Then there’s SFG. Operating from 23 locations, the group provides financing to niche industries across the country and does aviation finance internationally. Allen Qualey, president of SFG, came to 1st Source Bank in 1986 with the goal of starting an aircraft financing focus. Qualey was aptly qualified, having earned his undergraduate degree from Embry-Riddle Aeronautical University with a major in aviation management. “I came to South Bend and five years later my boss retired,” recalls Qualey. “I was promoted to run the entire Specialty Finance Group, and I’ve been doing that for 21 years.

1st Source’s SFG focuses on seven areas of expertise: medium- and heavy-duty trucking, auto rental and light-duty trucking, environmental equipment, construction machinery, delivery vans, funeral cars and aircraft. “Aircraft is our largest concentration and includes corporate jets and smaller aircraft,” explained Qualey. “For the most part our customers buy an airplane for non-revenue producing purposes, though we do have some aircraft that are used commercially. One of our aviation ‘sub-niches’ is financing helicopters for operators transporting personnel to oil rigs in the Gulf of Mexico or performing aerial power line repairs.” Customers range in size from mom-and-pops to billion-dollar businesses.

Different Than Most

At many other companies, the leasing business is a separate subsidiary under the parent company, but 1st Source’s SFG operates differently. “We are part of the bank itself and operate as a business banking group instead of as a separate entity,” explains Qualey. “As opposed to offering tax leases, 96% of our outstandings are loans or full payout leases.”

The genesis of 1st Source Bank gives the company a different perspective on how it approaches its products and geographies. The company story began in the early part of the 20th century, when a local businessman formed Associates Corporation, a family-owned company that provided retail financing for automobiles for consumers. Back then, financing cars was a new idea. As the company grew, it acquired some ownership in a bank, First Bank and Trust, which was one of few that survived the Great Depression. The bank chairman was also the chairman at Associates, so the two companies shared a close alliance. Associates became a big player in financing construction machinery and over-the-road trucking companies, and the bank relied on the company for much of its marketing and sales origination.

But changes in the banking industry and new regulations necessitated a well-defined separation between the two companies, and once that split occurred, the bank could no longer depend on Associates. Because the bank chairman had developed a strong background in truck financing, he decided to build those talents in house at the bank. He started the “Truckers Bank Plan,” and hired people from Associates to build a portfolio of truck loans and leases across the country. These are the seeds of the Specialty Finance Group. SFG is unique in the banking environment, because its represents 50% of 1st Source Bank’s entire loan and lease portfolio.

“Most banks have a specialty area, but we are not fond of strong concentrations in any one thing,” states Qualey. “We strongly believe in diversification, and our portfolio is balanced between geography and products as well as between specialty finance and traditional banking.”

It’s not unusual for an employee to come to 1st Source and decide to stay there. Other than retirements, Qualey says there is very little attrition. “We have a different attitude from the big banks. We expect our people to work hard, but we don’t have the bureaucracy that can come with a large corporation. We hire experienced, competent people, and we don’t micromanage them. We set the objectives and give them the tools to do the job. They make their own choices about airline tickets and hotel rooms. As long as they perform, we don’t require them to fill out lengthy sales reports. Rather than giving them sales quotas, we set minimum sales targets, which we call ‘thresholds.’ We offer incentives to go beyond the threshold, but we don’t dictate a lot of stretch sales goals. We don’t want our salespeople pushing for marginal business just to meet a quota. If you hire the right people, it works well. We hire people with a strong background in their area of industry expertise, and that leads to strong customer relationships.”

The SGF organization is divided among four division heads who report to Qualey. Each division averages five sales officers who are dedicated to specific industries. “We don’t go out with a goal of penetrating a geographic territory by financing whatever equipment we can find there,” Qualey says. “Our salespeople have years of experience serving a specific industry, and they cover a large geographic territory looking for smart opportunities within their field of expertise.”

SGF does about $200 million in business outside the U.S. “In the late 1990s we dipped our toes into the aircraft markets in South America, Mexico and Canada, with more aggressive growth in 2003-2004,” reports Qualey. “The U.S. is by far and away the number one market for business aircraft, followed by Mexico, Brazil and Canada. Because of the relationships the U.S. has with Canada and Mexico, it’s a reasonably good fit. Brazil is a strong, interesting country that, due to its size, uses a lot of business aircraft. The Brazilian manufacturer Embraer has come on strong in the last 20 years, and we do quite a bit of business with them. Many of our transactions involve used aircraft, so we are less affected by the current slowdown in the aircraft production industry.”

