Executive Summary: In recent weeks we have seen unprecedented volatility and uncertainty. Yet, management still needs to generate revenues by serving its current and prospective customer base. The current environment presents increased challenges but still provides opportunities for strong revenue generation and, even, selected growth.
We are currently completing work on the 2008 State of the Equipment Finance Industry, an annual report published by the Equipment Leasing & Finance Foundation.* As part of our analysis we interviewed about 30 industry leaders representing leading U.S. banks, independent firms, and captive finance companies as well as investment bankers and vendors to the finance industry.
One of the themes discussed in the Report highlights the expected increase in market dislocation and how that impacts the relationship between the customer and the lender. The issues that the financial services industry faces include:
- Declines in portfolio quality. Data provided by surveys, interview comments, and other industry analysis all demonstrate that portfolio performance is deteriorating. The good news is that most players have quality issues under control. Historic delinquency and loss levels are not being reached. In short, credit policies are in place and working for most.
- Continued volatility. Not surprisingly, virtually everyone we interviewed expects continued volatility. Most expect another “shoe” to drop, although some disagreement exists concerning what that shoe will be. Areas offered up include credit cards, consumer finance, and commercial real estate, among others.
When can we expect calm to return? The timeframe offered for a clear turnaround tends to vary from the second half of 2009 to the beginning of 2010. No one thinks we will see stability soon; a rocky ride is ahead.
- Growth taking a back seat to quality. With one or two exceptions, most players have reduced their growth expectations; instead they are focusing on improving current portfolio performance and being increasingly selective in the new business they take on. They are making sure to service strong customers first and, in some cases, are no longer pursuing customers or industry segments that they previously served. We have heard from several industry players that one additional side effect, at least in the near term, is that “a damper has been put on innovation” as simplicity and “the tried and true” gain greater focus.
- Relationships taking precedence over deals. Many equipment finance sales people are transaction-oriented. (So too are many traditional bankers.) Increasingly, that approach is no longer acceptable to bank management. One-off deals are losing out to relationships. While relationship banking is hardly a new concept, for many, the current crisis is making this approach mandatory rather than something that bankers give lip service to. Cross-sell and breaking through existing silos are becoming the norm. Without that approach, it will become more difficult to justify continued involvement in equipment finance or, for that matter, in other areas as well.
- Funding and capital issues increasing. No news here, as this issue appears to become more prominent every day. However, it does mean that equipment finance groups as well as other groups must demonstrate to their corporate office why they merit capital allocations versus other investment options. This focus appears to be bringing a level of rigor to the internal capital allocation process that, for many players, is unlike anything they have seen before.
In addition, units that had not focused on deposit generation are now expected to help address funding needs. In particular, commercial finance and leasing units owned by banks are being given deposit goals. Using remote deposit capture technology, the out-of-state customer now becomes a target for demand deposit generation. Some players not owned by banks are creating or buying their own banks as they seek to increase deposit options. Of course, this deposit-focus ties back to the increased emphasis on relationships; for many deposits are a central part of that focus.
So What Now?
When the current environment plays itself out, we see a different competitive environment both in equipment finance and banking. Certainly a compelling argument can be made that, for long-term survival and growth, brawn (capital size and resource depth) is at least as important as brains. That was not the case in the easier funding and capital access world of a few years ago.
What are some of the take-aways from our analysis for bankers and others managing through this remarkable time?
– Continue to be in the market. Although it may be an understandable approach, now is not the time to be an ostrich. Lenders need to be in the marketplace both for defensive (to understand what trends are evolving) and for aggressive (good deals still exist) reasons.
– Continue to analyze the portfolio. Particularly now, all customers are not equal. Lenders need to develop a rapid response model when problem areas emerge.
– Communicate to clients. Now is when the customer needs to know you are there for him/her (assuming you are).
– Segment/select where to focus. Capital is constrained and funding is tight. You should be operating with an articulated strategy that justifies your focus and quantifies the required investment and results. That strategy needs to be stress-tested and its recommended investments need to be prioritized in light of other options available to your parent.
– Demand deposits. Whenever appropriate, link in deposits with any loans made. Make deposits the priority by shifting compensation.
– Upgrade talent. As mentioned in earlier newsletters, mediocrity cannot be tolerated but often is. Get rid of those players who are marginal. Better people are available.
One Final Note
The quote accompanying this article indicates a rare event. A corporate leader is taking personal responsibility for the failure of his company and volunteering to share in the economic pain. This is a very gracious act that we hope others emulate.
*2008 State of the Equipment Finance Industry published by the Equipment Leasing & Finance Foundation, www.Leasefoundation.org to obtain the full report.