Raising the Bar: Are You Prepared for a New Year of Risk?
by Paul Bent and Joe Nachbin January/February 2019
Paul Bent and Joe Nachbin of The Alta Group take a long view of the coming year, assessing the risks that the industry will have to address and giving some advice on how to do so.
As we welcome in the new year of 2019, we are excited about new opportunities, new business prospects and a fresh look at how to achieve success in our business lives. But we would all be well advised to consider, in addition to the promises of the new year, what new and continuing risks may lie ahead for the equipment leasing community.
There are some areas of risk that simply cannot be avoided — risks that affect many sectors of the U.S. economy and markets, including equipment leasing and finance. Perhaps highest on a list of the most immediate of these concerns is the outcome of potential trade wars between the U.S. and other countries, notably China. If your primary customer base relies heavily on international imports of equipment, machinery or durable goods you are no doubt concerned about the impact of higher tariffs, duties, and cross-border taxes on your customers’ willingness to acquire greater volumes of assets. And even if you are not affected directly by cross-border matters, the indirect effects on the U.S. supply chain and the overall market pricing of asset financing and financial products is something you still must consider in this context.
The overall state of the U.S. economy must also be closely watched, regardless of your specific industry or customer relationships, because credit underwriting guidelines and your ability to find funding for transactions will certainly be affected (whether directly or indirectly) by any overall slowdown or speedup of the economy. Although some industries and market sectors will undoubtedly be affected more than others by the state of the economy (and by the reasons for any change, whether positive or negative), there is little doubt that the health of the equipment leasing industry generally will reflect the state of the country’s overall economic wellbeing. Staying well informed and a step ahead of shifts in this volatile financial market would be a good course of action for the coming year.
UNPREDICTABLE SHIFTS IN COST OF FUNDS
With continuing uncertainty about potential changes in reference interest rates in the U.S. and globally, careful and informed reviews of potential funding alternatives and pricing are also in order. If it seems that interest rates are likely to continue rising, is this a good time to focus on securitization of receivables and other vehicles by which current long-term rates may be locked in for future funding? Conversely, if it appears that rates are likely to continue fluctuating in the near term, should floating rate funding vehicles (and perhaps even floating rate customer transactions) be instituted as a way to hedge both your revenue streams and your funding costs?
Prudent lessors and financing companies may also have to consider establishing or readjusting separate credit underwriting guidelines and pricing structures for separate industry lines of business or product offerings. Disruptions and unforeseen changes in costs and availability of funds may affect different industries and customers differently (and perhaps unexpectedly) from one another. Such differentiation of pricing and credit issues may provide the hedge necessary for a lessor to maintain margins in one product area while adjusting for surprising fluctuations in another.
As we all watch for signs of possible major changes in costs of funding, it will be very important to consider all methods of counterbalancing your margins and returns with your costs of funding and holding assets.
ONGOING LEGISLATIVE CHANGES
Keeping an eye on state and federal legislative activity has always been a wise course of action; and in the coming year it may be more essential than ever. Continuing legislative changes in the U.S. Tax Code and consequent regulatory pronouncements and requirements following 2017’s tax overhaul will require on-going vigilance in transaction pricing, documentation and even sales practices, as customers will be asking more questions and demanding more accommodations from financing companies in an effort to cope with their own tax issues. Changes in healthcare laws and regulations, for example, may have ripple effects on reimbursements and insurance benefits that could drive spending decisions and leasing and loan pricing and terms. Frequent changes in reimbursement rates and insurance coverage available from third party payors could also greatly affect your customers’ need for and usage of medical equipment, facilities and valuations.
Likewise, certain high tax state and local laws and regulations are expected to be modified to account for reductions in the deductibility of state and local taxes (SALT) against income in calculating federal income tax obligations. Customers and lessees may determine to postpone or modify their equipment acquisition requirements in the hope that new tax treatments or accompanying regulations will at some future time help to alleviate this additional burden; or, perhaps equally likely, lessors may find that the fear of these additional income taxes could help induce customers to consider leasing as a beneficial economic alternative in their acquisition strategies.
In any event, lessors and lenders must remain informed and aware of all the possibilities and variations in customer behavior (and in their own planning) that may result from continuing legislative and regulatory changes. They must accordingly be prepared to adjust pricing and respond to customer expectations if they hope to maintain adequate margins and realize on all available opportunities in the coming uncertain times of 2019.
NEW FORMS OF COMPETITION
Perhaps one of the most important risks facing traditional equipment leasing and finance companies in the coming year is in the form of so-called fintech providers — leasing and finance companies operating with minimal overhead and streamlined underwriting, documentation, and funding processes, using highly automated methods. Although computerized credit scoring and documentation procedures are not brand new, they are becoming more prevalent throughout the industry. Traditional funding companies are well advised to learn more about their competitors in this area and to begin (if they haven’t done so already) to adopt practices and policies that are designed to remain competitive in pricing and servicing.
While fintech providers have so far been operating largely in the small ticket and middle market segments of the industry, their methods and practices may be expected to be adapted to large and more complex transactions as technology advances and demands grow among more sophisticated users and customers. And in the event of any major upheaval in the larger economy, companies which have integrated such methods into their systems and processes may find themselves more adaptable to change by employing more automation and lower operating costs overall.
On the other hand, the pricing and underwriting policies and practices in the fintech world have yet to be tested in the winds and waves of a true economic downturn. Lessors who adopt the new technologies and methods of fintech would be well advised to stress test their underwriting and pricing tools to provide some assurance of their stamina and robustness in the face of potential recessionary and sub-optimal economic, funding and market conditions.
OF COURSE, THERE’S OPPORTUNITY, TOO
If the U.S. economy remains relatively stable and if international trade in durable goods is not badly disrupted through taxation and high tariffs, there will be lots of opportunity for lessors and lenders. Many customers and potential lessees have been holding off on large scale acquisitions while they assess the economic landscape. If the economy holds in a reasonably strong growth mode in the near term, the coming year may prove to be a good one for growth in financing of those long-awaited assets.
THE KEY: FLEXIBILITY
Whatever happens in 2019, lessors and financing companies that remain flexible and well informed about economic, tax, regulatory and trade issues will be well served by their continuing review of the markets, and the development of methods and practices which allow them to react quickly to changes. Foreseeing risk and preparing alternatives in advance for dealing with a variety of economic and market scenarios will prepare you for whatever comes your way in the new year.
Some sales tax concepts for the leasing industry are simple; others are more complicated. Brian Greer, Partner and CRO at TaxConnex, gives some context to the more complex terms and offers advice on managing tax obligations.