FREE SUBSCRIPTION Includes: The Advisor Daily eBlast + Exclusive Content + Professional Network Membership: JOIN NOW LOGIN
Skip Navigation LinksHome / Articles / Read Article


No One Was Ready for This

Date: Sep 03, 2020 @ 05:00 AM
Filed Under: Construction

No one was ready for this. The economic impacts of the 2020 COVID-19 crisis have affected almost every global industry, including construction contractors, equipment dealers and manufacturers. One of the most glaring repercussions on the industry has been a slowdown in construction projects and new contracts due to delays or outright cancellations. These negative effects were amplified by early disruptions to materials and equipment supplies, and are still impacted by worker shortages and personal protection requirements at build sites. All in, the construction industry – from manufacturer through dealer through operator – is under assault from every angle.

Subsequently, equipment lenders have also been significantly impacted: In 2019, new business loan volume grew 10.5 percent in the equipment finance industry. However, construction loan delinquencies grew 24 percent in Q1 2020 as COVID-19 forced developers to shut down or delay projects, translating to total volume of delinquent construction loans on bank balance sheets climbing to $3.67 billion in the quarter, according to the S&P Global Market Intelligence. In terms of overall loan volume, construction loans represented only 3.37 percent of total loans and leases in Q1 2020, down from 3.44 percent in the previous quarter and 3.49 percent a year earlier.

Contributing to the challenges posed by delinquencies, lessees face risks as well as incentives that threaten demand for new loans. It’s the perfect storm that no one in the industry has ever experienced. Three factors create uncertainty for lenders, and contribute to fluctuations in demand:

  1. Incentives are commonplace for borrowers: In response to cost pressures and uncertain future projects, many equipment buyers are sensibly taking a cautious approach to purchasing new equipment. If they’re not altering purchase plans right away, they’re at least working to extend the life of existing equipment and waiting for optimal price windows to appear (e.g. fire sale prices) for new acquisitions. Dealers and manufacturers, projecting slower second half sales, are over a barrel. To maintain their volumes, many have offered deals, including deep discounts on capital equipment, lower interest rates, and cash discounts.
  2. Deferrals are growing: Another factor is reflected in the metaphor of our summer construction season weather – there are clearly storm clouds gathering on the horizon. Though many lessees are granted deferrals now, these deferrals could translate into delinquencies in the near future. If those skies open, the flood of defaults could be terrible. To counter the increase in deferrals, many banks have offered an array of programs to help individual and business customers affected by the pandemic, including fee waivers, deferred payments and other accommodations. A smart equipment lender will take such actions now, but should also have a crisp understanding of residual equipment values in case the loan conditions change quickly.
  3. Rental volumes threaten to reduce new loans: With uncertain future prospects, savvy construction owners are hedging their bets by shifting their mix of owned versus rented equipment. It’s an existing trend exacerbated by the COVID-19 impacts. Rental volumes have been increasing at the expense of new equipment financing, which will have implications to the origination of new loans and loan volumes for lenders. Since loans were a predominant form of equipment financing prior to 2020, these trends pose potentially large hurdles to the status quo for lenders. With the global equipment rental market already expected to grow at an annualized 5 percent from 2019 through 2026, the pressures from COVID-19 only increase the likelihood that contractors will hold onto used equipment longer, and that rental volumes may reduce the demand for new equipment loans.

All these factors spell potential trouble for lenders in the second half of 2020 and into 2021. However, there are concrete steps lenders can take (or as we argue, must take) to strengthen their position. The bottom line here is that although loan volume and demand have been suppressed from the impact of COVID-19, there are tools and tactics that lenders should use to reduce their risk and take advantage of pent-up demand. By most accounts, some modest but uncertain recovery is on the horizon: According to data calculated by telematics specialist Trackunit and published by KHL Group, beginning in early June 2020, there was an increase in construction machine activity of 8.2 percent, reaching similar levels as the same time in 2019. And a surge of construction activity could continue in late 2020, driven partially by low interest rates and liquidity being injected back into the market, especially if municipal revenues hold up to fund spending. Fingers crossed.

That said, to thrive in this environment of uncertainty, lenders need to be proactive, think like their customers and understand the advantages contractors have and the limitations they face.

First, lenders should determine how to deal with reductions in loan volume due to fluctuations in demand in the future. Lenders are often at the mercy of what contractors and lessees tell them. That might work when business is stable and predictable, but this year has been anything but that. To build a more objective position, lenders should gain better, direct knowledge of equipment economics through understanding of usage, trends and future values. As an example, what impact does a flood of contractor bankruptcies have on residual equipment values? There could literally be tens of thousands of units hitting the market, with supply driving down values. Such equipment value curves can be generated by expensive third-party appraisers or via EquipmentWatch subscriptions, market data and via custom data projects.

Second, work with contractors to better understand their fiscal and competitive position. Understanding future uncertainties for each of your lessees can help you anticipate specific challenges and address them proactively. For the construction industry, fragmentation and disruption are driving forces shaping the nature of the segment – the largest contractors have the ability to survive the slow times ahead, but the vast middle and long tail of mid-size and small contractors are more susceptible to short-term disruption. Long-term trends are affecting many contractors, including decreased demand related to potential lower GDP growth, shortages of skilled labor, increased technology investments, greater requirements for sustainability and greater competition for fewer projects. Getting a solid grasp on factors by market segment can help lenders anticipate potential hurdles and build contingencies.

In closing, although the events of 2020 have upended the entire construction industry, there is sufficient evidence that the most challenging aspects of the current crisis are anomalies, rather than deteriorations in the economy at large. Trends such as rental demand will certainly pose transformational changes to the equipment financing industry, but by all accounts, pent-up demand should recover some of the worst impacts from the current crisis. That noted – the coming recovery will be uncertain and uneven. Not every contractor will survive. That requires lenders be informed and vigilant. And be empowered with data and market insights.

To understand more about current issues contractors face, and how the rental market is impacting resale equipment and demand, readers are invited to review EquipmentWatch’s new research-driven report, “Future-Proofing the Construction Business.”

Keith Tyson
Product Marketing Manager | Informa plc
Keith Tyson is the product marketing and brand leader for EquipmentWatch, a division of Informa providing leading data products and insights to the construction equipment industry. Tyson has 17 years of experience in consulting, product management and marketing, providing thought leadership and strategic insight to numerous industries including construction.
Comments From Our Members

You must be an Equipment Finance Advisor member to post comments. Login or Join Now.