Scott Kiley,
Capital Markets Expert,

Independent lessors are keenly aware that building a strong capital markets team is critical their long-term survival. Bank lessors should be similarly aware that hiring the right personnel for a capital markets team is a critical function of business growth. This article discusses the ways in which a strong capital markets team can lead to more success and profitability for both lessors.

Warehouse Line: The Funding Source Anchor

The key goal of any successful syndication strategy for independents is securing consistent and diverse funding sources. Unlike bank lessors, who are not concerned with where their next funding dollar is coming from, independents must devote a lot of time and resources to meet their complex funding needs that requires many different “buckets” of money. Thus, hiring the right capital markets personnel is a critical function for every independent lessor.

The senior secured warehouse credit facility provides the anchor funding source for independent lessors to meet the daily funding needs of their customers in a timely manner. Step one is finding a bank that has a track record of providing warehouse lines to independents, as well as an experienced team that can structure a line with the most flexibility to meet daily liquidity needs. While the capital markets group may have some involvement in the warehouse line, that relationship is typically handled by the CEO and CFO.

Debt Financing: Risks and Rewards of Ownership

The capital markets group is charged with finding a permanent home for the deals funded under the warehouse line because those advances must be paid off by a set maturity date. For single investor leases originated by independents, this long-term funding typically takes the form of assigning only the rentals and retaining the equity or residual risk. Often referred to as “debt discounting,” this allows the lessor to keep the risks and rewards of ownership, including claiming depreciation tax benefits and realizing the fair market value (FMV) purchase option or end of term renewal proceeds. While the debt rate provided by the funding source for an individual debt discounting transaction is important, it’s not the most important factor — which is a good thing. The most important attributes sought out in a debt discounting funding source are reliability, consistency and a steady appetite for deals.

Differing debt rates produce different funding amounts resulting in a higher or lower “equity” investment from the independent lessor, but, oftentimes, these differences can be negligible or immaterial. However, if your debt discounting source fails to meet an important closing timeline or drives your closing team crazy with a cumbersome process, that could result in material damage to your relationship with a customer or to your relationship with that funding source. That’s why the lowest rate doesn’t always win.

In addition to traditional debt discounting, over the last several years, there has been more demand from lessors to fund all or a portion of the equity in their transactions with third parties. This allows them to grow at a faster rate with the amount of capital available to deploy. This can be done on a full recourse basis (typically not desired by lessor) or on a non-recourse basis, which means the funding source is taking equipment or residual risk, and the sole source of repayment is from the sale of the equipment or from renewal rents.

An independent lessor’s debt discounting partners are the most logical parties to approach about equity funding, but one quickly finds out that the appetite for equity funding is far less than for traditional debt discounting. The borrowing rate for an equity note will be — and should be — higher than the debt discounting rate because the lender is taking a subordinate interest in the equipment and the lease. More importantly, there is no set repayment source as there is with taking assignment of rents. This type of equity funding can be done on a transactional one-off basis, which can be cumbersome or on a broader pooled basis where the leases are cross collateralized and possibly a first loss amount absorbed by the lessor.

Pro Tip: Traditional debt discounting lenders should work with independent lessors to see if there is a type of “equity advance” lending that can increase the profitability of the entire relationship but still offer minimal downside risk. As a result of the bank crisis a few years ago, many bank lessors exited debt discounting entirely or severely curtailed this activity because it requires a lot of resources, and the returns are not stellar. If you can figure out a way to increase the profitability of the relationship via some form of equity lending, it will become a more strategic relationship and not so easily abandoned.

Securitization: Additional Efficiency and Scale

Securitization has become a very popular and important long-term funding source for independent lessors, which has led to less need for individual deal debt discounting. The involvement of the capital markets team in the securitization process varies among organizations. Securitization offers efficiency and scale not offered by debt discounting. However, some level of debt discounting is still needed due to customer concentrations, as most independents have a few large relationships.

For many independents, their direct origination capabilities can be a limiting factor to meet desired growth rates and can lead to a concentrated portfolio. Securing additional assets via indirect originations through vendor programs and buying from brokers or from other independents and banks can exponentially expand a lessors’ asset base. Independent lessors can be more nimble than banks in filling certain niches, and many independents do business with each other for their collective gain.

Capital Markets Teams Enhance Success and Profitability

The most successful and profitable equipment finance bank lessors have strong capital markets teams. Many years ago, the syndication efforts began primarily as a credit exposure management tool. As banks started to see the fees produced by their equipment finance syndication group, senior bank management began to demand increasing syndication fee budgets every year. Banks get addicted to fee income, as it has become such an important measure of success.

Since equipment finance groups don’t generate deposits, their “value proposition” to the mother bank is greatly enhanced by the fee income from syndication fees and remarketing activities. For these reasons, fee generation is now just as important as credit exposure management for most bank lessors as it relates to the syndication strategy. The net interest income generated by a bank equipment finance portfolio will never be enough to justify the continued capital commitment from the parent, and fee income has become a material contributor to profits.

After exposure management and fee income, the third most important function of the syndication team is to help establish a deeper and more meaningful relationship with their largest equipment finance (and bank) customers. This is especially true for regional banks that want to prevent their largest clients from leaving for the trillionaire banks because they can’t meet increasing credit needs. If your client has a $25 million annual equipment financing need, and your bank’s hold position is only $30 million, you must be able to offer a syndication solution that the client is comfortable pursuing to be their lead equipment finance provider.

As a bank lessor syndicator, finding the lowest buy rate is higher up on the pecking order than for a syndicator at an independent. That’s true for the very reason articulated above. Maximizing fee income is one of the primary goals of bank syndication shops. That doesn’t mean that rate is everything, but, as a buyer, you must be in the “ballpark” in terms of buy rate expectations in order to have a shot at winning the deal.

Building a Reputable Buy Desk

The importance of growing a reputable buy-desk is no more evident than looking at how new equipment finance groups get off the ground. It is no secret that most de novo equipment finance groups formed within a bank start out growing assets via indirect originations buy shops. The reasons are clear; it is the most cost-efficient way to start a diversified portfolio while developing direct origination capabilities. As the “new kid on the block” without equipment finance customer relationships or exposure, a newly-formed buy shop will attract the attention of syndicators. If you can perform as advertised, you can jumpstart an equipment finance portfolio to hundreds of millions in short order.

Establishing direct originations is not a call to abandon indirect originations. Quite the contrary, both channels are important to meet the overall goals of generating a diversified portfolio that can best perform through the economic cycles. We have all seen banks change the direction of their buy shops in material ways when capital becomes more precious. When this is done in a draconian manner, it can lead to reputational risk and an inability to leverage the buy desk for asset growth in the future.

Buy desk volume goals will always change from year to year, as this group is viewed as the “gap filler” of asset growth. Try to be as consistent as possible in terms of asset appetite, personnel and return requirements to establish a reputation as an industry leader.

Scott Kiley recently retired after a 35-year career in the equipment finance industry, including the last 25 years at Fifth Third’s Equipment Finance Capital Markets Group.