The good news about today’s heavy construction economy is that business is up in this nation. Nearly every financial company we interviewed for this story says that they will underwrite more loans in 2015 than they did last year. Business from the oil patch has softened somewhat, but the general economy, public works, and housing are all on a steady upturn.
The not-so-good news is that there are some shady companies out there who are misleading customers, says Rob Misheloff, president of Smarter Finance USA, Irvine, CA. His company provides financing primarily for smaller contractors and companies that are just starting up in construction.
“We often hear from our customers that they have visited one of these finance companies’ websites, and were told the rates were 6%—and then when they get a quote and do the numbers, the rates were actually 15% plus,” says Misheloff.
Misheloff says his company provides a few million dollars annually in equipment financing. He’ll do “much more” business this year than last, he says. “Number one, the economy is getting better and there’s more work.
“There is more work available than there are machines and workers,” says Misheloff. “A lot of people that—during the recession—went out of business, are getting back into business, and they can use as much equipment as they can get their hands on.” Misheloff says that for him, the Midwest is strong, and so is Texas and certain parts of the South, especially Florida.
John Deere scraper
That view is echoed by Jim Bowles, president of Nationwide Business Capital. “Based on our prior year-to-date we have recognized an 18% increase from last year and expect the full year to be comparable to that number,” says Bowles. “We are seeing an increase in both the residential and commercial markets, which are in turn creating more contracts. We deal nationwide and have recognized a greater increase with businesses on the East and West Coast than [with] the Midwest. Many contractors have bounced back from the recession. Many of our customers have shared that they are on track for a record year,” says Bowles.
David Schmidt at John Deere Financial says that based on how 2015 is going, the company will finance slightly more construction and forestry equipment this year than last. Schmidt says the upturn is probably not as pronounced as the company might have predicted a year ago, primarily because of softening in the oil and gas drilling and exploration activity. Still, the improvement is steady—and the housing market seems to have stabilized.
John Deere articulated dump truck
“I think our contractors now are much more focused on cash flow—cost per hour of using the machine—more than they were prior to the recession,” says Schmidt, manager of retail credit for the Construction and Forestry Division of John Deere Financial. “They’re looking for the most overall value and the cost of running the machines, so if a lower interest rate in combination with the price of the unit makes the operation cost less, given that the quality of the machine is comparable, I do believe that low interest rates are a factor in the buying decision. Those who are doing well are being very thoughtful about how they’re growing their business and managing their equipment fleet, based on the experiences that they’ve had.”
Top officials at both Caterpillar Financial Services Corp. and CNH Industrial Capital-NAFTA, say they will finance more construction equipment in 2015 than they did in 2014. “Many factors are driving the sale/lease and financing of construction equipment,” says Tom Mariani, chief credit officer for CNH Industrial Capital-NAFTA. “Some of those factors are improved market conditions, replacement of units by operators, and refreshing of rental fleets. We are seeing upticks in all regions in the US.”
“Low rates do induce action,” says Mariani. “A notable portion of our financing features manufacturer-backed low rate offers. For instance, CASE Construction is currently offering 0.0% financing for 48 months for qualifying pieces of CASE equipment.”
“The market for construction is growing, driven by the slow but steady improvement in the economy,” adds John Marino, North America region manager, Caterpillar Financial Services. “Most contractors have recovered from the recession. Their balance sheets are stronger. The one soft spot is contractors that support the oil and gas industry. With the decline in the price of oil, drilling has slowed down, so there is weakness in demand for construction of drilling pads and roads into the oil patch.”
We asked Misheloff if the current economic climate would change if Congress infused a significant amount of money into the Highway Trust Fund. “Well, yes,” he says. “But I’ll tell you that in most areas, there’s more demand for construction services than there are construction services to meet that demand. We talk to dump truck buyers, particularly, where the rates being offered to owner-operators are going up and up and up, because there aren’t enough of them.”
Barry Abelsohn, national sales manager at Alliance Funding Group, Orange, CA, says, “Our organization has seen more than a 20% increase in financing as it relates to the construction vertical market. We saw some great growth in year-end 2014 compared to 2013 in this segment, and it seems as if the construction vertical has been on a very steady course which we expect to continue for the foreseeable future.
“We’ve determined that the uptick in construction activity to be attributed to construction activity in the commercial real estate and public works projects,” says Abelsohn. “There has also been a tremendous surge in the rental sector. Business owners assume the rental would be a cheaper avenue and they often overlook the fact that ownership, in many cases, may be the lesser capital expense.”
Interest Rates Vary
Naturally, interest rates vary by contractor, by their financial position, and various other factors. “I financed a crane for somebody recently and they had pretty reasonable rates,” says Misheloff. “The rates were roughly 6.5% per year. So for every $100,000 of cost it was roughly $6,500 a year in finance charges. Then when we ran into somebody with rough credit, particularly a bankruptcy or tax liens, depending on the situation, rates could be really, really high. Sometimes we see financing quoted in the 20% per year range, or even higher, depending on how bad the situation is.”
A tracked excavator at work
Misheloff says he works with customers to calculate how much money they will make with a piece of equipment—then compares that to the payment. “In one case recently, a prospective customer says, “I could keep on driving someone else’s excavator,'” says Misheloff.
