Don Cosenza,
Chief Marketing Officer,
North Mill Equipment Finance

As the chief marketing officer of a broker centric, private lender, one of the most satisfying elements of my job is speaking to those with whom we rely on to drive originations — our team of referral agents. During my 10 years at North Mill Equipment Finance (NMEF), I’ve engaged in dialogue on everything from the state of our industry to the versatility of a Kubota tractor loader backhoe. As of late, a topic that garners plenty of interest is broker discounting — its definition, how it works, the benefits and who is eligible.

Surprisingly, there are industry veterans who have little interest in the subject. But, there are also those who are well-versed on how advantageous a discounting relationship can be for the experienced brokerage willing to invest the time, technology and human resources required for success.

THE BASICS — PRESENT VALUE

As we plunge into the subject, the natural first step is to address the concept that discounting is founded on — the time value of money (TVM). A core principle of finance, TVM, also referred to as present value (PV), notes that a sum of money is worth more now than the same sum will be worth in the future. Why? Because the money you have today can be invested to earn a positive rate of return, producing more money tomorrow.

Closely related to PV is its sister term, future value. As the term implies, future value tells you how much a sum of money will be worth in the future. For example, let’s say I want to calculate how much $100 will be worth a year from now if I invest it at a 20% annual return. I multiply $100 by 1.2 and arrive at $120. In other words, the future value of $100 at a 20% annual rate of return is $120.

Conversely, how much money do I invest today to achieve $120 one year from now at an expected 20% annual return? To solve, I go backwards. If I know that, in a year, I will have $120 given an annual rate of return of 20%, and I want the current, or present, value of that sum, I reverse the logic and divide by the rate of return. In effect, I’m ‘discounting’ back the $120 to its current value.

Meanwhile, taking it a step further, net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. While present value tells you what you’d need in today’s dollars to earn a specific amount in the future, net present value is used to determine how profitable an investment may be. While PV and NPV both use a form of discounting to estimate the current value of future income, these calculations differ in an important way. The NPV formula also accounts for the initial capital outlay required to fund an investment. We’ll see how this plays out in a broker-lender discounting relationship.

Understandably, since the value of revenue earned today is higher than revenue earned down the road, businesses discount future income by the investment’s expected rate of return. This rate, called the hurdle rate, is the minimum rate of return an investment must generate for a business to consider it a viable venture. This is an important concept to the lender that buys a stream of payments from its broker.

DISCOUNTING — WHAT DOES IT ALL MEAN?

As an equipment finance broker, there’s a good chance that many of the relationships you have with your lenders are based on a standard, straightforward process of deal submission. By definition, you broker transactions by bringing together customer with lender. You vet the borrower, package the deal and submit the paperwork to the finance company willing to fund the deal based on its business model, the transaction and its credit parameters and equipment guidelines.

There are plenty of referral agents, however, who have taken a giant leap forward by expanding their business models through the establishment of a discounting relationship with at least one lender. Indeed, discounting opens up a whole new world for the broker willing to make the investment necessary to be a successful partner. True, it’s a more complex, labor-intensive process, but the benefits for broker and lender alike far outweigh the added workload.

START WITH THE “TRADITIONAL” RELATIONSHIP

Let’s take a moment to review the various tasks associated with closing an equipment finance deal through, for purposes of comparison, a ‘traditional’ broker-lender relationship. What changes with discounting is not the tasks themselves, but which party performs them. At NMEF, we have three types of referral partner relationships: silver, gold and platinum. The latter two offer various forms of discounting, while the first represents a standard, traditional relationship. In this case, partners perform all the pre-work associated with prepping a deal for submission. They vet the borrower, assess the equipment, package the deal and submit through NMEF’s broker portal.

In most traditional relationships, the lion’s share of your job as an equipment finance broker is done after you submit the deal. Once in the hands of the lender, the deal flows through the adjudication process. The lender executes background checks, analyzes financials, assesses risk and prices the deal accordingly, issues documents and, assuming all open items are addressed, provides an approval. Once you sell your client on the structure and rate, you sit tight until the vendor and borrower are paid and you receive your commission.

Then there’s the world of discounting.

WHAT IS DISCOUNTING?

