IntroductionThis year will prove pivotal in the next chapter of the US economy. Financial pressures are increasing. Europe, Latin America and other regions are experiencing their own headwinds and tailwinds. Meanwhile, consumer regulations are creeping into commercial finance. These developments and continued disruption will affect the equipment finance industry’s performance in the coming months, creating new product opportunities as well as challenges.

Macroeconomic FactorsUS economy floats or sinks with election outcome The economy will glide along at about a 2% growth rate through the presidential election in November reflecting low interest rates, stable consumer spending buoyed by full employment and rising wages, and favorable regulatory and tax environments. Markets remain somewhat positive overall and that optimism should propel the Dow past 30,000 which some say reflects overall corporate optimism and forward earnings potential. So, expect continued interest in US-based companies from foreign investors – especially Japanese – while expansion lasts. Yet the longest U.S. expansion in history just might be standing on its last legs as the economy still faces some headwinds, albeit not as intense as in 2019, including slowing global growth, increased tariffs and the resultant continued contraction in business investment.

The direction of the economy beyond November is dependent on the outcome of the 2020 election. If the current administration prevails for a second term, expect to see more of the same – moderate growth and a positive labor market in the near-term. If a single party sweeps the Executive and Legislative branches, then the economic impact could be far greater – from either a significant cooling of the economy to one that includes another round of tax cuts and trade deals.

Recession watch continues: timing, depth could surpriseAfter ten years of economic expansion, a recession is certainly around the corner. While there is no threat of a recession for 2020, the outcome of the November election will determine its timing – will it be pushed off for a couple more years? The real question to ask is how deep will the recession be? Will its intensity be greater than normal thus matching the expansionary phase which lasted twice the typical cycle?

Equipment leasing demand depends on several factorsDemand for new equipment will be soft in 2020 particularly as tariffs have increased the cost of goods sold. What’s more, the propensity to lease may further decline in 2020 not only due to weaker equipment demand but also due to the availability of more cash for purchases due to tax cuts, tighter credit and other factors. However, interest limits on loans may give leases an edge this year.

January 2020

Expect investment in equipment to be around 1-2%. Across equipment types, we believe that sales volumes will increase, although muted compared to 2019. One area where we see prices and volumes falling fast is the truck and trailer category.

Most Latin American economies get a liftEconomic conditions look promising in most Latin American countries. There are no signs of recession. Demand for capital goods should grow throughout all the market economies including Mexico, Brazil, Colombia, Peru and Chile. Mexico, for example, has prospects for infrastructure investment and the new USMCA agreement in place. It is poised to bounce back from a 10% drop in new equipment and software purchases caused by political uncertainty. One major driver of regional growth: trade with China, which is the number one supplier to all Latin American countries except Mexico.

Eurozone economies: gloomy with bright spotsPredictions are for another year of weak global growth, amid a sharp slowdown in international trade. That’s a concern for heavily trade-dependent countries. The latest ECB Europe projections are for GDP to expand by 1.1% this year and 1.4% in 2021. Germany and Italy have stagnated, activity is holding up reasonably well elsewhere and French and Spanish economies are registering solid GDP growth. Positives include a sound labor market, subdued inflation and expansive outlook for fiscal policy. All of these should help stimulate domestic consumer demand.

Brexit will present more headwinds for European economic activity and investment, especially in the UK. It is likely to take Britain several years to negotiate meaningful international trade deals.

Regulatory IssuesConsumer laws creep into US commercial dealsAs consumer regulations continue to encroach into commercial finance, they will affect industries and transaction types at the margins between commercial and consumer uses of equipment, goods and services. This will require mainstream financing and leasing to be prepared to absorb more than the traditional regulatory burden. The fate of the Consumer Financial Protection Bureau will be a factor, too, because a stronger CFPB may be expected to increase regulation. For example, current rules require that credit decision-makers be shielded from knowing a borrower’s race or gender, a difficult requirement for small companies which are close to their customers. The drift toward more consumer-oriented law may also discourage new equipment finance participants from entering the fray.

US banking constraints prove major forceBanks, and by extension, their leasing operations, are under considerable strain from regulations by the Office of Foreign Assets Control (OFAC), including Know Your Customer (KYC) requirements. Because of this they will keep chasing a better quality market, resulting in thin spreads and cost concerns. They are reluctant to innovate because doing so might trigger a reaction from regulators concerning how they conduct business. There are opportunities for independents and captive lessors to step into the breech or form partnerships, and for technology providers to help banks manage impacts on processes, procedures and infrastructure expenses.

Regulatory laggards offer opportunityThe “kick the can” mindset about adopting lease accounting changes including the new standard for current expected credit loss (CECL) means some private companies are putting off the inevitable and will require assistance to catch up. This could benefit service providers with lease accounting acumen.

