First Rumblings of New Investment?

By Neil Irwin
Friday, June 5, 2009

United Airlines is planning a major purchase of new airplanes in the next few years, a sign that corporate America may once again be developing an appetite for new investment.

Businesses have dramatically pared back their spending over the past nine months, reluctant to make any investments in new plants, equipment or software. There have been many reasons -- loans and other financing have been hard to come by, businesses have less cash to work with as sales drop and, more than anything, they have been fearful of just how bad and how long the recession will turn out to be.

In the first three months of the year, investment in commercial structures plummeted at a 36.9 percent annual rate and investment in equipment and software fell at a 33.5 percent rate, according to Commerce Department data. Spending on transportation equipment has been particularly hard hit; in the first quarter, it was 67 percent lower than at the beginning of 2007 and reached its lowest level since 1970, even when adjusted for inflation.

Businesses are still being extraordinarily cautious, economists and other experts said. But there are emerging signs that companies are more open to taking the plunge on new investments than they were a few months ago. United's decision to buy new wide-body aircraft, disclosed yesterday, happens to be the most high-profile such investment.

The business investment environment was dismal through at least April, said Kenneth E. Bentsen Jr., president of the Equipment Leasing and Finance Association, whose members provide funding for businesses that need equipment. "But now there are a few inquiries and indications of demand and applications for borrowing," he said.

"It's very tentative, but it sounds like businesses are starting to come back and think about investing in plants and equipment," Bentsen said, based on conversations with members around the country.

For now, many companies are trying to extend the life of equipment rather than replace it, repairing machines rather than buying new ones. Part of this is that the nation's factories are running at less than 70 percent of their capacity.

But, economist Joel Naroff said, businesses are better positioned than in past downturns to rapidly ramp up their spending once they are confident that the worst days of the recession are past.

"With the information companies have about demand and their inventories, it's a lot easier to react quickly and sharply," said Naroff, of Naroff Economic Advisors, who expects business investment spending to bottom out in late summer or early fall. "They will have the information that sales are improving sooner and adjust accordingly."

United is making a longer-term bet. With major airlines experiencing crushing losses and orders for new aircraft poised to dwindle in the years ahead, the airline hopes to take advantage of this moment to upgrade its fleet on the cheap and be better poised to profit four or five years from now.

It is soliciting proposals from both Boeing and Airbus, essentially signaling that it will choose the aerospace company that offers it the best deal. "This is a bet that they'll be able to take advantage of growing air traffic in the future and strike now while they can get a good price," said Richard Aboulafia of the aviation consultancy the Teal Group.

A key question for United is whether financing will be available. The breakdown of the world financial system last fall has severely constrained the ability of companies to borrow money, even for promising investments. The Wall Street Journal reported yesterday that the airline is looking to buy up to 150 new planes at a cost of about $10 billion.

Mid-size businesses, with far more modest funding requirements, will face their own difficulties in obtaining financing.

"There are still finance and leasing companies out there that are reducing their portfolios," said Kenneth Collins, chief executive of Susquehanna Commercial Finance in Pottstown, Pa.

According to an April survey by the Federal Reserve, 40 percent of senior loan officers reported having tightened their credit standards for commercial and industrial loans. But demand for those loans also weakened: 60 percent of respondents reported less demand for loans.

"There is a lot of negative news out there causing confusion and putting people on the sidelines," Collins said.

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