It’s time to harken back to the concept of present value, as a discounted deal is handled differently. While each lender has its own unique style and requirements associated with discounting, by and large, there are some common elements that transcend lender individuality. For instance, many of the tasks that are performed by the lender in a traditional relationship are now performed by the discounting broker.

As mentioned, NMEF offers two types of discounting relationships — gold and platinum. The platinum program is unique to NMEF in that we allow the broker to underwrite the transaction based on our pre-approved credit criteria. As such, platinum brokers take center stage and own the processing of the transaction from deal inception. The broker reviews and underwrites the deal based on the credit and equipment guidelines provided by NMEF. These guidelines are quite specific and comprise everything that the company’s silver pricing scheme includes, e.g., minimum percentage of revolver availability, minimum number of years of industry experience and time in business, FICO ranges and so forth.

Platinum discounters use “white label,” or pre-approved, brokerage-branded documents that they forward to the customer. One of the last steps is to send the credit or funding package back to NMEF for final review and funding. Once approved, depending on the way the program is set up, the broker may issue payments directly to the vendor.

It is at this stage that the notion of discounting kicks in. Essentially, after paying the vendor and borrower, the broker has funded the deal. It was priced based on an agreed-upon rate with NMEF, and now the stream of monthly payments is discounted back to us based on the net present value of those payments.

THE BENEFITS

There are several benefits for brokers who enter into a discounting relationship with a lender. Three that rise to the top are control, efficiency and, most notably, economics.

Brokers who discount have greater control of a deal, and with more control comes greater efficiency. Control comes in different flavors. For example, some lenders offer the option for the broker to use pre-approved documents on their own letterhead. This sends a powerful message to the borrower about who “owns” the transaction. Moreover, given that discounting brokers may handle elements of the adjudication process that are typically managed by the funder, they move at their own pace. They file UCCs, complete the paperwork, address open items, perform the verbal agreement and fund the vendor and the borrower according to their capabilities and timeframe.

Another example of control is seizing the deal. “One of the most important things I can do is to take my deal off the street,” Michael Hong, president of Taycor Financial in El Segundo, California, says. “Given my platinum status with NMEF, I’m well-versed on the company’s credit and pricing parameters. I have a good idea not only whether a deal will be approved, but how it will be structured and priced. That gives me a competitive advantage of meeting my customer’s needs and closing the deal much earlier in the process.”

In addition to expanded control, a key benefit is based on revenue. Discounted deals, by and large, are more profitable than traditional transactions for the broker. Typically, a discounting broker may add a few additional line items to their compensation per transaction in addition to keeping a few points on the deal as standard commission. Some lenders let referral partners add their own fees to the transaction, baking them into the monthly stream of payments. Through NMEF’s platinum program, for example, discounters can add their own documentation fee, thus adding another line item of revenue to their payout.

The most profitable component comprising the broker’s compensation, at least with NMEF’s gold and platinum programs, comes from advance payments. One or two monthly payments from the borrower, and kept by the broker, could potentially double the compensatory pot. Assume an invoice of $500,000 at a buy rate of 12.5% over a 60-month term with a commission of 10%. If the broker opts for two advance payments, those alone boost total compensation by an additional $25,000. Compensation is increased even further with the addition of a documentation fee and interim interest, if it is charged. Again, this is above and beyond any ‘traditional’ commission that’s baked into the deal. It’s worth noting that the advance payments that are kept by the referral agent are not included in the discounted stream of payments back to NMEF.

According to Mitch Tobak, CLFP, vice president of corporate development at NMEF, another key benefit of discounting is prepping the business for future growth, thus expanding beyond the world of brokering. “Entering into a discount relationship with a funder is the start of a seamless transition for the referral agent looking to become a balance sheet lender in his or her own right,” Tobak says. Strengthening relationships with bank partners can make all the difference in the world for a brokerage looking to expand its business model, footprint and customer base.

A WINNING PROPOSITION

In a well-run discount program, winners abound. For the brokerage, there’s an opportunity to gain more control, strengthen its brand within its customer base and bolster its compensation. The lender running the discount program also benefits. •

Don Cosenza, CLFP is chief marketing officer of North Mill Equipment Finance.