With a recent surge of positive change in bank-owned equipment finance groups, Charles Wendel discusses major factors that are driving banks’ renewed interest in equipment finance and leasing divisions, while offering insight into the process of choosing whether to buy or build new, as well as advice on how to be successful.
Charles Wendel, President, Financial Institutions Consulting
Recent years have seen a significant positive change in the role and importance of equipment finance and leasing groups within banks. Bank-owned equipment finance groups have become critical growth engines, contributing not only revenues but leading many banks’ cultural transition toward a greater focus on targeted, relationship-based sales and cross sales.
Just three or four years ago, bank-owned companies operated in a world in which management discouraged asset growth, the emphasis was on portfolio quality, and equipment finance management often had to fight for the capital allocation needed to support its customer base. Since the downturn, a 180-degree turn has occurred. Today, bank-owned groups feel a different pressure: the need for growth in answer to senior bank management’s desire for new revenue sources.
Factors Driving Equipment Finance Growth within Banks
Six key elements have propelled banks’ renewed interest in equipment finance and leasing:
Limited growth opportunities elsewhere: Bank regulations, such as Dodd-Frank, have constrained banks in traditional consumer areas where they once exploited fee opportunities related to overdrafts, debit cards and other areas. Traditional loan growth such as consumer mortgages and commercial lending has also contracted in light of the overall economy. Banks have no choice but to look for new areas of asset and fee growth.
Cross-sell as a mandate not an option: Banks have touted the need to sell more to each individual customer for well over a decade, but internal initiatives were often half-hearted and unsuccessful. With limited business expansion occurring, banks now have no option but to mine each relationship and sell more to the same customer. At many banks, customer data availability, relationship management technology, and management follow-up has turned cross selling from an aspiration into a consistent growth engine.
Equipment finance as a natural add-on: Banks have realized that virtually all-commercial customers buy equipment, with many financing their purchases. Equipment finance has emerged as a logical addition to a bank’s traditional product set, leading management to take advantage of this opportunity before others do. For example, one $20 billion bank entered the equipment finance business specifically out of frustration that its customers were going elsewhere for their equipment needs, both taking away potential lending business and opening those customers up to broader competitive inroads. That bank realized that if it did not take action to meet its customers’ equipment needs, those customers could be lost to a full-service competitor.
Equipment finance’s strong performance: Equipment lenders tend to be disciplined in the types of deals they pursue. Both in good times and bad, portfolio loss experience usually outperforms the rest of the commercial bank. Equipment finance groups sometimes seem to suffer from being viewed as dealing with riskier borrowers, but the facts support its reliable portfolio performance in good times and bad.
Lead with leasing: More banks now realize the marketing power of equipment finance and the ability of an equipment finance group with its specialized capabilities to open doors unavailable to commercial bankers. Equipment finance can serve as the “wedge” product, introducing the bank to a new customer set while allowing for relationship building.
Equipment finance as a differentiator: Today, many borrowers view traditional C&I lending as a commodity product. They use an RFP process centered on selecting a lender offering the lowest rate. In contrast, equipment finance groups can often differentiate their offer based on industry knowledge and structuring expertise while providing their customers with a clear value added offer that can often generate a pricing premium over a bank’s term loan.
While the current attractiveness of the business seems clear, banks have been following different paths to entering the business and growing assets.
Entering the Business: Buy Versus Build
Many banks refocusing on this business lack the required marketing and operational skills. Even those with leasing initiatives in place often find that their existing groups are largely moribund or simply react to specific internal bank handoffs, not a prescription for growth. As banks consider how to grow this business, they are evaluating whether to buy existing companies or build from scratch.
Buying into the business: Independents, once viewed by many as struggling to exist long term, are now flourishing in the wake of funding availability and increased lending opportunities in part due to bank constraints, among other factors. In recent years, Independents have become attractive acquisition candidates for many banks, immediately creating a strong platform for growth. Examples include City National Bank’s purchase of First American Equipment Finance (preserving that company’s separate brand) and Umpqua Bank’s acquisition of Financial Pacific Leasing. Buying a company captures proven talent, allows for immediate asset generation and may be quickly accretive to earnings. Some independents, recognizing the opportunity to sell to a bank that will provide them with a much lower cost of funds, are actively positioning themselves for sale.