Regarding the new standards, CECL will be as impactful as has been predicted, as we already are seeing volatility in stock prices and investment strategies being driven by adoption of CECL. The lease accounting changes will continue to have little impact on lessee behavior. They will, however, cause stress in the funder/vendor relationship as it relates to managed services transactions and the hell-and-high-water clause.

Regulatory scrutiny mounts in EuropeLook for more environmental regulations promoting the circular economy. Basel III and IV are also having an impact. Regulators are increasingly focused on returns but with higher capital demands, resulting in banks moving away from holding non-credit risk. Still underway: pressure on leasing captives having to adopt banking type legislation such as compliance with KYC and anti-money laundering (AML). There is also the continuing extension of regulation to specific consumer lending products.

Latin American regulatory paralysis continuesLatin American regulators will continue to struggle with new financing structures, including those driven by technology such as servitization. There is poor understanding of related Basel guidelines, resulting in a sort of regulatory paralysis. Environmental regulations are also starting to impact equipment finance. So are fraud prevention, cybercrime and transparency efforts, and the “Panama Papers” leak in 2016 has triggered more due diligence of deals. In other trends, the industry is getting more comfortable – and closer to compliance – with new lease accounting standards.

Financial OutlookProfitability concerns climb in USWith modest growth predicted for the year, revenue expansion will be limited and therefore companies will have to focus on expense reduction to see any meaningful gains in overall profitability. Operating expenses will continue to face upward pressure owing to greater technology spend. This is primarily because of higher costs from selecting and implementing new systems or running old legacy systems. To a lesser extent it reflects larger compensation costs, too. Expect more margin compression as interest rates – already quite low – are squeezing margins beyond what would normally come from competition. It is possible the margins will further compress as lessors reduce rates in a quest for growth. Provisions for bad debt will likely increase as charge offs continue to rise. These are just a few of the developments affecting profitability this year.

Credit quality pressures mountExpect to see further deterioration in portfolio metrics from charge-offs to delinquencies in 2020. As portfolio quality remains under pressure, one area to watch closely is first payment defaults, traditionally a harbinger of fraud. We’re seeing an uptick in lenders being defrauded by cyber criminals whose sophisticated hacking methods target automated credit underwriting processes.

The next “credit event” will likely involve logistics, particularly trucking Class 8. Retail remains a concern, too, with continued store closings, bankruptcies and struggling malls.

Funding access on solid ground – for mostFunding access looks generally stable this year. Borrowing costs should remain low for established players though new entrants or companies without scale face higher costs. Equipment-backed securitization remains a viable funding option for lessors of scale in 2020. Small-ticket equipment-backed deals will be in demand by investors even though credit losses are starting to pick up a bit. Expect to see some volatility in trucking, construction, and agriculture ABS that reflect economic challenges, and pressures from the China trade deal.

European bank subsidiaries under strainLarger bank leasing subsidiaries in Europe will experience continuing pressures in their quest to reduce cost income ratios. Strategies they are using to improve ratios include outsourcing, process automation and adding ancillary services.

Latin American liquidity looks good – unlessLiquidity in the financial and capital markets of Latin America should fuel a high growth year. Most of the players in the industry exhibit reasonably healthy portfolios. All this could change though if portfolio quality is impaired by large losses or systemic events.

Industry StructureBank lessor dominance wanesBank lessors are a powerful force in the industry, but trends show this may diminish in the US. Expect more of their bank parents to exit equipment finance in 2020 to refocus on core offerings, improve capital ratios and avoid risks. Some banks may step away from equipment finance via mergers and acquisitions. This is most likely for those below the Top 5 bank-owned lessors, in the event that credit, economic returns and growth pressures rise. We are also seeing international banks, notably Spanish ones, pulling away from the US leasing market.

Independent lessors gain ground – for nowIndependents play an important role in the industry – historically the innovators. Free of regulatory and parent pressures, they are attractive M&A targets. Expect the launch of fresh independents and renaissance of existing ones in the short term because traditional bank financing and institutional funding will be tight for innovations and market entrants. The longer view? A landscape of more specialized providers and fewer big banks as the industry moves away from traditional hell-or-high-water leasing toward everything-as-a-service financing.

Captives evolve or risk fading awayCurrent large captives remain viable. But the future of smaller captives lacking in the necessary scale is less secure. This offers growth opportunities for vendor-oriented bank and independent equipment finance operators. Key reason: unless the economy changes, more manufacturers may opt for using competitive bank funding or specialized service independents vs. maintaining their own captive. Longer term, captives – even the larger ones - risk more OEMs questioning their relevance unless they carve out a leadership role in executing managed services.

Partnerships expand with fintechs, others This year will see a continued rise of bank-fintech partnerships as banks seek to boost business origination. Expect more banks and independents to adapt emerging financial technologies to improve the customer experience and reduce processing costs, too. Bank-independent partnerships should increase as well, as banks look to independents not only as M&A targets but also for their innovation, models and origination channels. Demand for sustainability related finance products such as subscription or pay-per-use finance will spur equity investments, acquisitions and strategic alliances by lessors in companies with the technology to enable such solutions.

