Mike Arness
CEO
Clearview Financial
Ephrata, Wash.
RER: How would you describe the current environment in rental in terms of availability of capital?
Arness: There's more capital available now than we've seen since the early to mid-‘90s. There are funding sources coming out of the woodwork right now. Just to give you an example, I had a couple of my clients call me last week and read off a list of eight to 10 lenders that had contacted them already trying to secure some business for next year's purchasing. The sad part is most of them are simply calling off of UCC filing lists, and know nothing about the industry.
The rental industry is unique in a lot of ways. One of the things a rental company should watch for is somebody who understands the industry. Every time we provide a lease or loan, we hold the equipment as collateral. So we file a UCC1, that's the instrument that gives us the ability to hold that as collateral, and that is public information. So anybody can run a UCC list and get lists of anybody who has borrowed money in the past. And that becomes a good call list because if they've borrowed money once, they'd probably do it again.
Around 2000 and 2001 the number of lenders lending money reduced dramatically. A lot of portfolios were failing; a lot of things were going bad. It was hard to get hold of a lender or even to get them to return your call. Now, I get calls two, three times a week from lenders wanting me to send some business their way. So we're seeing sources come out from everywhere and I don't ever remember it being more capital rich than it is right now, there are more funds for all kinds of projects than there has ever been. So that's the good side, because supply has recovered somewhat.
Most people look at money as a one-way thing, how cheap can I buy it? But without the supply side, you've got nothing to borrow. This is why I like to see prime go up a little bit, like to see the t-bill go up a little bit, because once my investors start seeing return on investment, we can get into deeper credit, more challenged credit, they can get a return on investment, we can be much more creative that way. When prime is low, rates are so low, margins are so thin, you can't afford risks and only A-list guys get loans.
With so many loans available, is there a risk of borrowers falling into the same cycle of a few years back and becoming over-leveraged?
Not necessarily. We've been through a couple of cycles with rental already, the boom and crash and then back up again. What we find is that most rental guys are pretty well disciplined; they are looking at return on investment. The average rental company owner gets eight to 10 calls per month from people wanting to loan them money. So he's had that availability for quite some time. Like you and I can get credit cards anywhere we want, we can borrow money everywhere we want, but we don't, we onIy do it on need basis. So when I look back over the past 15-year portfolio performance that I have in rental, that's not one of the problems I usually see. Occasionally, but it's a rarity.
Usually when I get a default it's caused by some other outside forces, such as a competitor comes into the marketplace, a personnel death, or maybe all of a sudden the highway has been re-routed out of the area and he has no traffic in front of him anymore. Those factors, especially in the rental industry, tend to have more impact on defaults from me than just somebody overloaded with debt they can't pay.
They are smart enough to avoid that.
The majority of them are. Our portfolio covers everything from machine tooling to class 8 trucking, and everything else in between. The rental guys seem to have much better business sense than that of any sector in my portfolio, rental performs the best. I have fewer defaults in rental. These guys know what they're doing; they are pretty savvy. You take a guy who owns an automotive shop, and he buys a new piece of equipment every 10 years, to replace a lift, a new balancer, a new frame-straightener, something like that. But rental guys buy all the time and as a result, they are much more savvy to the lending community, and to the possibility of over-debt. The vast majority of my clients in the rental business sign the payroll checks, they work at the business every day. These are a special type of client.
Absentee owners eat my lunch, a guy that lives in Los Angeles and has a machine shop in San Diego, and doesn't know anything is wrong until the collectors are calling him. And generally the hole is too deep by then.
What are the best current sources of reliable capital for rental companies?
The best is a mix, including their own banks and financing companies that have been into rental for a long time (and there are several of us). These are the most reliable sources for capital. We understand the rental business. What happens is you get these outside lenders that come in and say we'll give you this or that, but they find the complexities of rental, multiple invoices of vendors on one contract, varying terms for all the varying types of equipment that we carry, the very soft equipment, the table clothes, the napkins, china, all of those are hard to collateralize. We also deal with the computer systems that are used in the industry. Companies that know rental will be the best because they can accommodate these complex loans.
Another reason why it's nice to have us along instead of just the banks is that any time you work with a bank, you're going to have a certain exposure level, meaning that they will only lend you so much money. And so keeping some of the exposure level open at your local bank is a very healthy thing to do. If a guy buys a backhoe or some other piece of equipment, and then he has to borrow money for payroll or tax purposes, or he has to pave his parking lot or whatever the case may be, he may find he has reached his exposure level with his bank. This would have been the time to use our money for the equipment and preserve his bank line for unforeseen uses.
So I get calls all the time, the customer wishing he would have used my money and not his bank's. We want to see them have that banking relationship because it is important to have backup cash/money that can be used for any type of purchase. You can take your wife to Hawaii with those funds. When you deal with us, we're going to be bringing in an outside source of money, which is really nice because we don't affect your current bank line.
You mentioned some unscrupulous players coming into the market.
Some guy will get a letter or even a piece of plastic that looks like a credit card and it will say “You have been pre-approved for $100,000.” And then these guys go out and buy equipment thinking they have that $100,000 and it's just soliciting. Like when you get something saying you're pre-approved for a home-equity loan. It's the same with credit cards. But it's just advertising. Some rental owners get these things and think it's legitimate. Before they even know the terms and conditions or who they're working with, they start purchasing equipment. When you contact them to activate the card, that's when they take the credit application. You are usually never “pre-approved” unless you have previous experience with the company that is pre-approving you.
They claim you are pre-approved because they got our company name from a report, let's say a D & B report. When they order the report they request a certain class of business — a company two years or older, five or more employees, etc. According to this search, I've “pre-selected” you, because I've got people within a certain parameter. But that doesn't mean pre-approved.