However, acquisitions can entail a number of management challenges. Most independents operate in a flat organization with limited rules and may find it difficult working within a bank bureaucracy with its focus on following internal processes and meeting compliance requirements. Equipment finance employees tend to be more entrepreneurial than traditional bankers, potentially leading to frustration and even conflict. Further, senior equipment finance personnel will usually have a contract that ties them to the bank for several years. Once those contacts are up, they have the option to leave, taking their expertise and, perhaps, their customers with them.
De novo: While some banks want the immediate “pop” and infrastructure that an acquisition can provide, others avoid buying often to limit their upfront investment, keep goodwill off the balance sheet and minimize potential cultural conflicts. In addition, independents have also been rising in value as more banks consider this business, pushing up the price of entry by acquisition. Instead, these banks pursue existing equipment finance teams or leaders who can form units. This path requires more time before generating, and management will need to develop or buy infrastructure. Recently, we assisted a client in developing an RFP that detailed operational and systems requirements. We submitted the proposal to nine vendors; the entire process from RFP to the beginning of software installation took about four months, providing a strong infrastructure for the bank but also requiring a significant investment of time and personnel.
“Buy versus Build” depends upon the needs of the bank as well as the available pool of acquisition candidates. We expect continued activity in both areas with smaller banks emphasizing building groups to limit upfront entry cost.
The Path to Cross-Sell Success
Once up and running, how do banks achieve cross-sell success and make equipment finance a sustainable growth area? While individual bank practices vary, some principles appear to cut across the landscape.
Compensation: Let’s begin with the elephant in the room. For cross-sell initiatives to succeed, bank relationship managers must not only understand the equipment finance product and appreciate the value that an equipment finance specialist provides, but they need to get paid for referring a deal outside their group. The old cliché about people doing what they are incented to do accurately describes how a bank operates. The best case exists when bankers know they will be compensated equally for a loan or a lease.
Demonstrated expertise: Equipment groups need to present their capabilities to end customers, showing that the industry or technical knowledge they bring to a transaction provides the customer with features that a traditional term loan lacks. However, an even more significant marketing program may need to occur internally directed at a bank’s commercial bankers. Beyond aligning compensation, bankers need to believe that the leasing people will provide a high level of service while allowing the commercial RM to maintain “control” over the relationship. Initially, a high level of sensitivity exists at many banks on this point. Unless RMs become comfortable with this they may feign cooperation without providing deal flow.
Management focus: If management insists that all equipment transactions go to the equipment finance group, banks will increase their effectiveness. Doing so ensures a consistent process for credit analysis and structuring and allows the bank to fully leverage its expertise. However, at a recent industry meeting, an informal survey showed that practices varied with a few banks mandating referrals with most others leaving that choice up to regional managers or individual bankers. Those banks may be underusing the expertise they have in place and, in turn, underserving their customers and limiting their potential revenue stream from this business.
Independence from the bank: For bank equipment finance groups to succeed they need to develop their own deal flow and, in most cases, not rely exclusively on bank clients.
As one bank leasing executive stated the “dirty little secret” of the leasing business is that most of the volume bank groups generate results, not from bank clients, but from business the equipment finance group itself finds and closes. In some cases this can lead to additional bank cross see, but not in all instances. If it is to achieve optimal growth, management needs to understand and embrace this aspect of its leasing operation.
The prospects for banks in equipment finance remain strong. Equipment finance provides distinct value to customers, generates quality assets for the bank, and assists in the relationship building and stickiness so critical today. The most successful banks will be those that integrate the leasing offer into their commercial banks while allowing these groups to maintain the distinct culture that has been a key part of their success.
Charles Wendel is the president of Financial Institutions Consulting.
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