Keeping a pulse on the equipment quality, movement, and activity helps you head off and plan for any trends or issues that might be emerging within the collateral base. In different economic climates various risks emerge that can be mitigated via close monitoring and communications with the client. These key monitoring areas can be seen below:

  • Equipment Maintenance
  • Utilization
  • Capital Expenditure
  • Market Tracking

In tracking these it’s important to understand the company’s data and operations management systems, establish a clear line of reporting on a monthly basis, and know the context and impact of the data you might request and review.

Equipment Maintenance: Maintaining Quality

The condition and quality of the fleet is a key driver in the salability and value of the collateral. In times of uncertainty and business challenges companies often identify maintenance as an area to save and improve cashflow. Decreased maintenance might reduce cash availability downstream as appraisal inspections are conducted. Lenders should consider tracking:

• How has the maintenance spend been tracking?

• What is the volume of down units on a month to month basis, what’s the average down time?

• Are the assets still being maintained in accordance with OEM standards?

Answering these questions should provide certainty that the collateral quality has not deteriorated. Should there be any issues an additional inspection might be discussed to check the physical condition of the assets.

Utilization: Collateral Performance

Lenders are rightfully monitoring cashflow on a month-to-month basis. However, this singular view might not provide the complete story on how this figure might shifting each month. Observing utilization can better help understand seasonality, cashflow trends, and returns on the different types of collateral the company owns.

When looking at construction equipment and rental / dealer operations there are a couple key metrics which should be considered: physical utilization and financial utilization. A clear handle on both of these should help in both understanding variability in cashflow and how that might be trending on a future basis.

CAPEX: Changing Fleet Composition

As companies make investments and manage their equipment base the expenditures in fleet investment will naturally be tied to the borrowing availability at any point in time. As expenditures slow the company will likely be faced with a reduced credit facility in the next appraisal. Likewise, when companies invest in asset types divergent from their core the availability on those assets may be more or less than what they might forecast. Understanding the potential value on these should reduce friction as these come into the facility and companies can understand the cash output they might need.

Market Tracking

Lastly, lenders should be aware and keep an eye on key market drivers that might impact end markets in which their collateral is utilized. Most recently, the decline in oil prices has impacted key segments of the construction equipment market such as mobile cranes. Independently, COVID-19 has driven underperformance in the secondary market across equipment types in drastic ways over the past few weeks. Regular communication around these with your appraiser will enable better modeling and prediction in collateral values in between appraisals.

A comprehensive collateral monitoring approach is key as it reduces any potential looming risks that might only be picked up in the appraisal and keeps lenders and borrowers eye-to-eye.
This concludes the series on ‘ABL Guidance for Construction Equipment.’ Hopefully, this will provide more tools and strategies for managing your Asset Based Lending business and for engaging with your customers.

COVID-19 has driven a high level of uncertainty in the market as the estimated end point is unknown and economic implications are changing on a day to day basis. Rouse has been tracking this in detail and can provide a more complete overview of this were beneficial.

For further information or discussion feel free to contact Raffi Aharonian (Raffi.Aharonian@rouseservices.com) or Jacob McCarthy (Jacob.McCarthy@rouseservices.com).

Appropriately structuring the Asset Based Lending facility is critical to the success and ongoing performance of the credit. In setting up the structure for the facility it’s important to consider a range of factors covering:

  • Data Integrity
  • Asset eligibility and amortization
  • Accounting policies

A miss in any of these areas can have downstream effects that might lead to uncomfortable conversations with the borrower or even a scenario where under seemingly benign market conditions the lender is now in an ‘over advanced’ position and must trigger a repayment from the borrower. In the worst instance, a lender might extend financing on collateral that’s ineligible or is inaccurately valued as the client’s information, such as the model year, was incorrect.

