Our next two newsletters present some of the key findings from the Report and discuss its implications for the broader banking industry. We recently presented some of our conclusions at the Equipment Leasing Association’s (ELA) annual meeting in hurricane-impacted Boca Raton.

Companies’ Equipment Purchases Increased More Rapidly Than Financing Volume

The National Association of Business Economics estimates that business investment in machinery and equipment will grow by nearly nine percent this year. Over the same period, FIC estimates that equipment finance volume will increase by less than seven percent. There are a number of reasons loan growth has not kept pace with equipment purchases:

• Companies have access to multiple sources of capital – Today, companies are able to access funding from a variety of sources, many costing less than funding from a bank or commercial finance company. Large and even medium-size companies can access the Commercial Paper market, while venture capital and private equity firms actively strive to deploy their capital with up-and-coming small and mid-size firms. Small business owners often use the equity in their homes as a source of low-cost financing. In short, borrowers are increasingly resourceful and have more financing resources available to them, thereby undercutting banks.

• Businesses have excess cash – During the recent recession, companies of all sizes, unsure of the direction of the economy, hoarded cash. A recent report by FitchRatings states that Fortune 400 companies had enough cash on hand in 2004 to finance their capital expenditure requirements for 18 months. As the economy continues to improve, companies are using cash-on-hand, rather than taking on debt, to invest in new equipment. Their caution and fiscal conservatism work against a lending growth spurt for the banks.

Cost of Funds Rose, Pricing Fell, and Spreads Continued to Shrink

Despite a rise in the cost of funds over the past year, banks and commercial finance companies have been unable to pass that additional cost along to customers. As a result, average pre-tax spread declined. We see this phenomenon with virtually all our clients.

One factor resulting in reduced margins relates to the overabundance of capital in the market, mentioned above. In particular, the best middle market and large companies are poor lending targets for most traditional banks.

In addition, within commercial finance, changes in the accounting and regulatory environment, as well as continuing difficulty in the commercial aircraft market, have restricted opportunities in the large-ticket space (transactions over $5 million). Specifically, these changes have virtually eliminated the attractiveness of the highly structured, highly leveraged deals in which some large bank players specialized. This has left those players searching for alternative markets in which to replace that lost volume, adding to competitive and pricing pressures.

Implications for Banks

Because of these and related trends, banks must make a number of changes in their marketing and sales approach:

• Increase focus on non-lending activities – As new types of providers enter the market, businesses’ reliance on banks for financing may continue to decrease. In order to replace declining loan revenue, banks should focus on growing their fee-based lines of business, particularly cash management (including payments) and wealth management. These two areas, more than others, not only generate attractive returns, but also provide powerful relationship “hooks” that help lock-in customers and reduce acquisition costs. Except for the best credit specialists, relying on lending alone will result in slower growth and reduced margins.

• Be proactive  – Banks need to be aggressive in exploiting their strengths and segmenting their approach to the market. Most have the opportunity to leverage two of their distinct “natural” advantages over other players: trust and convenience. Banks, particularly community banks, remain relatively well regarded by most business owners and executives. In comparison to larger lenders and hedge funds, banks rarely encounter what General Tommy Franks referred to during an ELA speech as “C6 issues”, that is, they are rarely the subjects of a Column 6 article in the Wall Street Journal.

The banks’ branch system also provides convenience to the customer, an element that continues to be critical in how a customer selects and remains with a bank.

But trust and convenience are insufficient for creating a value proposition. Increasingly, financial service players are determining their priority segments and creating offers aimed at specific segments. Examples include: Union Bank with Hispanics, Zions and Wells with women business owners, Citibank with law firms, and National City Bank with medical professionals. Commerce Bank of New Jersey takes a different tack. Rather than segment by customer type, in effect, it segments by marketing to customers who value excellent service and will pay more for it.

Banks can leverage these inherent advantages and segmentation strategies by proactively approaching customers to discuss their needs and by offering solutions. The banks that are best at solution selling operate with a disciplined approach to sales management and a consistent and detailed account planning process.

• Differentiate the offer – As competition continues to increase, banks must work harder to differentiate themselves both from other financing sources and from other banks. In our next newsletter, we present some examples of how both bank and non-bank players have differentiated themselves within the middle and large corporate markets.

Concluding Thoughts

We have long focused on the need for banks to increase their emphasis on fee-based business, such as cash and wealth management. In addition, we have previously discussed the importance of more effective account planning and sales management. Data, such as that presented in the ELFF’s State of the Industry Report (http://www.leasefoundation.org/) details the increasing competitiveness of the commercial lending market and underscores banks’ need to take action to address what may be a marketplace that, over the mid-to-long term, is in systemic decline.