The other thing you need to watch for is when you call this company and they send you documents to sign before you've sent them invoices to pay. The exception to the rule is if you are signing a commitment letter or Master Lease Agreement. The intended use of the funds and the ability to have them returned should be spelled out.
One of the good things about working with companies you know in the rental industry, and I don't mean only my own company, there are a number of us, is that we make our living on referrals. We go back to the same well day after day. I have been to trade shows since 1992. I can't rip people off and keep showing up at that show. So we have the customers' interest in mind if for no reason other than it's a good business decision.
When rental companies are considering expansion, considering major investments in facilities, equipment, people, acquisitions, what are the primary questions they should ask themselves?
The main question should be: “Is this a viable investment?” When I finance buildings or equipment for my clients, I don't look at it as an expense to them, I look at it as a cash-making investment to them. And that's how they need to really consider it. If they are looking at simple equipment — one of the keys to knowing you need to buy a line of equipment is if you've sub-rented it so many times. If somebody walks up to the rental counter at almost any rental center and says “Do you have this?” and they don't, it goes on a list, and the owners who review this on a regular basis and see multiple requests for an item determine they can cash-flow it. A lot of equipment is financed in this industry and to make that finance work properly, you want to look at return. You're looking at renting this machine for $350 for a two-day rent, and your payment is only $400 a month, so I only have to rent this for two days and the rest is profit. Plus you're gaining equity on the equipment. Then it's a good investment.
If I'm looking at property, or if I need another division, if I want to bring party in, it's the same, I've got to look at the costs in implementing this new building and what kind of return do I expect to see on that. Nobody has a perfect crystal ball, but is it a whim, or a fad or an ongoing trend that you can continue to grow and build upon? Then let's make an assumption that you're all wrong on this, do you have the historic income to pay for it if it doesn't generate additional income? Or could this venture be the one that puts you under?
This is an up-cycle period, a period of expansion and growth overall in this market. How would you compare it to the mid- to late-1990s?
I would say it's very similar, but I feel this one is a little more explosive. We weren't hurting bad in the ‘80s at all, and then in the ‘90s it just got better and stronger. What really blew us up in all honesty was the high-tech world, not the rest of the planet. You probably remember five years ago, four years ago, watching a Super Bowl game, you had no idea who most of those advertisers were or what they were advertising. The next year you didn't see those ads because 90 percent of those businesses went out of business in that one year. And so we had this crash of the dot-commers. That really kind of slammed the door; we lost a ton of money out of the economy, trillions of dollars, due to this kind of overvaluing. So we had a nice gradual climb and it was very strong and very sturdy.
Now I feel it's building quicker. And any time you have a quicker build like this, you're on a little bit wobblier ground, which leads us to the question you asked about inflation. Any time you recover too quickly of course you have inflation concerns, but I think the Feds, by raising interest rates, they're doing a pretty good job. They are moving these in increments of 25 basis points so they're not radical jumps, so they continually are putting a little finger in the dike in order to manage that. All the numbers that we're looking at are good, manufacturer numbers up, inventory numbers are down, nobody's keeping inventory, a lot of things are going on out there that we feel very very good with. And I believe that unless barring another terrorist attack, some kind of outside influence, I think that we're in for another good decade of solid growth. I really feel that from so many indicators.
And again, I draw a lot of this off of not only rental business, but all the other facets of industry that we serve. The only one I don't think is ever coming back is manufacturing. I think we are in deep trouble there. And even with equipment manufacturing in the United States, you'll find 30 percent of the components are manufactured outside of the United States.
Construction is certainly looking strong.
Construction is booming, and the natural disasters don't hurt, but they really only affect pockets. We are seeing a strong construction market. The rates to buy a home are still extremely reasonable, we haven't seen that slowing down. Construction in manufacturing and storage plants is looking pretty good. I feel very good about construction, it's in a good position right now.
Are there certain ratios you look at when you're considering a company, such as debt to equity?
Debt to equity I do look at, but we generally look at asset to equity rather than debt to equity. We like to see that they own at least half of their assets. So you're looking at an asset-to-equity ratio of about 2-1.
Debt to equity depends so much on cash flow. We all look at these ratios, same thing with return on investment, we'd all love to see 10 to 12 percent, but there are so many variables involved. For example, if I look at a construction company, its debt-to-equity ratio to me is going to be much more of a concern than a rental company. A rental company can have one of the highest debt-to-equity ratios in the land, because most of its debt is directly income-producing equipment, providing immediate return on investment. For example, a guy buys a chair for $12. He rents it for $5. He may have that chair on a three-year term with me because he's bought a couple thousand chairs. He rents that chair twice, he's paid for his investment. Can you get a better return on investment than that? We'd love to do that on our backhoes, but the numbers aren't there obviously. So when you look at the individual item within a rental company, its return on investment is going to be extremely different. Take a look at a small compressor, $300. They are renting those for $45 a day. The return is still very good, but not as good as a chair. Then you look at the excavator you spent $200,000. What he gets for rent on that, the ratio has gone down again, but it's still a reasonable return in dollars, but the ratio has gone down.
So we always go back, especially in rental, to deal with cash flow than a lot of these ratios. The average guy I deal with in rental is highly leveraged, because he's in a position of continually having to buy new equipment. So we have more leniency there as far as leverage goes than we do in any other industry. So to peg a number on it is not a fair thing to do. It's more of the understanding of what kind of debt you have. Here again, the debt that you have because of your new parking lot and signs, all of that is necessary, but we'd rather see that debt in equipment, because it's generating revenue.