Data Integrity: Quality in, quality out

A key variable in the appraisal process is the company’s asset register. To the extent there is any errant information within the file this can drive a large disconnect in the appraisal values and create stress in the borrowing base as this persists. Any missing information should be prioritized so borrowers are held to a standard that supports an accurate lending facility. A lender should partner with the appraiser to ask key questions around:

  • What’s driving the cost / NBV provided? Does the cost appear to be reasonable based off the nature of the purchase (new or used) and is the NBV accurate? Has cost been remarked based off a balance sheet review to a value other than acquisition cost such as Fair Value or a prior NBV as an asset was transferred?
  • Are the model years representative or have they been derived from the acquisition date?
  • Do they track and report on the usage, configuration, location and status of the assets?

Asset Management: Eligibility and Amortization

Within any collateral pool, there are often individual assets or groupings of assets that may not be suitable for inclusion in a borrowing base. This can include:

  • Down Units: Companies typically run a constant line of down assets and it’s natural for units to cycle in / out of this bucket. In a distressed situation, where capital is limited, maintenance can become a lower priority. It’s possible for these to be neglected and these assets can be ‘red flags’ for prospective liquidation buyers
  • Low Cost / Accessory Components: Often borrowers will have a supplemental inventory of attachments and other various low-cost items that support their core business. These assets may be not clearly tracked or easily identified. Dependent on these factors, these might be a candidate for ineligibility
  • Old / Obsolete Assets: While the concept of ‘slow-moving’ assets or obsolescence is most often reserved for inventory valuations, there are scenarios where you might also consider this when looking at construction equipment. Is the asset no longer used or perhaps technologically obsolete? Is the age well past the typical observed in the market?

Trying to find opportunities to ‘squeeze’ dollars out of the assets most often leads to false inflation in the availability.

It’s common within ABL facilities, especially in cases where appraisals are less frequent, to incorporate an amortization factor on the outstanding balance. Within the construction equipment domain there are a variety of assets a company might own for different applications from high cost wear and tear rigid mining trucks to low impact skid steer loaders.  Likewise, different asset classes can oftentimes exhibit varying degrees of deprecation.  A good understanding of these variable residual value depreciation rates can enable a borrowing base structure that aptly aligns with the collateral in question.

Accounting Policies: Depreciation and its implications

Assets can be deployed / utilized in a variety of functions within a company’s business and often dependent upon this they have a different depreciation policy assigned to them. Lenders should ask: Is the policy reasonable? How would this impact my projections as I model future availability? Overly ‘aggressive’ policies will lead to high volatility in the advance rate as assets tend to lose value at a rapid rate and the resultant minimized NBV denominators can cause high fluctuation in key lending ratios. Likewise, overly conservative policies lead to natural questions from a borrower around “Why is my NBV higher than OLV? This doesn’t make sense.” A reasonable and understood policy will minimize these sorts of questions and help in modeling future advance rates. Similarly, most equipment rental / dealer companies will have a New Stock, Used Stock, and Rental business division. These divisions might all be subject to different depreciation policies and potentially recovery characteristics, generally sales stock is not depreciated where rental assets are. Developing an advance rate against each of those is key so changes to the mix of these business units don’t impact availability.

Lenders should be keen to establish the best foundation possible for the Iending facility and the Appraiser should serve as a key partner in helping assess the potential fleet. In the final part of this series we’ll discuss key areas for collateral monitoring as part of the ongoing ABL management.

For further information or discussion feel free to contact Raffi Aharonian (Raffi.Aharonian@rouseservices.com) or Jacob McCarthy (Jacob.McCarthy@rouseservices.com).

