Today’s market is awash in liquidity and characterized by continued optimism for the future, but the world of financing and capital availability for contractors has changed significantly since the 2008-09 downturn. While many of the changes are in reaction to the overall recent recovery of the industry, a significant portion have been a result of new regulations and, on a more limited basis, technological advancements.
This article will provide current market outlooks on these changes and offer additional perspectives on the near-term future of financing and capital availability in the construction industry.
Moderator Dave Sauerman (commercial banking) shares the following discussion about the current status of the financial markets and the construction industry with Matt Gibbons (commercial banking), Scott Cleland (equipment finance), and Tim Sznewajs (investment banking).
Dave: To start, in terms of the availability of capital for the construction industry, are we in a soft or hard market (or somewhere in between)?
Scott: I am seeing that very low rates are chasing big dollars on equipment financing from many banks with little experience in the construction industry. We are also seeing very aggressive lease residuals from these banks. Manufacturer captives are still higher, but they’re coming down on residuals because some have been burnt on returns. Historically, these signs are often a precursor to a slowdown.
Dave: So lots of money chasing big equipment deals is drawing a lot of inexperienced but eager players into the construction market. Why is this a problem?
Scott: When large amounts of capital are available to poorly run construction companies, it just increases “bad” competition for the better run companies. An overabundance of capital can also hurt well-run companies, as it can compress margins in the industry overall.
Also, when overly long repayment terms are made available, there is plenty of opportunity to get upside down. This occurs when the loan balance is higher than the value of the equipment in question, and the company may not get into a market equity position until very far into the life of the loan. If a piece of construction equipment pays for itself within 30 months, why go 84 months?
Matt: The senior bank market remains very accommodative to construction industry participants that have been fueled by favorable revenue and margin trends over the past five or more years.
Participation is broad, with few lenders shying away from companies due to a contractor bias (as we tend to see in down cycles). This has resulted in easy access to capital and favorable pricing and covenant arrangements for those contractors whose financial profile satisfies basic underwriting criteria. Regulatory driven credit and performance metrics remain critically important, which means that underperformers are not likely benefitting from favorable market conditions.
Credit availability, for both senior bank and non-bank, has been conducive to capital transactions, which has led to an increase of financial sponsors and employee stock ownership plan (ESOP) activities in the space. Self-governance has resulted in industry leverage remaining at relatively modest levels, but we have seen an ability to stretch for those that remain bullish on market conditions.
I expect the ability to attract leverage will remain until we see a softening in construction spend and/or a broad increase in execution and performance-related issues driven by tight conditions in the construction industry.