Technology has changed so many aspects of our daily lives, from the way we work to the way we shop and interact with friends, family and colleagues. But equipment finance, for the most part, hasn’t experienced a dramatic impact from the rise of technology … yet. What will the industry face as emerging technologies become more mainstream?
“Our bet is that emerging technologies are going to create some rapid change,” Bill Verhelle, CEO of QuickFi, says. We haven’t really seen that yet, but we think it’s going to move from what has been a very stable environment in equipment finance for about four decades, to a rapidly changing situation because of these new technologies.”
The foundation of Verhelle’s belief comes down to the power of technologies that bring unique new capabilities that may change the way business is done. “Disruption is really about a business model changing,” Verhelle says. “It’s not about just automating something or making it more efficient. We’ve been doing that for 40 years. Disruption is really about when the technology is so powerful there’s an entirely different way to do business.”
Examples of this have been popping up everywhere and they are beginning to change the way equipment finance companies do business. “Continued innovation and technological advances will drive efficiencies and consistencies across all functional areas of our industry: originations, underwriting, documentation, booking, syndications, portfolio management and client interface,” Dave Fate, CEO of Stonebriar Commercial Finance, says.
Verhelle points to driver’s license authentication microservices, based on facial recognition technology, as a prime example of this type of disruption. “Previously you had to drive to a bank branch and hand your driver’s license over the counter,” Verhelle says. “Things like that can change the whole business model; they changed the potential for the way the bank could do business with people.”
“As certain effective technologies are adopted by the market, clients will increasingly expect more timely decisions, competitive economics, predictable and repeatable closing processes, and real-time access to information,” Fate says.
More Connection, More Clarity
Scott Nelson, president and chief digital officer at Tamarack Technology, says equipment finance companies should look for emerging technologies to impact them in three ways:
First, products that are connected and can work together, will make it possible to finance networks of products. Increasing the demand for operating software that drives automation for both labor and energy efficiency.
“You will no longer be able to think about one piece of equipment by itself,” Nelson says. “Over the next few years, everything’s going to be connected. Everything’s going to be networked, and there’s going to be just a massive increase in the demand for software to make use of those connected products. Companies have to start thinking beyond the physical asset and start thinking about how these assets will work together.”
Second, sensing technology will allow new ways to manage and forecast risk — not just the equipment itself but also the financial performance and the risks being taken by the businesses using the equipment.
“Connected products are going to have more and more sensors, which mean there’s more and more data,” Nelson says. “So you’re going to have a robust number of ways to do risk analysis, risk monitoring, and risk mitigation.”
And third, Nelson believes that cloud connectivity, digitization and the use of once dark data will enable those companies that leverage machine learning and artificial intelligence to transform how they view risk management, origination and disposition. “You don’t have to think about centralizing all your data, you’ve got to think about centralizing your access to it,” Nelson says. “Once you have access to the data, that’s where machine learning and artificial intelligence come in. Data can be can be turned into actionable insights and once manual processes can be automated. Based on what we’re hearing from customers, there’s no question this is where the industry is headed.”
“Technology driven enhancements will be first, and likely exclusively, applied in the smaller ticket and flow business segments of our markets,” Fate says. “Market inefficiencies in this segment will contract. Larger, more complex and structured transactions will continue to require more bespoke and hands-on diligence, structuring and documentation. Premium yield will remain for those lenders and lessors that have the expertise to close these transactions and deploy meaningful capital.”
Labor Challenges, Automation & OpEx
Predicting the future can be difficult without a crystal ball, but two things are certain: change is the only constant and technology is evolving exponentially. Given these facts, what will equipment finance look like in five, 10 or 15 years?
“The equipment finance and leasing industry has proven its durability and resilience through economic cycles, financial crisis, health pandemics, shifts in capital markets, changes in tax and accounting policies and periods of consolidation,” Fate says. “As other forms of capital enter and exit the market as conditions change, the asset-centric lending and leasing community consistently provides secured capital through these cycles. I fully expect equipment finance and leasing to be an active and growing industry in the decades ahead.
