Leasing as a Bank Product: Enhancing Profits and Customer Relationships
by Bill Bosco July/August 2018
Banks have been jumping into the equipment finance business and now have the largest share of the market. But many banks have yet to take this vital step. With newcomers in mind, Bill Bosco covers the basics of incorporating a lease product business unit into a larger bank organization.
Bill Bosco, Principal, Leasing 101
The lease product meshes well with commercial banks as it can provide financing for assets existing customers use in their business and point of sale financing for products these customers sell.
To finance the equipment customers use in their business, the bank typically sets up a direct business (sales force) to call on customers. The operating lease — structured as either a tax or synthetic lease — is the primary product needed, with loans or capital leases required on occasion. My former employer had a revolving master lease line product, which worked well with bank clients as the relationship unit provided the credit sign-off. These lines were typically used to finance non-core assets like PCs, cars, trucks and office equipment. We also had large-ticket structured finance capability for equipment and real estate leases.
To finance the assets bank customers sell, the leasing company typically sets up an indirect business, meaning the end-user lease and loan business comes indirectly from the customer’s relationships. The leasing unit sales force calls on manufacturer vendors, captive finance companies and dealers and sets up finance programs. When client companies have their own sales force, the program provides a lease alternative at the point of sale executed by the bank lessor’s staff. For customers selling through a dealer network, the bank lessor’s sales staff works on the end-user retail deals resulting from the customer’s sales. Wholesale products include working capital and floor plan financing for dealers and portfolio financing for captive finance companies and dealers that complete their own financing transactions with end-users. Retail products include operating leases (tax leases, Split-TRAC leases and synthetic leases), capital leases, CSAs/loans and municipal/tax exempt leases. A bank must be prepared to offer all options or risk losing the relationship.
Some bank leasing companies do business with non-bank customers, but, in my experience, this strategy has many pitfalls and leads to spotty results.
Working with Parent Bank Sales Organizations
The business side must work closely with the relationship units. Our leasing salespeople got to know their counterpart relationship managers in their assigned industry. The leasing sales team also learned about assets types most commonly used by customers in their industry segments and became industry experts. The relationship managers must understand which products the leasing company offers and how they work for the customer’s benefit. This can be accomplished with product knowledge conferences or product presentations at relationship unit meetings.
I developed a “Why Customers Lease” presentation for relationship mangers and also communicated information via newsletters. The newsletters highlighted successful transactions to demonstrate how the lease product helped customers and focused on new products or tax and accounting changes which would affect customers and the lease product.
Description: Operating lease financing of a $25,000,000 standalone retail store. The store was to be constructed on land owned by the customer with the customer managing the construction project.
Customer needs: Customer wanted 100% off balance sheet operating lease financing with low cost LIBOR based pricing and level “interest only” rents. Customer wanted the right to buy the asset at the end of the lease for a fixed price.
Solution: We executed a “build-to-suit” leveraged synthetic lease.
Structure/Terms: Five year synthetic lease with monthly interest only rents. Fixed price purchase option at expiry set at original cost. Renewal can be arranged based on market rates/conditions. TRAC-like provision at expiry allowing the customer to return the asset with any upside on sale but with a capped residual guarantee if sold for less than cost. Customer’s line banks participate as low cost senior lenders. We provided the “equity” which represents the residual risk.
Liquidity: 100% financing, interest only rents
Low cost: Senior debt priced reflecting customer credit, off balance sheet frees up costly capital
Financial ratios/measures: interest only rent expense replaces depreciation and interest in ownership financed with a mortgage. EPS/ROA improve due to off-balance sheet structure
Control of Property: Customer can buy at fixed price or negotiate a renewal.
Timely newsletter topics include the Tax Reform Act, how leasing may be better than borrowing, the implications of impending lease accounting changes and why the reasons to lease remain strong.
These newsletters can be modified for distribution to bank customers. The goal of these communications is to help relationship managers recognize opportunities with clients as they review new projects and financing needs and set up calls for leasing sales staff if an opportunity arises.
The leasing company may have to research the bank client list to identify where opportunities lie. Look at the operating lease commitments footnote to determine how much leasing the bank clients actually did, since many relationship managers claim their customers do not lease. To estimate a prospect’s amount of equipment leases, make an educated guess on the amount of real estate leases and back them out. Once prospects are identified, ask the relationship managers to set up calls.
Participating in the relationship units’ annual planning meetings is vital. Use these opportunities to present successful transactions and new product ideas and review issues like tax reform and accounting changes. Establish joint goals for number of calls and new business volume, which trickle down to the individual relationship managers and lease sales staff. Reporting lease balances and revenues in the management accounting results at the relationship unit, leasing product and customer level is also important. Each deal must be tagged in the leasing unit accounting system to allow for this double reporting of financial results.
