Rick Remiker,
Vice Chairman, Equipment Finance Advisors,
The Alta Group

Any relationship with a parent is fraught with complications. And equipment finance businesses sometimes find themselves in difficult family situations— grateful for a home and support but knowing that their vision and expertise is sometime at odds with the parent.

I’ve had the unique opportunity to be on both sides of this relationship, having successfully built and run several large equipment finance organizations, having worked in both regulated bank and non-regulated commercial finance environments, and as one of the few equipment finance executives to have also run a large commercial bank. I’ve served in these roles in challenging and diverse economic climates and from my experience, the parent company relationship is one that needs to be regularly nurtured.

Having a good, healthy relationship with those you report up through is essential for long term success, and survival.

To figure out how to balance your business to better suit a bank parent, ask yourself these three simple questions:

1. Do you want to be the bank’s equipment finance business, or do you want to be an equipment finance business owned by the bank?

These are the two basic approaches an equipment finance subsidiary can take with its bank parent. As the bank’s equipment finance business, you will have to put a significant focus on servicing the bank’s customers and helping to bring new relationships into the bank by leading with an equipment loan or lease.

In this model, the equipment finance business is there to help bank customers with appropriate equipment finance solutions and to bring new customers into the bank through their own services. It’s all about introductions: introducing bankers to your equipment finance clients to manage their wealth, or bringing customers into the bank for real estate loans, treasury management services, private banking and other products or services the bank offers. With multiple products, the bank sees a larger profit from that customer and creates a stickier relationship. And when that customer needs additional equipment finance, they are more likely to come back to you. This makes the equipment finance subsidiary part of the core fabric of the bank.

On the other hand, an equipment finance business simply owned by a bank often has very little to do with bank customers. It’s one spoke in the wheel of the bank. This makes the connection less essential and connected to the bank parent and allows executives in your business to focus solely on equipment finance customers and products.

There’s no right or wrong answer, because every business functions with its own priorities. But there’s much more risk in the second model for equipment finance executives. You must be prepared to face the consequences of that relationship, while in the first model you become much more integrated into the bank’s core product and services offering and are often an important financial contributor.

2. Do you understand the bank parent’s changing needs?

Historically, equipment finance businesses have been used as an asset-generation tool for the bank to help achieve loan growth targets.  Times have changed and at any given time, an equipment finance subsidiary may need to consider a bank’s larger goal, which could shift to non-interest income, considering its risk-weighted asset mix, deposit growth or relationship profitability—to name just a few. Are you prepared to assist your parent bank in all these scenarios, some of which are not necessarily core strengths of traditional bank equipment finance platforms?

The parent company’s needs are driven by the expectations of shareholders, by research analysts’ expectations, and by the board of directors and regulators. And these needs can change on a regular basis—not yearly, but quarterly. There is peril in not adapting, and that risk is in being sold, downsized or de-emphasized. It’s different than it was a decade ago when the singular focus was on new business generation and asset growth. The bank parent has more complex (and varying) needs today and expects more from their equipment finance business executives.

For example, back in 2008-10 during the Great Recession, equipment finance companies generally outperformed most C&I lending areas. This is because equipment often has an essential use aspect to it, and strong risk management policies supporting it. The revenue producing and labor-saving nature of many equipment categories also were particularly attractive at a time when commercial and industrial banking were lagging.

And during that time, banks realized that equipment finance subsidiaries could be used like a faucet, and turned on a little—or a lot—based on asset growth targets. When the bank needs loan growth, they turn to their equipment finance partners. But sometimes a bank doesn’t need loan growth. They’d rather stabilize their risk and grow non-interest income (fees) or deposits instead.

A year ago, at the start of the COVID-19 pandemic, most of us thought a disaster was in store for the economy and borrower defaults were on the horizon, but it didn’t turn out that way. Banks are actually well reserved, and soon were flush with deposits. That was not the expectation early in the pandemic. So now, banks are ready to put all the liquidity to work and lend again.

Equipment finance businesses will once again be counted on to contribute to bank loan growth via equipment loans and leases. But for how long?  And, will you be ready when the winds change from loan growth to fee income, deposit generation, relationship profitability, etc.

3. Have you prepared to educate your bank parent on residual risk?

Residual risk is a significant differentiator from other lending areas, and often, the equipment executives and their team are the only ones who truly and fully understand residual risk within the bank.

Residual risk can be intimidating for bank executives, and for good reason.  If an equipment finance business has a material “miss” on just a few large assets, or a single asset class (i.e., business aircraft, railcars or technology) it could have an earnings impact for the Quarter or Year for the bank parent.  If you are wrong on the future value of the asset how much impact will it have on the bank’s earnings?

Strong residual controls are the first line of defense.  Have you and the bank parent come to agreement on how much aggregate residual risk the bank is willing to take in any one future Quarter?  Do you have limits on how much residual risk you are willing to assume in any single calendar year, on any single asset, or with any one lessee?  Is your residual risk well diversified by geography, manufacturer, industry, individual lessee, vintage, etc.?  Do you have asset concentration limits that might meaningfully alter how you do business?

Ongoing regular monitoring of your residual book is not only good practice, it’s sound accounting policy.  Regularly assess residual risk due in future quarters and keep the parent bank informed so they can prepare for significant gains or losses. Know years and months in the future what’s coming due and how the risk is performing—and be open with the information. Bank parents tend to react worse to bad news when they are caught by surprise.

Perhaps the most important element of managing residual risk with the parent bank is demystifying it through regular, transparent communication.  Holding an annual or semi-annual meeting with the commercial banking executive, CEO, CFO and the board is essential to show how residuals are set, monitored and managed. To do that, bringing in an external equipment finance industry expert without a stake in the overall business can make your parent bank (and regulators) more comfortable with the unique risks your business is taking. Sometimes there are also new regulators and internal and external auditors to add to the mix. Remain transparent and ready to educate them, as well.

A sound residual policy, coupled with appropriate yet meaningful residual controls, will help ease concerns with bank executives and other constituents.

Remember: stay agile, and be prepared

With preparation, even unforeseen events like the pandemic, which happened so fast and intensely, are easier to handle in an inherently risky industry. And expanding that preparedness to the whole bank parent means a systemic shock doesn’t need to be so shocking, because the whole family can work together toward success.

Equipment finance business lines have always been counted on to help the bank parent achieve loan and lease growth.  In today’s world, equipment finance executives must be even more nimble by aligning to the changing needs of the bank parent.  They must also ensure their long term viability by strengthening residual policies and controls while being transparent with bank partners regarding residual risk.

Rick Remiker is a vice chairman of The Alta Group equipment finance advisors. His regulatory, risk management and investor relations insights inform work for Alta’s clients. Rick previously served as chief commercial banking executive and senior executive vice president of Huntington National Bank, where he led its equipment finance business earlier in his career. His past experience also includes launching Merrill Lynch Capital’s commercial equipment finance business and holding top leadership positions in the ELFA. He can be reached at [email protected].