When the equipment leasing industry was created, leasing was the go-to product. But as time went on, the industry morphed into a subset of secured lending. Paul Bent explores the cycles of the industry and says as market conditions shift, the old roots of yesteryear may be giving rise to a new generation of lessors.
Paul Bent, Senior Managing Director, The Alta Group
“You really should get one of these new data processing machines for your business. You can keep track of payroll, account for time, manage inventory — lots of things you do now by hand. And you can get a DP machine with more than eight megabytes of memory, with four 250-megabyte hard disk drives, and with six magnetic tape drives for long-term information storage (all of which will fit into only 2,000 square feet of your existing office space) for a price of just under $1 million. Oh, and if you can’t afford to pay in cash for all this equipment we can provide an exciting new way of financing for you — it’s called an equipment lease, which allows you to pay for all this over three full years while you’re actually using the system — and we’ll come and get the equipment when you’re finished with it, or even better, we may let you extend the lease or upgrade to a newer model.”
This is a sales pitch you would have heard in the 1970s, when computers represented a major new investment for businesses, and equipment leasing was still a novel way of financing the acquisition of these marvelous (but expensive) new machines. What was the appeal of leasing? Well, pretty much the same things that appeal to customers today — with one major exception. Customers were drawn to equipment leasing because they could:
Acquire equipment with no money down because leasing companies were willing to take some risk on recovering the leased equipment in the event of a payment default.
Get lower monthly payments because leasing companies were counting on achieving a certain “residual value” at the end of the lease.
“Walk away” from some leases (usually for a modest “termination fee”) when they were finished with the equipment or it became surplus to their needs because leasing companies often specialized and made a market in specific types of assets, such as computers (or “data processing equipment” as they were known then). Leasing companies could sell it or lease it to other lessees and make the original deal economics work out.
Benefit from the income tax treatment available to equipment owners, particularly a fixed 10% investment tax credit, because leasing companies would often share some portion of this “discount” in the form of lower monthly rent.
Of course, this last item is the major exception in today’s leasing world. The 1970s and 80s versions of the ITC went the way of the dodo bird when the 1986 Internal Revenue Code was enacted (although some forms of credit are still available to lessors on certain specific classes of assets, notably alternative energy generation equipment). The extinction of a generalized 10% ITC, when combined with gradual but significant changes in worldwide accounting rules —particularly the elimination of so-called leveraged leasing, which had allowed lessors to leverage their investments without recourse to participating lenders — contributed greatly to the industry’s gradual shift away from the risk-taking, equipment-centric ways of the 1970s.
Lessors or Bankers?
In short, the equipment leasing industry over time took on a lot of the airs of . . . well, banking. Rather than thinking in terms of equipment, equipment values, equipment refurbishment, equipment sales and specialized equipment markets, a large portion of the industry seems to have morphed into thinking primarily in terms of syndication opportunities, borrowing rates, credit methodologies, funding cost, securitization implications and such. Actual equipment sometimes feels like an afterthought — the collateral that you’ve got to have, but you hope you never really have to deal with.
The slow but inexorable trend toward becoming secured lenders rather than actual lessors has of course been energized in large part by the acquisition (or formation) of leasing units by many major banks. The culture of banking has slowly become part of the leasing culture as well. (It must be noted that one of the original large leasing companies in the U.S. was indeed owned — and funded — by one of the largest banks in the country. But the focus of BankAmerilease could even then be said to be more on funding than on equipment per se.) The current widespread use of Equipment Finance Agreements (EFAs), Conditional Sales Agreements (CSAs), $1-out “leases,” and other forms of full-payout financing structures, particularly in the small- to middle-market space, is a testament to the transition away from the industry’s original focus on equipment and toward the business of simply lending money.
The Fruits of Rich Soil
But old roots, while lying dormant, may often sprout new life when the soil is rich enough and the prevailing conditions allow for their shoots to grow and flourish. In addition to the more recent upward creep of interest rates and the consequent upward cost of bank financing, which potentially provide leasing with a bit of market advantage, other elements may be pumping nutrients into the non-bank loam, as well.
Technology, for example, is becoming more sophisticated, more broadly capable and much more functional in our industry — not just in transaction management, not just in credit scoring and decisioning, not just in documentation, but also in actual transaction structuring, organizing and enforcement. Electronic signatures and contract execution are already becoming nearly universal, and widespread electronic contracts, automated security interest filing and management, and actual real-time deal administration, through blockchain and so-called smart contracts, are on the near-term horizon. Artificial intelligence, as ill-defined as that term is now, is expected to play a more and more important role in decision making, pricing, and deal structuring — and perhaps even in asset acquisition and deal negotiations. All these aspects of technology are making equipment leasing and financing more widely available and more efficient.
More importantly, they are serving to make leasing (as a non-capitalized form of acquisition funding) applicable to an increasingly wide range of “financeable” assets. These include not only computer software and repair services but also service agreements of all kinds, industrial processes, manufacturing systems, autonomous motor vehicles and transportation services, and the entire gamut of Industry 4.0 products, services and capabilities incorporating expanding IoT functionality — the age of “Almost-Anything-as-a-Service.”
A growing proportion of these emerging developments in industry, leisure and everyday living is outside the traditional realm of banking and bankable equipment and assets. They do not provide the forms of collateral security that have historically been acceptable to banks and traditional lending institutions. But they are acceptable to a new and emerging breed of leasing companies and providers of integrated services and the professionals who run them — financing companies that depend upon the continuing consumption of services and payment of subscription fees rather than traditional hell-or-high-water lease or loan payments. These newer leasing companies are the progeny of the entrepreneurial founders of the equipment leasing industry, and they reflect a return to the roots of customer service and financing solutions tailored to customer needs while moving away from bank-style lending and processes.
It will be exciting to see how the next generation of “leasing” leaders continue this trend away from practices and forms utilized by a generation of largely full-payout capitalized financing practitioners and into the new world of services-based and subscription-based models that depend upon the underlying assets and customer services for their support — new ideas sprouting from the roots of our industry in years gone by.
The opinions expressed in this essay are those of the author and do not necessarily reflect those of The Alta Group or any other party.
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