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E Q U I P M E N T L E A S I N G & F I N A N C E F O U N D AT I O N
State of the Equipment Finance Industry
Review and Economic Outlook for 2014-15
Prepared for:
Equipment Leasing & Finance Foundation
Prepared by:
Robert F. Wescott, Ph.D.
President, Keybridge
Presented:
San Diego
October 20, 2014
Agenda
I.
Snapshot of our 2013 Report on Equipment Finance
Activity
II.
U.S. Macroeconomic Outlook 2014-15, including
geopolitical risks
III. Trends in Equipment Investment
2
I. 2013 equipment finance report: First the good news--low interest
rates and an expanding economy increased propensity to finance.
Propensity to Finance Index
Index, 2005.Q4 = 100
180
151
160
134
140
120
112
100
80
60
2006.Q2
2007.Q2
2008.Q2
2009.Q2
2010.Q2
2011.Q2
2012.Q2
2013.Q2
2014.Q2
Source: ELFF 2014 Survey of Equipment Finance Activity
3
More good news: Portfolio performance strengthened in 2013, as
delinquencies and charge-offs dropped to very low levels.
Portfolio Quality
Weighted Average
6%
Charge-Offs
Non-Accruals
Delinquencies 90+ Days
5%
4%
1.6%
3%
2%
1.5%
1.9%
0.4%
1.2%
1%
1.4%
0.8%
0.7%
0.3%
0.5%
0.7%
2010
2011
2012
0%
2009
0.9%
0.2%
0.4%
0.3%
2013
Source: ELFF 2014 Survey of Equipment Finance Activity
4
Pretty good news: New business volume increased solidly in 2013, but
not by the double-digit rates of the previous two years.
New Business Volume
Annual Percent Change
16.5%
20%
16.4%
9.3%
10%
0%
3.9%
-2.2%
Share of 2013 New Business
Volume
14%
Banks
-10%
-20%
-30.3%
33%
54%
Captives
Independents
-30%
-40%
2008
2009
2010
2011
2012
2013
Source: ELFF 2014 Survey of Equipment Finance Activity
5
Bad news: Abundant liquidity and intense competition meant the cost
of funds, spreads, and yields further declined.
Yield Composition
Weighted Average
8%
7.2%
7%
6.1%
6%
5%
5.1%
3.9%
4.5%
4.4%
3.1%
3.0%
1.8%
1.4%
1.4%
2011
2012
2013
3.6%
4%
3.3%
3%
2%
Pre-Tax Yield
Pre-Tax Spread
Cost of Funds
3.3%
1%
2.5%
0%
2009
2010
Source: ELFF 2014 Survey of Equipment Finance Activity
6
Bottom line for the industry: Financial performance remained strong in
2013, but profitability dipped. The result: a huge focus on productivity.
Profitability Ratios
Median
18%
16.3%
16%
2009
2010
2011
2012
2013
14.7%
13.0%
14%
12%
9.5%
10%
8%
6%
4.3%
4%
1.0%
2%
1.5%
2.2%
2.1%
1.9%
0%
Return on Equity
Return on Assets
Source: ELFF 2014 Survey of Equipment Finance Activity
7
II. U.S. Macroeconomic Outlook 2014-15—finally achieving escape
velocity?
Source: The Economist
8
On balance, bright spots in the U.S. economy are outweighing negative
factors. 2013-14 have brought a lot of healing.
Headwinds:
Slowing World Economy
Geopolitical Risks
Bright Spots:
Improving Labor Market
Credit Flowing Again
Fiscal Healing
9
First reason for optimism: The U.S. labor market is rapidly healing.
Adding 3 million workers in a year is boosting income.
Unemployment Rate
Initial Jobless Claims
Percent
Thousands, 4-week Moving Average
12%
700
Unemployment
Rate
10%
600
500
8%
400
6%
300
Initial
Claims
4%
200
2%
0%
2007.10
100
2008.10
2009.10
2010.10
2011.10
2012.10
2013.10
0
2014.10
Source: Macrobond Financial
10
Second reason: Credit is flowing again. Bank lending to businesses is
up notably. Credit is finally flowing again to consumers as well.
