Equipment asset-backed securities (ABS) continue to be a favored asset class with a growing and diverse investor base. The volume in the public equipment-backed market has been fairly steady and is expected to be $12 billion-$13 billion for this year. The issuance in the first half of 2000 was higher than in the first half of 1999 primarily due to the timing of a couple of large issuances this year.
The investor base for equipment ABS continues to grow as the asset class becomes better understood. Because the collateral underlying equipment ABS is commercial obligations (and generally essential-use/revenue-producing equipment), many investors feel equipment ABS provide good diversification against consumer exposure.
Except for some isolated cases of weakness, the collateral quality remains strong as performance statistics show delinquencies and net losses to be stable and manageable. The prepayment insensitivity of equipment ABS has long been a strong selling point to investors new to the asset class. The short-term nature of the underlying collateral (generally five years to six years to final maturity) makes equipment ABS less sensitive to prepayments.
The equipment leasing industry is large and fragmented. the Equipment Leasing Association, the industry's trade group, estimates more than $150 billion of equipment will be leased this year. This is a large pool of available collateral and contributes to the general feeling that this is an asset class with room for growth. There are also more than 2,000 independent leasing companies originating equipment leases. Most of these companies are not investment grade, which makes ABS an effective and cost-efficient means to access capital.
The first half saw some consolidation in the equipment industry as several well-known players merged or were acquired. Newcourt, which has been securitizing since 1996, was acquired by The CIT Group in late 1999. In the second quarter, Citigroup acquired Copelco Capital, a pioneer in equipment ABS, having completed more than 40 deals since the late 1980s. European American Bank acquired Fidelity Leasing, a first-time small ticket issuer. Finally, Wells Fargo acquired Charter Financial, a mid-ticket lessor specializing in media post-production equipment.
After acquiring Newcourt, CIT issued an equipment ABS - CIT Equipment Collateral 2000-1 - in May. The deal was more than $759 million in size and was well received by investors. CIT has indicated it will continue to access the ABS market several times a year with this collateral. It is unknown if Copelco, Fidelity or Charter will issue equipment ABS.
In light of the foregoing acquisitions, ABS investors naturally asked where the supply would emerge. The answer seems to be from new entrants into the ABS market. For example, GreatAmerica Leasing Co. (which brought two small deals in the mid-1990s) brought a $241 million transaction in June 2000. Other companies, such as SierraCities.com (formerly First Sierra Financial), DVI Financial Services and IKON Office Solutions Inc., continue to use securitization as a funding tool.
It has long been our contention that equipment ABS should trade in line with auto ABS. In actuality, equipment ABS have provided investors a yield pickup ranging from a few basis points to as many as 30 bps, depending on the technical situation prevailing at any particular time. As with most asset classes, there is tiering in equipment, with frequent issuers such as CNH Capital, CIT, Heller Financial and Copelco being the bellwether names in the market. Other issuers trade back of these top-tier names for a variety of factors, including frequency/size of issuance and the relative financial stability of the seller/servicer (or parent). Issuers such as Orix Credit Alliance see a tightening in spreads as they come to market more frequently.
One potential explanation of the spread differential between equipment ABS and autos is that the underlying equipment collateral is unique to each issuer and sometimes to each transaction. For example, the collateral characteristics of the largest issuer of construction and agricultural equipment-backed notes, CNH Capital, are markedly different from the collateral characteristics of the largest general equipment issuer, CIT. This diversity requires the underwriters to have detailed knowledge of their issuer and the equipment leasing industry. This knowledge is especially important when marketing subordinated bonds, bonds backed partially or completely by residuals and in bringing new issuers to market.
Buyers of subordinated bonds tend to undertake a more detailed credit analysis than buyers of senior bonds. These buyers also tend to have expertise in particular asset classes. In selling to these investors, it is important that the underwriters communicate the story of the particular issuer and place the issuer in the context of the broader asset class.
The use of residuals to fully support a bond or as credit enhancement also requires extensive investor education. Each issuer in the asset class has a unique residual booking policy, historical residual realization rates and process of residual realizations. An extensive knowledge of both the industry's and the issuer's residual realization trends is crucial to rating agencies giving proper credit to residuals in a transaction and marketing the bonds to investors.
Because of underlying collateral differences among issuers, bringing new issuers to market in the equipment asset class requires more investor education than in a more commodity asset class such as autos. Again, an underwriter's extensive industry knowledge is crucial to achieving fair enhancement rates from rating agencies and fair spreads from investors.
The advantages to educating investors on the merits of equipment collateral and the specific issuer were demonstrated in the recent GreatAmerica and Orix transactions. GreatAmerica was a first-time public issuer and the enhancement for the bonds came partly from residuals. After investors were educated on GreatAmerica's position in the industry, its conservative underwriting and strong residual realization history, the bonds met with broad investor demand.
