With this newsletter, we continue our series presenting summary views on the areas in which we specialize. Over the past eight weeks, we have focused on small business, middle market banking, and wealth management. This week, we highlight some major themes and outline tactics to improve performance in equipment leasing.

 

 

Leasing Basics

The leasing industry has suffered over the past several years. In addition to a decline in equipment sales caused by the economic slowdown, shrinking margins, increased regulatory pressures, and a dramatically changed competitive landscape have made business as usual in the leasing industry all but impossible.

 

Yet, despite these difficulties, significant opportunities exist for those lessors that execute effectively against the key success levers, including:

 

Leasing profits demand effective pricing and a low-cost operating structure. Over the past five years, bank-owned lessors’ market share (by new business volume) has increased nearly 60 percent – the most dramatic change in the competitive landscape. While a number of factors (discussed below) are driving banks into the leasing market, once they are there, the low cost of funds provided by their deposit base gives bank-owned lessors a significant pricing advantage.

 

Nevertheless, even if non-bank lessors cannot compete on price, they must still work to drive their pricing as low as possible while earning a reasonable profit. One way to do this is by managing their operational costs: running a leaner, meaner organization. Another way requires managing their cost of funds. Lessors reduce their funding costs by running their business in a way that permits them access to the least expensive capital available, typically the capital markets.

 

One of the few small, independent lessors still able to access the capital markets for its funding needs attributes its success in that area to its long history of comprehensive and transparent financial reporting. Lessors that hope to leverage the securitization or other capital market must begin preparing years in advance.

 

Origination costs must be minimized. While automation has driven much of the cost out of the back-end of the origination process, the cost to acquire new customers is significant.

 

Captive lessors have always operated with a clear advantage in origination cost. With their point-of-sale financing model, customers come to them. They have limited need to field a large sales force additional to the manufacturers reps.

 

Logically, bank-owned lessors should have a similar advantage. They operate with a large pool of captive customers (the bank’s existing commercial clients) and a large sales force that, in effect, someone else is paying for (the commercial bankers). However, it has only been in the past year or two that a handful of banks have begun to take advantage of what would appear to be their customer relationship advantage.

 

Lessors and bankers cite internal silos as well as compensation systems that pay bankers to prefer loans to leases as reasons that bank-owned lessors usually fish outside company waters for new customers. However, increasingly, senior bank management recognizes the benefits of cross-selling leasing to its commercial customers. Those benefits include: increased asset growth, returns that are typically significantly higher than those generated from commercial lending, and improved customer retention. As a result, top players have made aggressive efforts to break down internal barriers, realign compensation policies to reward profit rather than revenue, and create formal cross-sell initiatives.

 

Independents appear to be at a disadvantage in this area. As a percentage of total operating costs, they spend 25-30 percent more on origination than other lessors. However, innovative players have found ways to increase the effectiveness of their existing sales efforts and/or reduce them. For example, one middle market lessor focuses exclusively on phone-based origination. While the most traditional lessors may say that a phone-based system cannot work, this player has made it work.

 

Here, as in our last three newsletters, segmentation plays a critical role. By first understanding their position in the market, and then by defining their optimal customer and arming their salespeople with information on likely prospects, lessors can focus their sales efforts on the most desirable and most likely targets.

 

In addition, a number of independent lessors have reduced origination costs by redefining who is the customer. For some, the customer became the mid-sized manufacturer that saw the value in having a captive finance company to aid product sales but lacked the resources and skills to create one. By operating as the manufacturer’s private label captive, these independents were able to take advantage of the efficiencies of point-of-sale origination.

 

Lessors have to select a defined strategy. Only the largest lessors, like CitiCapital and GE Capital, can successfully operate as “generalist” lessors. Moreover, even these giants are increasingly defining where they intend to play, in terms of either asset class, end-user industry segments, or credit quality. Why? Because they recognize that leasing is no longer an industry or even a business. It is just one financial services product among many, and, for many financing users, it is becoming increasingly indistinguishable from a basic loan.

 

Increasingly, top players are seeking ways to distinguish themselves from their competitors. As bank-owned lessors turn inward to focus on existing bank customers, their customer knowledge and ability to bundle leasing together with an array of financial services solutions becomes their competitive advantage.

 

Several years ago, a number of captive lessors expanded their leasing focus beyond their manufacturing parents’ products with an eye toward becoming “the next GE Capital.” In the past two years, many of them abandoned their generalist focus to concentrate once again on their core product. They recognized that their intimate knowledge of that equipment (residual value, remarketability, etc.) is a significant asset in the market, but that outside of their core products, they offered little value to the customer.

 

Successful independents are able to differentiate themselves in a number of areas. Some leverage their risk or asset management skills to create a successful business leasing to credits that others would not touch. Others market their flexibility and overall customer “experience” as differentiating factors. However, all successful independents share a common foundation: a clear understanding of their markets and clients as well as an effective origination strategy. Only after they create that foundation can they leverage their operational strengths.
 
Conclusions

In our view, the equipment leasing industry will continue to evolve as lessors respond to customers’ demands for innovative financing tools. Successful lessors will continue to pay close attention to costs, but they will emphasize growth. In doing so, they will develop clear and defined strategies articulating what they want to be in the marketplace and how they intend to get there. Conversely, we expect lessors that continue to do business as usual will soon cease to exist.