ABL Guidance for Construction Equipment: Key Focus Areas (Part 1 of 3)

As an asset-based lender your goal is to minimize your risk exposure and optimize the financing structure and availability for your borrower. Rouse takes a ‘360’ view on tracking all aspects of the construction equipment market by maintaining the most complete database of secondary market transactions to tracking key market indicators. In this three-part series we’ll explore the critical areas that ABL teams can focus on to ensure proper management of the credits in their machinery & equipment portfolios. In part one of this series we’ll begin with a focus on understand the market. The first element of this is…

Market Tracking

Lenders need to maintain a sharp view and focus on what is currently happening in the marketplace for construction equipment. Values tend to move in cycles and dependent upon the cycle should be evaluated accordingly. Through the rich data set of transactions that Rouse collects and manages, Rouse has developed a real-time index that tracks construction equipment values dating back to the 2000’s, as seen below:

 Each monthly data point illustrated above represents the average recovery, as a percentage of cost, for ten different model years of equipment ranging from new to nine years old, with each year weighted equally. The categories contained within include, aerial equipment, telehandlers, support equipment, and small-medium earthmoving equipment, each having an equal impact.

Is the market in a state of growth? Are we at peak levels? Should we anticipate a future downturn? These are all questions a Lender should look to contextualize within the ABL structure and plan for as they may have adverse / favorable effects on future availability. Rouse tracks secondary market values and trends on a month-to-month basis, making the trends available for customers through our monthly Equipment Report. Keeping an eye on the current and future market values provides insight into planning ahead and enables you to assess proposed changes to the borrowing base as well as to…

Understand the ‘Downside’

There should always be a plan for the ‘worst case’ scenario and reserves should be managed accordingly. Below we examine two recent use cases of market downturns and their effects on equipment values.

“Great Recession” declines versus “Mini Recession” declines.  In the value index chart shown above, we show the time period from 2007 through 2018.  Declines in the 2008/09 Great Recession were severe and swift moving down ~21% on a relative Basis for OLVs (holding the fleet profile and age constant).  The downward movement is most extreme for the auction channel of sale (FLV) where peak-to-trough movements were ~-32%.  If we look to the slowdown in late 2014 / early 2015 which was precipitated by the decline in Oil and Gas prices we observe a more moderate reduction in values of ~8.4% on an OLV basis steadily over a period of roughly two years.

Q2 2008 peak pre-drop Q3 2009 trough Peak-to-Trough Q4 2014 peak Q4 2016 trough Peak-to-Trough
FMV 69.6% 60.2% -13.5% 77.1% 73.1% -5.2%
OLV 61.0% 48.0% -21.4% 65.1% 59.6% -8.4%
FLV 52.4% 35.7% -31.8% 53.1% 46.2% -13.0%

 

The implication in terms of the potential borrowing base and asset values is that there might need to be appropriate asset and capital management to guard against observed declines in values for the equipment. These market movements can play out in a variety of ways depending upon the profile of the asset base which is why it’s critical to…

Keep a pulse on the Collateral

Lenders need to stay ahead to changes in the portfolio to ensure risk is minimized. Too often do we visit a fleet annually or bi-annually to find that values and key lending ratios have shifted dramatically since the prior appraisal. There are a multitude of factors which might drive this including:

  • Market Conditions
  • Changes in fleet age
  • Changes in fleet mix
  • Acquisitions
  • Fleet Maintenance
  • Accounting Practices / Depreciation Policy

It’s important to understand how each of these might drive values and lending ratios, such as the Net Liquidation Value vs. the Net Book Value, up or down. For example, as the company invests in a different type of equipment with less liquidity and a weaker value recovery this might impact availability projections. These changes tend to be gradual as companies manage their fleets.  However, over the course of a period of six months or more these changes may move enough that an updated appraisal can have a meaningful impact to availability / liquidity. Tracking these and having regular conversations with the company enables planning so any changes are baked into the borrowing base. A best practice is to include the optionality to trigger an additional appraisal should material changes happen either with the market, the company’s performance or otherwise.

In the next part of this series we’ll plan to dive deeper into some of the specific components and elements that should be considered as part of the ABL setup and management.

For further information or discussion feel free to contact Raffi Aharonian (Raffi.Aharonian@rouseservices.com) or Jacob McCarthy (Jacob.McCarthy@rouseservices.com).