Effects of the Recession

Unlike many lenders, 1st Source did not change its credit standards before or during the tough times. Even so, its outstandings shrank as much as $200 million, often simply because companies could no longer meet its credit standards. “We focus on outstandings rather than volume,” shares Qualey. “Because of our various business concentrations, some of our product lines turn more quickly than others and have a much shorter average life. We do a lot of lending in the rental car industry, and the average life of those loans is about 12 months. The average life of other products is seven to ten years, so you can see that volume is not a meaningful number to us.”

Having been in the industry 36 years, Qualey has been through four recessions. “Every time you think you’ve figured it out, you find out what you thought would happen is wrong. That’s one of the reasons we like to be diversified among products and geographies. It gives us less systemic risk, because you can never know exactly how businesses are going to perform.

“We knew there would be a downturn; we just didn’t know when,” he continues. “We thought we had a strong product line and strong customers that would weather the recession well. Our construction machinery performed better than we thought it would, and we were pleasantly surprised. Our auto rental business performed well, too. Trucking did a little better than we thought, though we had a couple of rough years at the beginning. A certain number of trucking companies failed, and we suffered some wounds but they were survivable.” Attesting to the unpredictably of recessions, Qualey remembers the downturn prior to this last one during which SFG’s construction machinery didn’t fare as well as trucking.

“The biggest thing we’ve learned is that it’s key to have a lot of different products,” asserts Qualey. “Our biggest surprise, by far, was that the value of top quality business jets dropped 70%. After that debacle with the Big Three automobile companies going to Detroit in their personal jets to ask for a handout, a number of people discarded their company airplanes to avoid being part of that shared perception. The industry really fell out of favor. However, most of our customers survived quite nicely despite the drop in values. That’s what is important to 1st Source — that our customers can survive and come back. I think jet values will also come back.”

Though 1st Source survived the recession well, Qualey says you really can’t know how well you survived a downturn until you go through a complete eight- to ten-year cycle. “We took some pretty good charge-offs in 2009-2011, and some of that will likely get recovered over the next several years. Our losses were at acceptable levels, but obviously we now have a pool of recovery to work on as we harvest collections. The long term outcome remains to be seen.”

Looking to the Future

Looking ahead, most agree that there are many unknowns: pending government regulations, the impacts of Basel III and an upcoming presidential election. With an asset size under $10 billion, Qualey says 1st Source may be less impacted by some of these issues. “Relative to our peers, we consistently keep strong capital ratios and high reserves. We think about the impacts of Basel III, but it won’t affect us the way it will affect the trillion dollar banks.”

In terms of risk and credit strategies, the company stays disciplined. “You can’t operate like a roller coaster. You don’t want to use products as filler to target an industry just to get some loan growth and then abandon that industry as soon as there’s a little downturn. The in-and-out players typically don’t fare as well, and they don’t create the necessary internal expertise. When you are in these products consistently over time, you learn more. Institutional knowledge is a valuable thing; without it, you are going to make more mistakes.”

SFG consistently tweaks its business. As industries and markets change, it may expand the use of one product over another. Qualey says there are times when it is appropriate to be aggressive and other times when you should back off. “We certainly like to grow, but we only believe in growth if it is profitable growth. We don’t have a mandate by our board that we must grow, and our objectives are more focused on providing a return to our shareholders.”

Though the company tends to hire highly experienced sales officers, about 20% of its force falls into the area of being less experienced. “We plan to develop them for the future, but you have to be very careful when doing this,” Qualey warns, “because you don’t want to train them only to have them take institutional knowledge and business contacts to a competitor. We are very careful in how we manage that process and encourage our people to stay.”

When half of your company is a community bank and the other is an international specialty finance group, it’s easy to wonder how management balances the two sides of the business. “We work well together,” declares Qualey. “In fact many of our back offices are commingled. They all report up vertically to the entity that combines the bank and Specialty Finance. If a business banker finds specialty finance business within our local bank footprint, we assist him. If a local company is buying a fleet of trucks, for instance, we often lend our specialized expertise, but we keep the relationship where it belongs in the local bank. As product specialists, we offer an added benefit.”

Qualey says the things that differentiate 1st Source’s SFG from its competition are its service level, the commitment to specific industries and the skilled professionals that operate in an effective manner. “When you are financing construction machinery, you have to understand the value of the equipment,” he cites. “You must know how it will be used and how to set residual values. This takes experience, so if you have to rely on third parties such as appraisers, you probably are not going to succeed. You need to have that talent in house.”

Some banks have been pulling back on out-of-footprint originations, which Qualey attributes to an inadequate level of expertise. “If you don’t have the right team, you will make more mistakes. I tell my people that when times are good, we learn nothing. When times are bad, we get an education. When we were first in aircraft financing, our losses were almost zero. When you have that type of success, you don’t learn how to work through the problems. In this industry, the education comes during the tough years.”

Lisa A. Miller is a freelance writer who has worked in the equipment financing industry for 15 years.