Evolve, Grow & Adapt

by Lisa Levine June 2007
Each year, the Equipment Leasing & Finance Foundation’s Industry Future Council (IFC) meets to discuss and deliberate the future of the equipment finance industry over the next five years. Their discussion addresses trends, market conditions and potential economic indicators that affect and potentially will “drive” the equipment finance industry in the near- to mid-term.

The IFC is comprised of more than 20 executives from independent and captive leasing and finance companies, banks, financial services corporations, broker/packagers and investment banks, as well as industry analysts, rating agency personnel and service providers.

The IFC’s conclusions are then extrapolated into the IFC Report. In addition to presenting the IFC’s findings, the report serves as a positioning and planning “workbook,” but more on that later. Designed to be a strategic planning tool for equipment leasing and finance companies, the IFC reaches a broader audience, including Wall Street analysts, funding sources and other interested parties.

The 2007 IFC looked out on an industry that has changed a great deal in the past few years, and will continue changing for the foreseeable future. Here are just a few of the issues the IFC tackled.

A Repositioned Industry
To begin the 26th annual IFC meeting, the council held a lengthy discussion on the repositioning of the industry. Not too long ago, a leasing company simply wrote leases on equipment. The lease was a singular product that could be tailored to offer customers unique benefits. But leasing became commoditized with more companies offering similar lease products. Customers became more sophisticated, demanding more than just a lease on equipment, while tax and accounting regulations threatened to strip the lease of some of its advantages.

Today — and likely for the foreseeable future — lessors provide a plethora of financing options, as evidenced last year when the Equipment Leasing Association (ELA) renamed itself to the Equipment Leasing & Finance Association (ELFA). According to ELFA’s 2006 Survey of Industry Activity, two-thirds of the new business volume reported by respondents is made up of non-lease financial products. This changing mix between leases and loan-like financing offered by companies in the market caused the IFC to focus on the associated evolution of the traditional drivers of the broader industry.

Not only are the industry’s product offerings different, so are the companies doing the offering. The IFC discussed the evolution of the “traditional” player within the industry. Generally, IFC members agreed that industry players can still be identified as either “bank,” “captive” or “independent,” but they also agreed that independents could be further divided into two sub-categories:

  • Large, diversified, well-funded financial services companies that generally originate, buy and hold a portfolio, or
  • Privately held, smaller companies that typically focus on organization.

The major new entrant in the market — and the one the IFC believes this industry should watch closely, are hedge funds and private equity firms. These industry rookies tend to be savvy and creative, and one IFC member suggested, “Perhaps what these investors see is an opportunity to build around or to aggregate things that in total may be worth more than their individual parts.”

An example of this was recently announced: According to The Wall Street Journal, private-equity firm Cerberus won the bidding to buy automaker Chrysler Group from DaimlerChrysler. Cerberus, which owns 51% of GMAC, the financing unit of General Motors Corp., would probably slash costs by combining GMAC with Chrysler Financial, The Journal reported.

The IFC suggested it’s important to become familiar with these new players and their product offerings, to try to understand their motivation. The actions of the hedge funds and private equity firms may signal changes in the direction or momentum of the market.

Growing Dependence on Fees
Related to the “…and finance” issue is a growing trend to add soft costs to a transaction. In many cases, customers demand that soft costs (costs for services, for example) be “bundled” into equipment finance transactions. But equipment finance companies are coming to depend on those costs as a revenue stream, and likely will as long as the margins on leasing and lending transactions continue to be squeezed by the abundance of capital in the market. This dependence on fees is leading some to offer new products very different from their core competencies and perhaps exposing them to risk they’re unused to taking.

The IFC recommends companies review their product offerings and carefully weigh the pros and cons when making decisions on adding new products. They should have a mechanism in place to identify impending corrections, have an exit model and be prepared to act quickly in the event of a market correction. Discipline is key!

Diffusion of Risk
While the IFC did talk of a potential economic “correction” to the broader U.S. economy, and its probable implications for the equipment leasing and finance industry, the IFC members also pondered a new factor, which could affect the dynamics of such a correction — the diffusion of risk. The increasing use of derivatives, particularly in the credit-default sway market, along with syndication, has changed the fundamental management of risk.

