Financing Equipment using our technology – A funder’s perspective.
Today’s post looks at equipment finance from a funder’s perspective, an area that hasn’t been covered so far on the blog. This ties in with the analysis feature we launched the other day that looks at net returns, volatility and correlations of equipment funding and core asset classes.
McKinsey and DB recently estimated an outstanding amount of $225 trillion of debt. To give a sense of scale, global equity markets (shares/stocks) were estimated at $69 trillion. So the value of all outstanding debt is approximately 4X the value of all publicly listed companies. Lots of product for investors to choose from, right?
The problem is that supply of debt securities struggles to keep up with demand. Structural changes have increased pension fund appetite for fixed income while industry changes such as the shift to LDI strategies have increased natural appetite for fixed income product. Non-traditional investors such as family offices, sovereign wealth funds and even, despite the name, private equity funds have increased allocations to fixed income.
On top of all this, in an effort to stimulate their respective economies, central banks started buying debt several years ago in what is commonly referred to as quantitative easing. Approximately $600 billion every month last count. As with anything where the demand outpaces supply, the price has risen and the yields compressed. There is now approx. $10 trillion of sovereign and supra debt that is negative yielding. The yield on an index of European Corporate bonds IG is 0.68%. Inflation in Europe is hovering around 2%.
At least the above are typically quite liquid (easy to be bought/sold) and fundamentally low risk but the knock-on effect across higher risk/higher return markets has been profound. A BB rated corporate bond (where there is a 8% probability of default over a five year holding period) the yield on offer averages around 2.5% yield while the BOFAML high yield bond index which is incorporates even riskier bonds is offering 3.14% yield at close of markets last Friday. Institutional investors are in increasingly being burnt in a very hot desert.
Within this enormous (but crowded!) universe there is a well agreed consensus that part of any investors portfolio of fixed income should be secured debt (where there is security by way of a claim on the borrowing entities balance sheet or some asset of the entity). Ultimately this is considerably smaller universe and unsurprisingly it is dominated by real estate/property. Bricks and mortar – Solid ✓ Limited land – growing population.. ✓ What’s the problem with real estate?
Two key concerns: While real estate has performed par excellence over the past twenty years, it has shown itself, especially here in the UK to be very cyclical with considerable stress during the last recession. The lows are more than compensated for by the ups for equity investors (those who actually own the property) but for debt investors it’s the downturns that are concerning. Secondly right now yields on real estate product are very much squeezed with rental yields in London based residential property struggling to reach 3% and yields on prime commercial even lower!
So what is an institutional investor with a fixed income mandate to do.. directly financing large tickets to corporates/ infrastructure and financing loans over marketplace platforms are two strategies that have grown in popularity over past few years.
As part of that trend institutional funders are looking at options that allow them to put funding to work in less commoditised, traditionally less well banked arenas of credit. Asset Finance is one of those and the EquipmentConnect platform will provide the technology and mechanism for funders of equipment and machinery where they aim to achieve returns, net of fees of 7-9%. This return will be fixed over a term of between two and six years.
Importantly the return will be achieved with ring-fenced security as the funder retains legal title (leasing) or a legal charge on the equipment being funded. Ultimately funders are also attracted by the ‘business critical’ nature of the asset they are funding and an amortisation profile that offers improved collateralisation buffer over time.
In a forthcoming post we will be discussing the results of our credit model and risk scorecard and will provide some detail on expected risk in an equipment finance portfolio.
Ref: (1*) : Mark Wakowski @ Marketwatch
Ref: (2*) : zero hedge July 2016