Another good year for M&A A strong US stock market combined with a shortage of sizeable quality independent finance companies should result in strong valuations for US M&A targets in 2020. We anticipate no shortage of potential buyers for quality companies, thanks to excess liquidity in the markets.

Independents rise in Latin AmericaIndependent leasing companies will expand in Latin America this year, some becoming stronger through acquisitions. Bank leasing portfolios will decline slightly, driven by their inability to adjust to the new normal of risk management. OEM captives will keep declining but there will be a number of channel captives entering markets to take the front seat on managed services transactions. M&A activities look bright since banks and global players are entering key markets including Mexico, Brazil and Colombia.

Bank dominance shifts in Europe We anticipate more non-regulated equipment finance players in Europe after years of concentration in major banking groups. This is partly because banks are pulling back some to reduce cost income ratios. New entrants see the opportunities caused by the retrenchment of banks as well as opportunities for delivering new value-added solutions that banks can’t or don’t want to address. Market demand for as-a-service solutions is growing and helping fuel partnerships between new players and established finance companies. Other trends: consolidation of some smaller leasing players, plus major OEMs bringing more captive operations in house in part to address changing customer needs that are currently underserved by the broader market actors.

Developing ProductsManaged services become mission-criticalManaged services, which have been slow to take hold, are becoming increasingly important to equipment finance. As advanced software and technologies are incorporated into equipment to make them “smarter,” maintenance is more difficult so end users are demanding more sophisticated managed services contracts that can provide turnkey maintenance and support. And then there are several implementation challenges that are taking time to resolve like IoT enablement to capture key metrics and funder comfort around new contract T&Cs related to shared risk, performance issues, variable meter billing and more. As a result, OEMs will look at vendor programs with a more critical eye and want to exert more control in the process. This is likely to push them to multi-funder programs to meet user demand for flexibility. Otherwise they may opt to hold these assets on their own balance sheets under flexible rental programs. It also makes transactions invisible to the equipment finance industry and difficult to track the momentum of these programs.

Fintechs show promise for real scaleConditions are ripe for the growth of fintechs in equipment finance. There are two drivers for more fintech players: one, the handful of existing commercial finance fintechs achieved scale and a staying power after arriving on the scene about a decade ago; and two, demand for commercial equipment is now catching up with how fintechs acquire and finance equipment. For both of these reasons, we see even more fintechs entering the space. Meanwhile, large vendor finance companies to purchase, make investments in or create strategic alliances with fintechs that have point-of-scale finance and usage-based products. There is also potential for traditional players acting more as funders to fintechs and less as providers of integrated vendor finance solutions.

Sustainable solutions momentum buildsClimate change and the push toward sustainable solutions will increasingly impact the equipment finance industry. There is a marked rise in environmental, social and governance (ESG) goals and disclosures for all company types, including equipment manufacturers. Rating agencies are also including ESG factors as risk areas in underwriting criteria.

Technologies to watchAmong other developing products, expect internet of things (IoT) data mining to become a focus for growing alternative revenue streams. Fintechs and independents who can leverage this will be invaluable to OEMs.

Additional technologies showing promise include blockchain and artificial intelligence (AI). Equipment leasing businesses remain skeptical of blockchain, but emerging technologies are using it to some degree, and this should boost the industry’s comfort level. AI has potential to improve equipment finance sales, credit, pricing and remarketing but has growing pains. Before AI engines work right you need to feed them enough data, then observe and correct.

Looking for more on this?Contact Valerie L. Gerardvgerard@thealtagroup.com +1 917-664-4192 (mobile)

Thank you to the following equipment finance consultants for their contributions to our 2020 predictions

The Alta Group: Valerie L. Gerard, Paul Bent, Diane Croessmann, James Jackson, David Wiener, Patricia Voorhees, John Hurt, Andrew Mesches, Shawn Halladay, Carl Chrappa

The Alta Group Latin American Region: Rafael Castillo-Triana

Invigors EMEA: Kieran O’Brien, Ian Robertson, Paul Johnson-Ferguson, Patrick Gouin

Legal Services

Asset Management

Business Quality Assessm

ent

Mergers & Acquisitions

Str

ate

gy

& C

ompe

titiv

e Al

ignm

ent

Profe

ssio

nal D

evel

opm

ent

www.thealtagroup.com

The Alta Group:Realize your goals using our unparalleled expertise

Grow faster, resolve problems, enter new markets,

create winning strategies and optimize

all vendor/captive phases

Conduct intensive investigations of critical income

performance, asset quality, and

business processes

Use insightand experience

to support pre-litigation and litigation

objectivesOptimize the

buying or selling price, and the due diligence

process

Improve your sales and operational

performance through programs that fit

your needs

Optimize equipment collateral & residual value

portfolio performance