“Additionally in 10-plus years, today’s diverse emerging talent will be in leadership positions across our industry,” Fate says. “It’s vital now that today’s leaders recruit, develop and retain best-in-class talent within their organization.”
Nelson believes the next five years in equipment finance will be focused on energy costs and the shrinking labor force.
“Equipment finance companies should look for an increase demand in automation equipment for everything from manufacturing to medical diagnostics to transportation,” Nelson says. “They should also expect that this kind of equipment will require the addition of automation software that reduces labor and/or energy costs to all equipment contracts — currently Caterpillar, John Deere and Volvo have such software offerings.
“The market effect of connectivity will be the fragmentation of the markets,” Nelson says. “Customers will expect a personalized experience and the OEMs will find ways to deliver it with software. This will make niche specialization a winning strategy and require larger firms to become software-centric in how they adapt to market needs — specialization Amazon and Netflix style.”
In 10 years, Nelson anticipates that the IoT will be widely adopted. Along the way, equipment finance companies will have opportunities to finance solutions that include connected hardware nodes and software that makes the networks valuable. But they must learn how to manage the risk of widely distributed fleets of equipment. The market will have fragmented in terms of risks and requirements so equipment finance companies will need to learn how to use the IoT to manage risk specific to a segment or application.
In 15 years, Nelson expects that the economics of Uber, AirBnB and App Stores will dominate the capital markets. “Equipment finance will be the go-to market approach for OEMs and OpEx will implement lean capital for operating businesses. CapEx could be gone in 15 years,” Nelson says. “The J.P. Morgans of the world will try to aggregate equipment finance demand from SMB to Fortune 50, treating equipment finance as a capital approach to all markets.”
Exponential Change Starts Slowly
“Five years is hard to predict,” Verhelle says. “Six or seven years ago, while speaking at an industry executive roundtable event in Dallas, I asked the 25 CEOs present if they thought the U.S. equipment finance industry would be largely the same, or substantially different in five years. It was half-and-half. I was in the half that thought it would be largely different in five years. And I was wrong. The industry is largely the same today.”
Verhelle notes that dramatic, exponential change starts very slowly until the 18-to-24-month doubling happens several times, thereafter it moves very fast. He points out that many of the greatest disruptions in business were envisioned and discussed then largely overlooked by the masses until a few companies that stuck with it, like Amazon, became extremely successful. The successes seemed sudden, only because many of us had been focused elsewhere while the doubling continued.
Although exact predictions are impossible, Verhelle sees the trends of massive simplification, transparency and customer self-service gaining ground in other industries. Verhelle notes that Amazon or Tesla do not spend a great deal of time selling to their customers. Instead, their customers can access the information they need to process a deal on a mobile device platform any time that fits into their schedule. For this reason, Verhelle predicts that fewer people will be selling financial services for most of the relatively simple equipment finance transactions that happen each year.
The Power of Simplification
“One of the areas of pushback I get when I share that idea with people is that there are certain types of products that are very complex and would need somebody to explain it,” Verhelle says. “First, I acknowledge that’s true. Maybe you’re financing an aircraft and there are a lot of tax implications and structuring, and maybe there are registration issues about where you register it and FAA issues. I get that certain transactions do have more complexity, but there are also a lot of transactions that people are referring to that don’t need to be as complex as they are.”
To illustrate this, Verhelle describes his wife’s experience purchasing a Tesla online. To streamline the customer experience, Tesla doesn’t have as many options available as other car manufacturers. They give customers six options to turn on or off, making the process so simple that they can navigate the process themselves without the help of a salesperson.
Verhelle says people who protest simplification of more complex transactions are projecting on the borrower that they want and need that complexity. “Sometimes we in the industry have foisted that complexity on customers, maybe unconsciously, so they need us to talk through it,” Verhelle says. “Maybe it could be made a lot simpler for the buyer, so that they could do it themselves in a lot of cases. Not all of them, but some of them.”