A credit default swap (CDS) is a privately negotiated bilateral contract that acts as a kind of insurance against credit risk. The largest players in the CDS market are commercial banks. Traditionally, a bank’s business has involved credit risk as it originates loans to corporations. The CDS market offers a bank an attractive way to transfer risk without removing assets from its balance sheet and without involving borrowers. Further, a bank may use these swaps to diversify its portfolio, which often is concentrated in certain industries or geographic areas.

With an estimated size of between $28 trillion and $30 trillion globally, the rapid growth of the CDS market has surprised industry analysts and government regulators, who have had difficulty developing a system to track deals.

While spreading risk around may ultimately be good for equipment leasing and finance companies, the IFC identified a downside: risk is being distributed so broadly into the market that it may even be difficult to identify where the ultimate risk resides when a classic “work out “ is required with a customer. As lessors, it’s important to know who holds the risk in each deal and to know if you are being compensated for the risk you hold.

People Problems
Appropriately for a meeting that stresses the future, the IFC took a hard look at the “graying” of the industry and the difficulty in identifying and hiring personnel with the potential to be tomorrow’s leaders. As the baby boomer generation begins to retire, this industry will be hit with a “brain drain” without a strong bench of smart, experienced young executives waiting to step into leadership positions. Currently, young business school graduates are gravitating toward the “cool” Wall Street investment banking firms, with their publicly promoted large bonuses and high visibility.

IFC members believe that the answer is to make equipment leasing and finance cool again and to present this graying of industry leadership as an opportunity. Now more than ever, employers must be flexible and provide growth opportunities for their employees. They should emphasize that college graduates entering this industry will acquire experience in selling, negotiation and structuring transactions. And they should stress the rapid growth and appetite for acquisition of many industry companies, which in turn will create more opportunities for finance professionals.

How to Plan Your Future
As mentioned earlier, the IFC Report serves as a strategic planning workbook for equipment leasing and finance executives. It includes many questions on a variety of trends and issues that companies must ask themselves in order to position themselves for success over the next five years. The following is a summary of the general drivers that spur those questions:

  • “Leasing” and “financing” have become less differentiated, as indicated by the broader umbrella defining “the industry.”
  • Contemporary “lease” structures may present a more challenging risk-adjusted return profile than in the past.
  • The market is being defined by customer-driven product design and terms.
  • The mix of equipment, soft costs and services in “solution-type” financing continues to evolve.
  • Plentiful capital and recent loss experience have compressed margins overall and narrowed credit spreads.
  • Risk is being diffused, packaged and dispersed through capital markets.
  • The distribution of risk may present different challenges for workout and recovery processes.
  • If historical cycles are predictors of the future, current conditions suggest a “correction” ahead.
  • The timing and intensity of a correction remains uncertain; predictive indicators may come from other industries.
  • Previous cycles may not be accurate predictors of the “peaks and valleys” of future cycles.
  • New entrants suggest a continuing, robust industry, but new forms of value creation may be motivating their interest.
  • The U.S. domestic marketplace is increasingly affected by international standards and influences.
  • The ability to attract, motivate and retain new talent will depend on psychic, as well as financial, rewards.

Despite, or perhaps motivated by, ever-changing tax, accounting and financial variables, the equipment leasing and finance industry continues to evolve, grow and adapt. When the 2012 IFC looks back, the shape of the 2007 leasing and finance industry will look like what it really is — a step on a path leading in directions no one can today predict. But we can make one prediction: those 2012 IFC members will be those who were best informed, most adaptive and cleverly responsive “back” in 2007.

The 2007 IFC Report is sponsored by American Lease Insurance and International Decision Systems and is available through the foundation website, http://www.leasefoundation.org/IndRsrcs/IFC/2007. Foundation donors receive the report free of charge. It is $200 for non-foundation donors.


Lisa Levine HeadshotLisa Levine, CAE, is executive director of the Equipment Leasing & Finance Foundation. The foundation is the non-profit organization providing vision for the industry through development of future-focused information and research. Supported entirely through donations, the foundation is dedicated to development of future-oriented, in-depth, independent research for the equipment financing industry and industry partners.

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