The intricacies of automobile financing are like a microcosm of the larger vendor finance world. So how do you distinguish the key players? Dexter Van Dango discusses the roles of captive finance companies, banks, independents and brokers and how each competes in the field.
When he was president of GE Capital – Vendor Financial Services, Bill Cary described vendor finance in a simple way: “It’s not that complicated. We help folks sell more stuff.”
Helping folks sell more stuff by conveniently positioning a simple financing solution at the time and place of purchase. Providing an answer to the question, “How will I pay for it?” That’s it. That is vendor finance.
Car dealers have been offering a form of vendor finance since the earliest days of the industry. In fact, the world of automobile financing is like a microcosm of the larger vendor finance world. You have the major captive finance companies providing attractive promotional financing for the makes and models they want to push off the lots. Then there are tens of billions of dollars in bank financing made available to the dealers’ finance and insurance (F&I) departments, providing additional profit opportunity for the dealerships. On the bottom rung is the independent lessor or broker — oftentimes a part of the dealership itself. The lucrative ‘tote-the-note’ guy gets a decent down payment from the buyer along with payments that may be due weekly, and he won’t hesitate to repossess the car if a payment is missed. Just clean it up, put it back on the lot and sell it again.
Let’s take a closer look at the four types of players involved in the auto financing description above — captive finance companies, banks, independents and brokers — to see how each competes on the vendor finance playing field.
Captives play a significant role in vendor finance. They dominate certain key markets like information technology, construction equipment, trucks and trailers, office and printing equipment, and medical devices.
Some would argue that the captives always have the advantage over their competitors because they hold all the cards. They produce profits for their parent company from the sale of the equipment. They control the earning asset on their books and take profit from pricing dynamics, including the tax benefits and perhaps even the end-of-term gains. They control the messaging to their clients through periodic invoicing and they hold the flexibility to upgrade equipment throughout the term in order to maintain customer control. But despite their agility and flexibility, captives can be beaten at their own game. It takes one to know one.
One captive can effectively take out another captive by offering a better deal. The deal can come in the form of better pricing on equipment, better terms on financing, or acceptance of the competitor’s equipment and payoff of its existing contracts in exchange for signing the new deal. This horse trading takes place nearly every day between Caterpillar and John Deere, GE and Siemens, Canon and Ricoh, HP and Dell, or between Paccar and Daimler, for example.
Captives will commonly take on excessive risk when a traditional funding source might otherwise shy away. There are many valid reasons for taking on such risk. Cisco Systems Capital was famous for taking credit risk as a means of accessing the lofty gross profit margins that were prevalent during their early days of development. Reckless investing is less commonly used today, but it still shows up in high-margin products like software financing.
One form of excess risk borne by captives is concentration risk. In an attempt to control their customer, a captive might accept two or three times more credit exposure to a single client than a bank would lend to the same company.
Enter the banks.
Today’s banking world has undergone a total remake. Discretion has been taken out of the equation. The new world order is rules-driven. The regulatory environment is daunting. Whether it is the Dodd-Frank Act, the Consumer Financial Protection Bureau, the Gramm-Leach-Bliley Act or the Office of the Comptroller of the Currency — someone is always looking over the shoulders of the banks. And even if they are not a bank but are deemed to be a Systemically Important Nonbank Financial Institution, many of the same rules apply.
The impact of this tightened regulatory oversight has made it difficult for banks to differentiate themselves among the competition. Some believe it is the banks’ fault that pricing has been driven so low in the current market. Banks can no longer stretch or accommodate as they once did. The rules forbid the banks from straying from policy. Today there is not a hill of beans difference between many of the bank competitors.
It’s a wonder that the banks are able to compete in the vendor space at all. Or is it? Lest we not forget … the bankers have all the money! It is the banks that the captives turn to when looking to reduce their concentration risk. And it is the banks who offer the most attractive pricing.
Banks can and do play a vital role in vendor finance. Referencing the 2013 Monitor list of the 25 Active Players in the Vendor Channel, all but one of the top ten names was a bank or bank subsidiary. One could argue that De Lage Landen (DLL) is a bank since its parent is Rabobank, but for this exercise, neither DLL nor Rabobank is listed on the United States Federal Reserve System – National Information Center list of top 50 bank holding companies.
On another note, the Fed lists GE Capital as the eighth largest U.S. bank holding company. GE did not participate in 2013’s Monitor assessment of the vendor channel. If they had been included, 10 of the top 11 players would have been banks, representing more than 90% of all vendor channel volume activity.
Since most banks look alike and are restricted in how much leeway they can exercise with vendor clients, they leave the door open for more nimble competitors: the independents.
Independents may have higher funding costs. They may have less sophisticated back office systems and may or may not have fully integrated front end systems to accept electronic receipt of credit information. These potential disadvantages are easily overcome by what independents do possess — independence. Sure, they may have restrictive covenants with lenders and have triggers tied to key performance indicators, but on that one transaction identified as “strategic” by his vendor partner, the independent has the discretion, the leeway, the hutzpah to make a relationship call and not worry about the consequences with the auditors. While character is no longer included among the four Cs for banks, it still remains valid with the independents.
Vendors cannot afford to put all their eggs in one basket. The exclusive funding source concept disappeared even before Dodd-Frank. Vendors need independents to thrive alongside banks and even brokers.
For example, many office equipment dealers have developed a dependence on the service levels delivered by GreatAmerica Financial. Medical device manufacturers rely upon the audacious approval rates and seemingly unsophisticated documentation requirements of Med One Capital. Point-of-sale equipment specialist Lease Corporation of America finances products that other lessors avoid. Creekridge Capital continues to display impressive growth in the medical and technology verticals. Element Financial is rapidly growing aviation, fleet and rail books of business: aircraft, helicopters, trucks, trailers and railcars. It could be LEAF Commercial Capital or Vision Financial Group or Direct Capital; the point is, they all play a role in the vendor channel. They have the flexibility to do what others cannot.
Even brokers can play a role in vendor finance. Some deals are simply too hairy for a traditional funding source. Trying to explain a credit decline to your vendor partner can cause heartburn. Having secondary and tertiary sources for tougher credits can help to appease the situation. Brokers use structure to make ugly deals palatable. They put lipstick on the pigs. You may not like it, but there is definitely a place for brokers in vendor finance.
If presented with the opportunity to start a vendor leasing company tomorrow, without hesitation, I would start an independent. They represent less red tape, more independence and huge opportunity. A large number of successful independents have been swept into the arms of larger companies and banks over the years. The prolonged low interest rate environment we have been living through for the past several years has led banks to look for better ways to deploy capital. Fully amortizing term debt is far more attractive in comparison to untapped lines of credit.
For the foreseeable future I see banks on the prowl seeking attractive acquisitions of leasing companies or teams of originators. If you have the leadership skills, the financial acumen, the ability to raise capital, the ambition and the patience to grow something from scratch, then you should consider building an independent vendor finance company.
But hey – what do I know? I’m just a haggard old leasing guy in the twilight of a mediocre career. I welcome your feedback at email@example.com.
Dexter Van Dango is a pen name for a real person who is a senior executive with more than 25 years of experience in the equipment leasing industry. A self-described portly, middle-aged, graying, balding leasing guy in the twilight of a mediocre career, Van Dango will provide occasional insight from the front lines via Monitor .
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