Commercial/Corporate Bank Loans, 2014.Q1
Percent Change, Y/Y
Citigroup
11.0%
U.S. Bancorp
9.7%
PNC
9.5%
Bank of America
8.3%
J.P. Morgan
Wells Fargo
6.6%
5.9%
Source: Forbes, “A Look at the Loan Portfolios of the Largest US Banks”, 6/14/14
11
Third reason: Sharp U.S. fiscal contractions/spending cuts are largely
finished. And state spending is finally rebounding.
Federal Government Contribution to GDP Growth
Percent
2%
Obama Stimulus Package
Spending cuts
are winding
down
1%
1%
0%
-1%
-1%
-2%
2006.Q2
Fiscal Contraction
2007.Q2
2008.Q2
2009.Q2
2010.Q2
2011.Q2
2012.Q2
2013.Q2
2014.Q2
Source: Macrobond Financial
12
Still mending: Business capital spending. Business confidence needs a
boost. Capacity utilization hitting 80% would help.
Real Nonresidential Investment: Equipment
Percent Change Y/Y
Capacity Utilization
Percent
30%
100%
80% capacity utilizationthreshold for firm expansion
20%
95%
90%
10%
85%
0%
80%
75%
-10%
70%
-20%
-30%
1990.Q2
65%
1996.Q2
2002.Q2
2008.Q2
60%
2014.Q2
Source: Macrobond Financial
13
Housing is also still disappointing. Despite improved fundamentals, the
housing recovery remains subpar.
NAHB Builder Housing Market Index
New Housing Starts
Index
Thousands
100
2500
80
New Housing
Starts
2000
60
1500
40
1000
20
0
1990.09
500
NAHB Builder
Index
1994.09
1998.09
2002.09
2006.09
2010.09
0
2014.09
Source: Macrobond Financial
14
Two wild cards for 2015: Slumping world growth and lower oil prices.
World Growth
• U.S. exports added 0.5 percent to GDP growth in the past 4 quarters
• Stronger dollar and slow foreign growth could subtract 0.3 to 0.4% off GDP in
2015.
Oil
• Oil prices are down to their lowest level in 4 years (down from $108 to
$82/barrel).
• A further drop to $70/barrel could boost GDP growth in 2015 by 0.5 to 0.8%
15
Bottom line: Compared to the rest of the developed world, the U.S.
should be the growth leader. Expect growth of 3 to 3-1/2% in 2015.
Projected 2015 G-8 Growth Rate
Y/Y % Change
4%
3.1%
3%
2.4%
2%
1%
2.7%
1.5%
0.5%
0.8%
0.8%
Italy
Japan
1.0%
0%
Russia
France
Germany
Canada
UK
US
Source: IMF, “World Economic Outlook, October 2014”
16
The brewing battle at Yellen’s Fed. The fight between the doves and
new “financial imbalances” hawks is heating up.
TRADITIONAL DOVES
“FINANCIAL IMBALANCES” HAWKS
VS.
Janet Yellen, Fed Chair
Richard Fisher, Dallas Fed
"Too many Americans still can't find a job or are forced
“There is a tipping point where monetary
accommodation comes to be viewed not as a pleasant
stimulus…but instead becomes an agent of financial
recklessness.”
to work part-time…I promise to do all that I can,
working with my fellow policymakers, to achieve the
very important goals Congress has assigned to the
Federal Reserve.”
Source: The Federal Reserve; The Economic Club of New York
17
What should the Fed be doing if it followed its own historical
experience? Taylor rules help to show this.
Taylor Rule Using PCE Inflation and Output Gap
Percent
10
Actual FFR
5
0
Taylor Rule
-5
1986.07
1990.07
1994.07
1998.07
2002.07
2006.07
2010.07
2014.07
Source: Macrobond Financial, Keybridge
18
Crisis: QE was a logical policy choice, because of the difficulty of
negative rates.