“When companies change their processes significantly, they are changing their business model,” Verhelle says. He likens transforming the business model of a thriving company to rebuilding your car while driving it to California. “You can’t be driving it at the same time you’re trying to rebuild it into something entirely new.”
Companies can continue to improve their efficiencies but only for so long. “At some point you say, ‘Wait a minute. I just spent my IT money for this year, and I expended it on my old business model. It didn’t move me an inch closer to my desired new business model. Now it’s more difficult for me to walk away from the old one because I just invested in it.’ In a peculiar way, that becomes clear after you really start challenging yourself about where you want to go from a strategic perspective. Sometimes the money you’re spending on technology is moving you away from where you’re really trying to go.”
You Down With ESG?
Environmental, social and corporate governance has been growing in importance over the last few years. How will ESG initiatives impact equipment finance in the long term?
“ESG, first and foremost, is impacting the ELFA industry indirectly through its impact on our customer base,” Fate says. “Customers are increasingly managing their own ESG exposure through their migration to newer and more efficient assets, increased focus on corporate responsibility and more transparent governance that is naturally passing through to our portfolio and our peers’ portfolios. At the end of the day, if it’s important to our customers it’s important to SCF and the entire industry.”
Nelson believes the equipment finance market should look for environmental and social criteria to create governance. “The good news is that governance happens slowly, so you can keep your eyes on it,” Nelson says. “ESG is also related to mission, and a company’s mission is going to be really important to attracting labor. And as I said before, labor’s going to be a challenge for the next five to 25 years, depending upon birth rates. So you must be aware of it in the context of, ‘How does our mission support the needs of our labor force in terms of knowing that they’re pursuing a valuable mission?’”
Digitizing Securitizations
Asset-backed securitizations have become a common method for capital access in the equipment finance space in recent years. How will digitization impact this process?
“We believe that securitization will see a lot of innovation in the next few years,” Nelson says. “The increased parameterization of deals, i.e., gathering much more data on the deal at origination as well as through the life of the lease, will make bundling of ‘like’ deals easier and more diverse. The number of securitized bundles can increase because of the precision of the bundling process driven by data.
Similar to the way securities are grouped by risk in portfolios, such as an ‘Efficient Frontier’ approach, Nelson says financing products can be categorized and grouped into portfolios that have a range of risks delivering a given return more safely than a portfolio with all the same perceived level of risk.
“The digital chattel paper and the digital servicing platform concept we are developing at QuickFi could really accelerate and simplify the securitization process,” Verhelle says, noting that the output of the QuickFi platform, digital chattel paper, can be moved from the originator’s vault to the securitization SPV vault in minutes, and the servicing and reporting for the securitization SPV can continue on the QuickFi platform. Verhelle says the same is true for portfolio sales from an originator to a bank or other purchaser of digital chattel paper.
Creating a Winning Strategy
Given the uncertainty of the future, how can equipment finance companies create a strategy that will ensure their success for decades to come? Fate provides several suggestions:
Hire and train the best talent in financial services. Senior leadership should proactively transfer knowledge gained through decades of experience and empower their younger talent to bring new ideas, technology and strategies to the organization.
Ensure the right side of your balance sheet properly supports the diverse assets being originated. A strategy lacking appropriate capital to support its originations isn’t sustainable.
Do things differently and better than your contemporaries. Think about the market, assets, risk and opportunities uniquely and creatively. Create value in ways others cannot or are unable to due to the current regulatory environment. In so doing, the capital provided is more than a commodity and creates greater value for all.
Stay true to historically successful strategy while being nimble and open to opportunity. Be attentive to new market opportunities for growth, optimization, efficiency and a stronger client experience.
Take every meeting. Listen closely to prospects, clients, competitors, advisors and other centers of influence. Learn from them. Stay close to the market and then stay ahead of it.
Nelson shares his suggestions for ensuring consistent success:
Rita E. Garwood is editor in chief of Monitor.