Most officials interviewed for this article says a contractor’s credit track record and current work backlog are more important factors in getting a loan than is the expectation of new work coming in. We asked Misheloff if he would finance equipment for which a customer expected to get work.
A wheel loader at work
“Not unless they truly expect to get the work,” he says. “We’re working with somebody right now who has been paying $100,000 a month in rental on his equipment. And we’re working through the numbers, and he’s going to need roughly a million dollars worth of equipment over the next six months. And the payments probably will be in the $35,000 to $40,000 a month range. So $35,000 to $40,000 a month for equipment that you own at the end of the term is a whole lot better than $100,000 a month and at the end you have nothing.
“We talk to several first-time owner-operators of dump trucks who were making $60,000 a year driving a dump truck,” says Misheloff. “But once they get into their own dump truck they can bring in $20,000 to $30,000 of revenue monthly. And that’s not a wish. Sometimes the company they’re working for will say go ahead, get your own truck and we’ll pay you $80 an hour to haul for us. We work the numbers out with them, and after all costs are counted, including maybe setting aside $1,000 a month for repairs to the truck, and a lot of times the person—instead of making $5,000 a month—can net $13,000 to $16,000 a month.”
All lenders told Grading & Excavation Contractor that the requirements and qualifications for getting a loan become more escalated as the amount of the loan goes up. Misheloff says that profit margins—particularly a history of making a profit—are important in the go/no go decision. “In financing larger amounts, we want to look at two years of tax returns, and some financial statements,” says Misheloff. “It’s harder to make a loan to someone who has only been marginally profitable than to somebody who’s got a large amount of booked revenue and profit coming through. An underwriter’s projection of risk has a big impact on what the financing rate will be because we’re essentially underwriting that risk.”
Many lenders, especially where the borrower is a closely held company, ask for personal guarantees to back up a loan. Misheloff, who finances mostly smaller contractors, says he asks for a personal guarantee on almost all loans. “But we do run across some larger companies, call them corporate only,” he says. “If the company has been in business for five years or more, has a strong Dun & Bradstreet profile, and a strong history of paying their creditors on time, then we can do a corporate only loan.”
Caterpillar’s Marino says smaller, closely held contractors are usually receptive to offering a personal guarantee. Larger contractors where ownership is spread among several individuals are usually more reluctant to offer a personal guarantee. “If a company is rebounding from difficult times, a personal guarantee becomes more critical to show the owner’s belief in his or her future prospects for their company,” says Marino.
At John Deere Financial, Schmidt says the company typically asks for a personal guarantee from a small- to medium-sized contractor that is closely held. “The personal guarantee is almost as much a check and balance tool as it is an expectation that we expect that person’s going to repay a bad debt from their personal funds,” says Schmidt. “If you’re making decisions about your business and you know that you also have a personal investment, then it’s like a check and
balance in the owner’s mind, versus if it’s just their business, and they feel like if they make a mistake on this, just my business is at risk.
Nationwide Business Capital offers an application-only program for financing up to $150,000. The application-only program is a one-page application, also available for applying online. If the transaction is more than $150,000 but less than $250,000, the company requires two years of personal and corporate tax returns for closely held companies, an interim financial statement, and a personal financial statement on the majority shareholders.
For transactions greater than $250,000, Nationwide requires three years of personal and corporate tax returns. “We do not traditionally ask for business projections,” says Nationwide’s Bowles.
We asked Alliance’s Abelsohn if a loan applicant needs to submit a business plan. “Unless the business is in an early stage, a business plan is not as important to us in credit review and analysis,” he says. “We are underwriting to their past history of payments, collateral, and the overall structure of the financing.
“Profit margins are very important in underwriting for our middle market group (over $250,000 deals),” says Abelsohn. “A business’ cash flow provides lenders with the comfort of the company’s ability to service its existing obligations along with the new purchase that we’re looking to finance.”
Technology Improving Cash Flow for Subcontractors
For many subcontractors, one of the biggest challenges comes from having little or no access to reasonably priced working capital. This stems in large part from a fundamental structural issue in construction: In typical financial processes, subcontractors are in effect financing the work in progress on projects. They carry out work and submit invoices but generally aren’t paid for weeks, or even months. Meanwhile, as they await payment, subcontractors still have to fund their own labor, equipment, materials, and other costs. This situation can put stress on their business, limit growth and investment, and even lead to business failure.
To help ease this burden on subcontractors, construction software provider Textura Corp. worked with supply chain finance experts at Greensill Capital to create the Early Payment Program (EPP). EPP enables general contractors to offer their subcontractors optional earlier payment—as few as five days after invoice approval or, on average, 30–90 days sooner than normal payment timing. With general contractors providing faster, more predictable payments with EPP, subcontractors should enjoy improved cash flow. This should make it easier for them to fund their operating expenses, strengthen their balance sheets, and enable growth and expansion.
Taking advantage of EPP is optional for subcontractors whose general contractor partners participate in the program. Subcontractors can decide—generally invoice by invoice—whether they want to take advantage of early payment, in exchange for a modest fee.
Textura’s CPM technology enables administration of EPP, while Greensill Capital performs the underwriting and arranges the funding, including working with the capital markets. Similar to supply chain financing in other industries, EPP is a win-win solution for general contractors, subcontractors, and owner/developers. By transforming how subcontractors are paid, EPP can provide benefits to the construction industry as a whole.
