit, Wells Fargo Equipment Finance looks for a strong balance sheet, not an abundance of leverage, and adequate cash flow.
“We also look deeply into inventory turn times,” continued Crum. Specifically: What were turns before the decline? What are they now? What have they been on a historical basis? If the dealer has excess inventory, what are their plans to move this out?
“We also want to know their forecasts for business this year,” he added.
In terms of parameters, Crum doesn’t believe that they are any different today than they were in the past. “It may feel different, though, because what may have changed is that the dealers have adjusted the size of their business,” he explained.
According to Wavro, lenders these days are still looking at the fundamentals. They want to make sure there is the right mix of inventory for the dealer’s business.
What’s of keen interest to Wavro and his team is: Have dealers adjusted their debt levels to be manageable with the amount of activity they have? Have they adjusted their overhead across the board?
“Those who adjusted quickly from what happened last year, and who got their P&Ls in line with the activity, are the ones who will still be able to work with lenders,” Wavro said.
Questions of interest to Webb and her team at GE Capital include: Have dealers restructured their businesses in light of the new economy? Are they continuing to lose money? Have they reduced SG&A (selling, general, and administrative expense)? Have they taken the necessary steps to right-size their inventory levels? Have they diversified their sources of revenue, such as sales, rental, parts, and service?
New Financing Options
Are there any new financing options available today for dealers and their customers?
Wavro and his team haven’t seen much of anything new in this area. In addition, they don’t anticipate seeing anything new in the near future.
“The problem with new financing is that it is often creative, and being creative creates risk,” he explained. “I don’t think you are going to see anything that is designed to create more risk.”
Crum hasn’t seen any new options, either. However, he has seen a rekindling of some traditional products, such as subsidized financing, including manufacturer-sponsored programs with extended floor plan terms.
GE Capital’s Dealer Financing has actually introduced a new financing option. According to Webb, although purchasing is more common in the construction industry, retail buyers are starting to turn to leasing because of the improved cash flow, enhanced liquidity, and greater flexibility that it provides. To respond to this shift, GE Capital’s Dealer Finance business introduced a program in late 2009 for retail buyers called the Rebate Lease. “It is designed to help them lower the lifetime operating cost of the equipment by more closely matching hourly expenses to their actual usage,” she stated.
Dealer Credit Challenges
According to Wavro, the biggest challenge for dealers these days is to get their “houses in order.” For example: How have they made the adjustments to these lower levels of activity? “The biggest part of this is controlling inventory,” he states. “They need a good mix of inventory to sell and/or to rent, and they need to realize that the demands of the marketplace are a little different today.”
Over the years, according to Wavro, equipment sales for AED dealers have always followed the trend of housing starts. With the dramatic drop-off in new housing starts, this has reflected dramatically in equipment sales. “I think housing starts will remain at a static level for the foreseeable future,” he said. “As a result, dealers who cater more to road work will do better this year.”
According to Crum, a challenge for dealers is the importance of making sure that their operations have stabilized. For example: Have they made the necessary adjustments to economic conditions, or do they still need to make these? “Some dealers believe that the current situation is going to be the norm for the next few years, and they are making adjustments based on this environment,” he added.
Another challenge that Crum sees for some dealers may be that some lenders have disappeared from the landscape, which limits the amount of credit that may be available to them.
Loan Restructuring Strategies
As the environment changes, Crum believes, it is important for dealers to communicate with their lenders in terms of what is happening in their business and what they expect.
“As far as we are concerned, a dealer can’t communicate with us too much or provide us with too much information,” he emphasized. “The more the better. There is no way they could flood us with more information than we can absorb.”
He adds that it is important for dealers to communicate bad information as well as good. “The earlier the bad information is communicated, the easier it usually is to come up with a resolution,” he explained.
Crum also encourages dealers to provide information on what they think the restructuring will do for them – short-term and long-term. That is: Does the restructure solve their problem now and in the future?
“You don’t want to get into a restructure that will cause problems in the future,” he said.
According to Wavro, dealers need to explore additional sources of credit. Whereas they might have been comfortable working just with the captives or the manufacturers, he believes that they also need to begin looking at some outside sources. “Then, if and when things turn down again, they will have some expanded options,” he said.
Wavro also believes that the ability to restructure their loans will depend on their individual situations with their lenders. “I think that most lenders, if they feel comfortable that the borrower has adjusted in terms of having the right mix of inventory, has found one or two niche markets, and is going to be able to maintain cash flow, will work with them,” he said. “I know that we have.”
