THE tank truck industry is riskier for lenders than the flatbed and dry-van segments, but the trucking industry as a whole is attractive, according to David Thomas, product delivery officer of credit for Bank of America.
In “How a Major Institution Evaluates Tank Truck Industry,” Thomas — who has orchestrated a number of loans in the trucking industry — said the tank truck segment is riskier because of nature of commodities hauled and the uncertainty of regulatory factors being discussed. He made the presentation May 11 during the National Tank Truck Carriers 62nd Annual Conference in Chicago, Illinois.
At the same time, he said trucking is attractive because it is a necessary service.
“If you are going to specialize in an industry, you might as well pick a big one so you have plenty of opportunities,” he said. “You want to pick an essential industry — something that's not going to be outsourced or that doesn't involve a lot of technological risk. You have to look at an industry that has high-quality assets.
“Most of the time when someone in the trucking industry is working with a larger bank, the person they're talking to is not the ultimate risk or credit approver. It is my job to communicate to people who are in that position why you are a credit-worthy borrower. I have more knowledge of the industry than most bankers. But I don't kid myself for a moment that I have as much core knowledge as you do, so you have to help me help you by telling me what I need to know about your business and what makes it special.”
He said there are two kinds of structures lenders use:
- Cash-flow lending.
“It generates steady, predictable cash flow to services. We usually have structures that are in some form of letters test and some form of coverage test. Cash-flow lending is better suited for companies that have stable EBITDA values, so lenders have a lot of confidence that they will not run afoul, even in a significant downturn. If you have a business that has some relatively high volatility in EBITDA, that can trigger covenant violations, renegotiations of the credit agreement. I can tell you from personal experience that in the last 18 months, we've renegotiated nearly every deal on the books because of the severity of the downturn.”
- Asset-based lending.
“Asset-based lenders are much more focused on collateral values. They treat cash flow as important, but more of a secondary consideration. The focus here is on driver quality and its evaluation and liquidity. They want to make sure you have ample liquidity, usually in the form of availability on the credit side. Because they are focused so heavily on collateral, if you have certain amounts of liquidity, they have fewer financial covenants, or, in some cases, no financial covenants as long as you have a limited amount of availability. Negative covenants are sections of the agreement that say, ‘Thou shalt not … ’ It's more prevalent on cash-based lending. The disadvantage of asset-based lending is the high frequency of reporting. And you are subjected to field exams. They do frequent appraisals.
“Asset-based is better if you have strong value of your assets, well in excess of the loan you need to support them, because the value of assets you have tends to have more stability and provides you with more credit availability to run your business. In the not-too-distant past, there were a lot of people who considered asset-based lending something to be done only in the last resort, only for financially distressed companies and turn-around companies. That's not the case anymore. A lot of companies use asset-based loans because their profile makes them more comfortable using that structure. Tank trailers have been a pretty good source for collateral. They're stable.”
Sufficient capital
Thomas said that a year ago, the Federal Reserve created a stress test on all large financial institutions and came up with estimates for losses in different scenarios, and required lenders to base capital so they had sufficient capital.
“That settled down the market quite a bit,” Thomas said. “Since the actual loss experience has not been quite as severe as what was outlined in the most stringent of the stress-case scenarios, most large banks now have adequate capital, by and large. And that is not constraining their lending at this point.”
Thomas said the Fed surveys loan officers of the nation's largest banks on their lending practices, asking, “In the last three months, have you tightened your lending standards, loosened them, or kept them the same?” He said that when credit quality starts to deteriorate, banks see evidence in the portfolio and start to tighten standards. A year ago, over 80% of the respondents to the Fed surveys said they were tightening standards.
“But in the last six quarters, we're seeing less net tightening,” he said. “In the last two quarters, most banks reported that they kept the standards the same. And a small percentage are loosening. If we have continued help from the economy and companies continue to perform better, there's reason to believe this trend will continue.”
He said that usually when banks have losses, that impacts their capital, and if their capital ratio falls below certain levels, they have to shrink the size of the balance sheet by reducing lending or raising capital.
“The Fed made that decision easy because they made us raise capital,” he said. “And so all banks generally at this point have sufficient capital to support lending as we move forward. That was the Fed's overriding goal of the stress-test program. They didn't want a downward-spiraling scenario where banks contracted the balance sheet, which led to more trouble. The good news is that banks sufficiently capitalized and have money available.
“There are a lot of companies that cut back on spending significantly in a downturn. They've paid down lot of debt. We're seeing these trends improving somewhat. We're still seeing weaker loan demand, but it's not as weak.
“Despite what you read about banks and all the activities we have, a lot of banks make money primarily on that interest margin on loans. So banks are all interested in making money and interested in trying to grow our earning assets, and loans are one of the largest. When you have a sharp drop like this, it may encourage lenders to rethink those standards.”