Taylor Rule Using PCE Inflation and Output Gap
Percent
10
Actual FFR
5
0
Taylor Rule
-5
1986.07
1990.07
1994.07
1998.07
2002.07
2006.07
2010.07
2014.07
Source: Macrobond Financial, Keybridge
19
However, today, Taylor rules would suggest that the long period of zero
rates should be ending. Might the Fed be behind the curve?
Taylor Rule Using PCE Inflation and Output Gap
Percent
10
Actual FFR
5
0
Taylor Rule
-5
1986.07
1990.07
1994.07
1998.07
2002.07
2006.07
2010.07
2014.07
Source: Macrobond Financial, Keybridge
20
Larry Summers’ worry – are rich countries doomed to “secular
stagnation”?
“We may be in a period of secular
stagnation in which sluggish
growth, output, and employment at
levels well below potential, and
problematically low real interest
rates might coincide for quite some
time to come.”
Source: The Atlantic; Reuters
21
Might rich countries have permanently lower economic growth?
The Secular Stagnation Debate
Factors that could indicate “secular stagnation”:
•
•
•
•
•
•
Aging population
Interest rates at their zero bound
Lack of productive investments
Inflation that is “too low”
Increased inequality
Lack of innovation
22
Are we stuck in a 2% growth world? This is too pessimistic.
U.S. potential GDP growth = %CH (labor force) + %CH (productivity).
Civilian Non-institutional Population, Ages 20-64
Y/Y % Change
3%
2%
1.8%
1.2%
1.2%
1%
0.8%
0.9%
2004
2014
0%
1974
1984
1994
Source: Census Bureau
23
And productivity is not as bad as pessimists say. It should average 1.6%
a year over the next decade. Potential growth can be 2.4% to 2.7%.
Nonfarm Business Sector Labor Productivity, Output per Hour
Y/Y % Change
10%
1974 - 1984:
1.5%
5%
1994 - 2004:
2.8%
1984 - 1994:
1.7%
2004 - 2014:
1.5%
0%
-5%
1974
1978
1982
1986
1990
1994
1998
2002
2006
2010
2014
Source: Macrobond Financial
24
Where will growth come from? A strong construction rebound offers
the best short-run hope.
Source: World Property Channel
25
Possible sources of longer-term growth—high-growth, high-reward
industries.
Unconventional Oil Exploration
Nanotechnology
By 2020, forecast to:
•
Create 2 million jobs in US
•
Build $1 trillion final products market
•
Boost productivity in energy, medicine, and
electronics industries
By 2020, forecast to:
•
Save $5.8b/year on consumer fuel costs
•
Add 300,000 jobs
•
Add $38.1 billion to GDP in 2020
Advanced Medical Technology
Currently generates:
•
1.9 million jobs
•
$381 billion in US economic output
•
For every 1 billion in industry revenues, estimated
$1.69 billion added to GDP
Industrial Automation
Currently generates:
•
300,000 jobs directly
•
$17.1b market, cost has fallen 50% since 1990
•
Boosts manufacturing productivity
Source: National Science Foundation, AdvaMed, International Federation of Robotics
26
Geopolitical risks that keep me awake at night.
Russia-Ukraine
Libya
Syria/Iraq/ISIS
Ebola Outbreak
China Growth
Slowdown
27
How do geopolitical risks affect global financial markets?
Transmission Mechanisms
Global Oil Prices
Regional Contagion
Effects
Business & Investor
Confidence
Risk of Expropriation
Capital Outflows &
Safe Haven Effects
Flows of People &
Goods
28
Putin’s aggression seems driven by Russia’s “inferiority complex” after
losing the cold war. Economic problems have contributed.
“First and foremost it is worth
acknowledging that the demise of the
Soviet Union was the greatest geopolitical
catastrophe of the 20th century.”
-Putin, 2005
Source: The Guardian, The Washington Post, “Russia is re-making itself as the leader of the anti-Western world” 03/30/14, NBC
29
My Russian concerns:
•
Crimea or economic growth? Putin will take Crimea.
•
Sanctions are biting—maybe a little too tough? If oil prices drop further, how will Russia
endure the pain?
