Dodd-Frankenstein Repercussions: Will Increased Regulatory Oversight Force Banks to Exit Vendor Finance?
by Dexter Van Dango May/June 2016
Dexter Van Dango looks at the evolving role of bank-owned equipment finance companies in the vendor channel. While banks have traditionally dominated vendor finance, many independents have entered the space by offering greater flexibility. Banks still have the advantage of lower cost of funds. Will that be enough to keep up with the competition?
In recent years, bank-owned leasing companies have carried a heavy burden: dealing with an ever-tightening regulatory environment while trying to compete in the vendor finance channel. Banks are starting to look like a one-legged man in an ass-kicking contest. How can banks effectively compete with independents and captives when the banks all share an undeniable degree of similarity in their credit standards and documentation requirements coupled with a lack of flexibility driven by their regulators?
A year ago, I wrote a piece for the annual vendor finance issue of Monitor titled “Vendor Finance for the Uninitiated: A Newcomer’s Guide to Building a Vendor Finance Business.” The article provided a set of 10 guidelines required to compete successfully in the vendor finance channel. No. 8 on that list was “Give a Little, Get a Little,” where I addressed how the regulated banking environment had crippled most banks’ ability to make accommodations or concessions when requested by their vendor partners. I concluded that to sustain vital long-term partnerships, vendors and their funding sources must find ways to work through the challenges of the regulatory environment and find ways to help each other meet their respective business objectives. Today it is getting harder and harder to find ways to overcome those challenges.
Not much has changed in the past year, except for the intense focus on compliance within the banking world. The competitive landscape remains fierce, leaving the inflexible banks at a disadvantage compared to their non-bank counterparts. Overcoming the challenges of the regulatory environment is becoming more and more difficult.
The heart of the matter is rooted in two words (two names, to be precise): Dodd-Frank. Christopher Dodd and Barney Frank were the chief architects of the bill that Congress enacted as law in reaction to the credit crisis and the near collapse of the U.S. banking system. Originally, Frank organized the new law’s goals into four categories: securitization, compensation, liquidation and systemic risk. Fair enough, but there is more to Dodd-Frank than those simple categories.
What began as an attempt to tame an unruly beast — an out-of-control Wall Street — ballooned into “the Dodd-Frankenstein’s monster,” as labeled in a February 2012 article in The Economist. The article elaborated, “The law that set up America’s banking system in 1864 ran to 29 pages; the Federal Reserve Act of 1913 went to 32 pages; the Banking Act that transformed American finance after the Wall Street Crash, commonly known as the Glass-Steagall act, spread out to 37 pages. Dodd-Frank is 848 pages long.” What was the title of this article? “The Dodd-Frank Act — Too Big Not to Fail.”
In an act that fills 848 pages, there must be tremendous clarity, right? There is not. Instead, nebulous terms remain open for interpretation by the reader. For a conservative bank, that means plan for the worst and hope for the best. Set the standards high and live within the rules. With oversight of commercial lending coming from The Office of the Comptroller of the Currency, The Federal Reserve, the Office of Financial Research and the Federal Deposit Insurance Corporation — all on a national level, as well as various state regulatory agencies, an overarching burden is created.
So the real question is whether banks will remain able to compete in the vendor finance channel while complying with regulatory hurdles. Can banks really expect lower pricing to offset the difference in approval rates? Will the lack of flexibility and willingness to accommodate lead to loss of vendor relationships? How much leniency or discretion has been lost due to regulatory oversight? And how has that impacted the banks’ ability to originate new vendor relationships?
Two observations come to mind as I answer some of these questions.
The Rise of Independents
First, there has been a visible increase in the stature of independent leasing companies competing for share in the vendor finance channel. Look no further than Ascentium Capital to find one that is rapidly surging with organic growth, increasing new business volume by 53% year over year in 2015. In addition, GreatAmerica Financial Services, LEAF Commercial Capital, ENGS Commercial Finance and Med One Capital all represent niche players that can be formidable competitors in their chosen markets within the vendor finance channel.
Independents hold the advantage of flexibility over bank leasing companies. Independents can approve a deal because they like the equipment, or because they know the CEO of the startup company and “have a good feeling about their eventual success,” despite negative cash flow and alarming amounts of debt. Independents can allow the requested accommodation without writing up an exception report. Independents answer to their shareholders — not the Fed, the FDIC or the OCC. But independents frequently have significantly higher cost of funds than banks. Yet the disadvantage in pricing can often be balanced by their increased credit approval rates, flexibility and less stringent documentation requirements, earning the independent a seat at the vendor’s table.
Second, banks have dominated a large portion of vendor finance for decades. Granted, captives have the advantage of owned markets, dealer networks and long-term loyal customers, yet banks continue to persevere. Of Monitor’s top 10 players in the vendor channel last year, nine were banks, if you include DLL as a part of Rabobank. Only Element Financial fell outside of the banking regulatory environment, though I’m certain they have their fair share of investor oversight and rules of compliance.
Banks aren’t going to disappear from the vendor channel. In fact, one bank, Wells Fargo, is about to fill an even more dominant role than it has historically held. When Wells Fargo became the winning bidder for the Vendor Finance, Commercial Distribution Finance and parts of the Corporate Finance business units of GE Capital, it became the new 800-pound gorilla sitting atop the U.S. vendor finance marketplace. Since this deal only recently closed, the results for this year’s top players in the vendor channel will not reflect the advancement of Wells Fargo Equipment Finance. Next year you will certainly see Wells Fargo lead in many of the categories tracked by Monitor.
Multi-Funding Source Model
The evolving landscape of the vendor finance channel has caused equipment, software and service vendors to shift from risking everything on one endeavor to spreading their business among multiple funding sources. The multi-funding source model is fast becoming the de facto method vendors utilize when designing vendor finance programs. It is common for a vendor to have minimally two bank partners and sometimes three. The banks compete on price, and in some cases, may bring superior market knowledge for a targeted niche. Coexisting alongside the banks will be two or three independents — again focused on targeted niches. For example, a healthcare vendor could rely on Med One Capital or Creekridge Capital for their C and D “story credits,” while a technology or copier vendor may look to LEAF or GreatAmerica. The independents play a vital role and will continue to thrive in the vendor channel.
Don’t expect banks to go away anytime soon. They will continue to serve an important role, both as wholesale funding sources for vendors with captive finance entities and as the price-competitive source for retail vendors who require the competitive advantage offered by banks. The focus of banks within the vendor finance channel has narrowed to the point where it may not reach beyond what are deemed to be A and B credits, which is why vendors will continue to rely on the multi-funder model, which allows for an extended credit reach through the flexible offering of their independent funding partners.
Do you have a different opinion? Please share it with me at email@example.com.
Dale Tower, vice president of remarketing at Corcentric Capital Equipment Solutions, discusses how, after climbing to the highest historic inventory levels for used trucks in 2019 and 2020, the market has overcorrected itself into a historic low for inventory levels.