According to Webb, her business is starting to see fewer requests to restructure loans at this point. “We will have to see what happens here in the future,” she added.
The Personal Guarantee Challenge
If a dealer is just starting to think about the personal guarantee issue, it’s probably too late, according to Wavro.
“This is one of the things that dealers should have been thinking about all along,” he said. “Most of their net worth is substantially in their business.”
The stronger the balance sheet, and the stronger their business is (with lower debt levels and the capacity of multiple lines of credit), this strength will hold them through these tough times. Many times, according to Wavro, principals have had to go back and tap some of their personal resources and infuse some new capital into their business. “I know a few dealers who have done this,” he said. “As a result, they have been able to maintain a good personal balance sheet, as well as a solid company balance sheet.”
According to Crum, the best way for dealer principals to protect themselves is to communicate early and communicate often with what is happening in their business. “If the lender knows what is going on, they will have a much higher comfort factor,” he explained.
Webb’s recommendation: “If a principal has any questions about personal guarantees, they should seek advice from an attorney or someone else with expertise in this area.”
Besides making sure they are in a position to quality for credit, smart dealers also want to take steps to make sure that their creditworthy customers can also quality for credit.
Wavro’s recommendation: “Start early, and start often,” he said. For example, if a transaction begins with a rental purchase option (RPO), the dealer needs to start early working with the customer, reminding the customer that they need to begin to get their financial information together.
“They need to complete their statements and put together a good credit package,” Wavro said. “If a customer thinks he needs 60 to 90 days before he buys, he should start the process early.” Wavro adds that the dealer should also encourage the customer to seek multiple lines of credit.
According to Crum, there is generally a requirement for more information today, because, just as dealers have seen a decline in business, most of their customers have also seen a decline in business. “Dealers can help customers prepare for questions, either through their own experience, or talking to the lender to see what information they will want,” he suggested.
“It is important for customers to be forthright about the state of their business,” said Webb. These include the challenges they face, as well as what they are doing to adapt to those challenges. For example: Have they right-sized their inventory? Have they right-sized their company as a whole?
What Does the Future Hold?
In terms of the rest of 2010, Wavro believes that things will remain pretty much the way they are now.
“I don’t think there will be a lot of loosening,” he told CED. “As the economy starts to look brighter as regards to construction work and construction employment, then I think we will see some more flexibility and more propensity to want to lend.”
He believes that lenders are going to continue to keep an eye on all of the statistics being put out by entities such as the Federal Reserve Beige Book, McGraw-Hill, AGC, and AED.
There is certainly capital available, according to Crum. “We are seeing, particularly with larger dealers, a better flow of credit to them,” he said. “Lenders are more confident these days. The ‘fall’ has happened, businesses have made adjustments, and this may not be a bad time to go back in and lend to businesses again.”
Webb adds: “We believe that there will be plenty of credit available for the remainder of 2010.”
GE Capital’s Equipment Finance Changes
In March 2010, GE Capital, the nation’s largest leasing company, announced that it was grouping together its wholesale and retail construction equipment offerings under Kristi Webb, commercial leader of its Dealer Finance business. Through its Equipment Finance business, GE Capital provides commercial leases and loans, typically ranging from $5,000 to $25 million, to small and mid-sized manufacturers, dealers, and end-business users. By coupling this new structure with technology investments, GE Capital is now able to provide construction equipment dealers with options to help them better manage both their wholesale purchasing and retail sales initiatives.
“Lower activity levels in the construction sector have created cash flow pressures for dealers and end users,” explained Webb in a press release. “Our wholesale options allow capital-savvy dealers to stock equipment without draining their own cash positions. Our retail leases and loans, including the Rebate Lease, help dealers provide affordable offerings to customers who are also concerned about financing their purchases.”
GE Capital is also investing in technology designed to provide quick decisions on credit applications, easy document preparation, and same-day funding decisions for retail lease and loan transactions.
In a recent interview, Webb updated the status of the new initiatives. “We have remained in the construction industry,” she said. “These days, we are placing more of our focus on construction dealers. Another part of our business continues to serve the construction end user market, with an emphasis on larger projects, such as highway builds.” One area the company has moved away from, though, according to Webb, is what it calls small-ticket construction to the end user.”
Today, GE Capital’s Dealer Finance business is aimed at offering product and serving dealers across a range of industries, including construction. “We do loans and leases, as well as capital for equipment acquisition, and restructuring,” stated Webb. Some of the current offerings are designed to help construction equipment dealers with both wholesale purchases and their retail sales.
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