•
Impact on business confidence in the EU (and Germany) has been worse than expected
•
Natural gas games this winter?
•
Geopolitical accidents? (Russia playing games in Sweden, Lithuanian, etc., doing trial
incursions, submarine probes, Cold War tricks)
30
China: Construction slowdown is well-entrenched. How much will it
slow the overall Chinese economy? (and the world economy)?
31
Xi Jinping’s balancing act: Sustaining growth and social cohesion as
construction slows. Can consumption pick up the ball?
In the first seven months of 2014:
22.4%
-15%
Vacancy Rate in 2013
Drop in sales price in large and mediumsized cities from Jan-Aug 2014
-17.0%
-73.3%
Drop in housing rent
Decline in Y/Y change of total floor space
under construction
Source: Mingtiandi, “China Housing Sales Drop 10.5% in 2014 as Credit Dries Up”, 8/14/14; Macrobond
32
Ebola: Low probability but high impact risk. Africa is largely
disconnected from the world economy, but…
Source: Wired
33
III. Equipment investment has clawed its way back to a reasonably
normal share of GDP. Further growth requires a breakout of demand.
Equipment & Software Investment
Share of Real GDP
9%
8 years
8%
6 years
Software
Investment
7%
6%
Equipment
Investment
5%
4%
3%
2%
1%
0%
1999.Q2
2002.Q2
2005.Q2
2008.Q2
2011.Q2
2014.Q2
Source: Macrobond Financial, Keybridge
34
Illustrating the need for a new investment breakout is the fact that
new leasing business volume in 2014 is roughly flat with 2013 levels.
Annualized rate through
August 2014. Down
0.7% from 2013.
MLFI-25 New Business Volume
Billion Dollars
$100
$82.9
$90
$87.0
$80
$70
$60
$80.2
$56.6
$84.4
$87.3
$86.7
2012
2013
2014*
$74.0
$54.6
$59.3
$50
$40
$30
$20
$10
$0
2005
2006
2007
2008
2009
2010
2011
*Projected
Source: ELFA MLFI-25, 2014 projection from Keybridge
35
Most likely source of a breakout? Capacity utilization rising above 80%
would likely support a new wave of capex spending.
Capacity Utilization, August 2014
Percent of Capacity
100%
80% Threshold
Indicates Expansion
80%
60%
40%
20%
0%
Source: Macrobond Financial
36
Meanwhile, the energy boom is for real: As domestic oil production
has jumped (5 mbd to 8.8 mbd), rail shipments of oil have surged.
Rail Traffic – Carloads Originated
Petroleum
Coal
Other Commodities
Y/Y Percent Change, 6-month Moving Average
70%
60%
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%
Sep-90
Sep-94
Sep-98
Sep-02
Sep-06
Sep-10
Sep-14
Source: Macrobond Financial
37
And finally, the U.S. manufacturing renaissance is for real and should
be sustained.
Boston Consulting Group Manufacturing Cost Competitiveness
1
Out of the 25 largest exporters, the U.S. is now the 2nd most competitive, behind
China. European firms are looking to shift production to the U.S.
2
U.S. manufacturing costs are 10-25% lower than all other top 10 goods-exporting
countries (except China).
3
The gap between the U.S. and China is narrowing: In 2004, U.S. manufacturing
costs were 14% higher, compared to only 5% today.
4
On current trends, U.S. manufacturing will be less expensive than China’s by 2018.
Source: Boston Consulting Group, NPR, “Study: U.S. Manufacturers Gaining Competitiveness,” 04/25/14
38
In conclusion: U.S. growth seems on track, but turbulence abroad
creates risks. Getting capacity utilization above 80% is key.
The U.S. economy is healing. 2015 should be the best year since 2006.
The Fed may face pressure to raise rates sooner than planned. U.S. potential growth
may be better than the 2% rate pessimists fear.
Russia and China and Ebola present geopolitical worries.
Capacity utilization reaching 80% and a strong housing rebound are probably
necessary for an acceleration in business investment.
Source: Getty Images, CosmeticsDesign
39