You Should Know
The Tax Reform Act of 2017 impacts asset finance strategies
Key issues in tax reform impacting the quantitative lease vs buy calculation:
IRS tax rate drops from 35% to 21% 100% immediate depreciable asset write off (100% bonus MACRS) Interest expense deduction capped at 30% of adjusted taxable income Rent fully deductible NOLs cannot be carried back NOLs have no expiration date NOL utilization limited to 80% of taxable income
Lease Structuring Opportunities:
For companies with NOL/interest deduction issues: Tax leases and TRAC leases structured as operating leases are favorable as the lessor takes the MACRS deductions and the rent, as opposed to interest cost, is fully deductible. The leases can be structured with fixed price purchase options which fix the cost similar to a loan financing. The off balance sheet structure frees up costly capital
For companies with no NOL/interest deduction issues: Synthetic operating leases are favorable as the asset and liability are off balance sheet yet the lessee/customer take the MACRS and interest deductions. The off balance sheet structure frees up costly capital.
When working with other units in the bank, keep the big picture in mind over individual unit results and individual salesperson compensation. Getting this right is difficult. Supporting vendor business internationally can be tricky when you depend on the bank’s organization in another country to service the deals. Vendor customers want to include their foreign business under the same program arrangement as their U.S. business. The international volumes are often low, so the bank must accept lower returns in the individual country profit reports servicing a client while the same client’s overall profitability across the bank is good.
Another problem area is cross selling, which seems to be the Holy Grail in big banks with multiple businesses. Two issues thwart success. The first is incentive compensation and commissions for the referring unit salesperson. They need motivation to work on a referral at the expense of spending time selling their prime product. In my experience, the commission most salespeople demand is too high. If the leasing business pays it in cash, the transaction, net of the fee paid, is not profitable. The solution is to make cross selling a goal with no commission and to link cross selling target achievement to raises and discretionary bonuses. Having management establish a process to report assets and revenue in both the leasing product and bank relationship unit’s management accounting reports is also essential. The second issue is the low volume and small-ticket size of commonly leased equipment where the competition is often from another leasing company’s vendor/dealer leasing business. Unless you are leasing larger-ticket non-core assets, the margins will be low, and the operating costs will be high.
Working with the Bank’s Internal Units
When you offer tax lease and tax exempt municipal lease products, getting the process right is vital to ensure the bank realizes the profits you priced and the leasing unit receives the right tax-affected financial reporting. With true leases, work with the tax department to obtain an allocation of tax shelter to ensure the bank’s tax plan has the profits to shelter. Typically, the bank files a consolidated tax return in which the leasing subsidiary creates a tax shelter for the good of the whole. Work out the process of intercompany tax payments and reporting of tax balances among the bank’s legal entities so the leasing company is paid for the current tax shelter created in the form of deferred tax balances.
Deferred tax balances should be credited to the leasing business as an interest-free source of funding its portfolio in management accounting profit reports. Current tax balances are often debit balances (receivables from the IRS) and should be allocated to the tax department or a headquarters expense code as these could be called assets of the leasing unit and hurt returns. An approach is to classify current tax balances as intercompany accounts, which are usually ignored in management accounting. Get the right composite tax rates from the tax department to use for pricing. Each legal entity in which the tax lease business is booked has its own unique composite tax rate due to tax ramifications from the states in which they do business.
For tax exempt municipal business, the rules regarding tax exempt income are complex. Managing the IRS de minimis limits imposed on a subsidiary by subsidiary basis is necessary. To maximize business, it may be necessary to use other bank subsidiaries with sizable asset bases as booking vehicles. Work with the tax department and staff of other bank subsidiaries on process and compliance issues. The tax department’s input on the tax rate to use is vital for pricing municipal leases.
The leasing business has evolved, and bank-owned leasing companies have the largest share of the market. Bank customer relations introduce the leasing product to customers, and banks have a low cost of funds compared to independents. Independents may be more nimble, but their entrepreneurial spirit and willingness to take risks are difficult to blend with a bank culture. Success in bank leasing is achieved by focusing on the good of the organization, maintaining profitable customer relationships and incorporating necessary risk-taking aspects of the leasing product into the bank’s risk management process. The devil is in the details of execution in delivering the lease — possibly the most complex bank product — to customers across a complex organization.
Kenneth P. Weinberg,
Baker, Donelson, Bearman, Caldwell & Berkowitz
Usury laws vary from state to state, which can make a lease or loan more complicated when the lessor is in one state and the lessee in another. Kenneth Weinberg discusses how this has played out so far in the courts, with favorable rulings for a lessor often depending not only on who files first, but where they file from.
Brokerage, like many financial and professional services, has changed over the years, with the rise of digital innovations, ease-of-use communications and new products on offer through the leasing industry. But for those just starting out, sometimes the old-fashioned way of growing a business is still best, as Bob Bell explains.