True leases may be harder to originate, but with multiple revenue streams and long-term portfolio value, Scott Kiley asserts that they remain one of the most underleveraged tools in equipment finance.
When I get a call from the ELFA that a company is interested in hiring me for an on-site training session of the Principles of Equipment Leasing and Finance Workshop, the first thing I do is set up a call with the customer. The first question I ask is, “Why are you doing this training?” The answer every time to date has been, “We really need to originate more true leases, especially FMV leases.”
WHY TRUE LEASES MATTER MORE THAN EVER
Why is this so important to every equipment finance company, or should it be if it isn’t? Because tax leases, especially FMV leases, are the most profitable product in any equipment finance portfolio. They create four possible sources of revenue, whereas a loan has just one, interest income. A true lease (the terms “true” and “tax” lease are interchangeable) not only generates interest income, but also can lead to equipment remarketing gains that may occur in the middle of the lease in an early termination, the end of the lease from renewal rents or from the sale of the equipment at expiration to either the customer or to a third party.
FMV leases (a lease with an EBO that isn’t exercised by the lessee becomes an FMV lease) can also generate material syndication fee income if you choose to monetize that asset before the lease matures, especially if you made a good bet on the residual. The fourth revenue stream is the tax deferral benefit. Stating the obvious, with a 100% bonus if you originate a $1 million lease today, that creates a $1 million tax deduction for this year, generating higher after-tax income for your company.
There is a possible and untapped fifth potential source of revenue in a true lease that is rarely pursued. You can restructure a lease in the last few years of the term, adding several years to the original term, generating an entirely new revenue stream.
Unlike a loan, a true lease requires ongoing monitoring of the residual because, just as you can generate remarketing gains, there is also the risk of a residual loss. Based on this ongoing review, you can decide whether to approach the lessee about extending the lease prior to maturity, encouraging an early buyout (if you are concerned about the residual), or simply deciding to wait for the lessee to make an end-of-term election.
I’m so passionate about the need for the equipment finance industry to increase true lease volume that I’ve come out of retirement to teach this class to as many ears that will listen. During my initial call with the company, many planned only to have their salespeople attend. I encourage them to include employees from every division (which most have) because to increase your true lease volume materially, you must create a culture that encourages and supports more true leases. That only comes from all your employees not only learning the technical attributes of true leases (through the three lenses of accounting, tax and legal) but also truly buying into the benefits to both lessees and lessors of true leases.
LEASES REQUIRE BUY-IN ACROSS THE BUSINESS
It doesn’t do you any good to train and fire up your sales team to go originate a bunch of new true leases if your credit team is biased against leases because the LTV on a lease is not as good as a full payout loan or if your asset management team won’t support market-based residuals to win deals or if your organization doesn’t flow through any of the tax deferral benefit in your lease pricing making you uncompetitive. Your entire organization needs to fully embrace the true lease product to grow the share of leases in your portfolio.
My last article highlighted the key benefits of true leases to a lessee and how to prepare a “CFP” or customized financing proposal based on the detailed information obtained from the company through a consultative selling approach. Now you understand how lessors can benefit from the five potential sources of revenue from more true leases. But the big question becomes, how are you going to handle the lessees’ objections to a true lease resulting from their lack of understanding of the product, past bad experiences with a lease or an unjustified bias against true leases?
THE “SIX CS” THAT KILL THE SALE
Art of Selling Truth No. 5: Planting seeds of uncertainty in every customer interaction will help you sell more true leases. What do I mean by this? It’s nearly impossible to sell a true lease to a customer who is:
1. Certain of strong cash flow generation and liquidity for many years and having plenty of availability under their line of credit
2. Confident they will have no problems staying under their leverage covenant
3. Convinced they are going to need this piece of equipment for a long time
4. Certain their bank will always be there for them even through a downturn
5. Confident they can fully utilize the 100% bonus depreciation tax deduction
6. Convinced that the lessor won’t be reasonable with the FMV purchase option negotiation
I call these customer perceptions the dreaded “Six Cs,” and most objections to leasing stem from the customer grasping onto some or all of the “Six Cs.” You need to intentionally and thoughtfully lead them to a place where they aren’t so Certain, Confident or Convinced about these positions.
Science of Selling Truth No. 6: Planting seeds of uncertainty can be accomplished in 3 ways:
1. Reminding them about historical macro-economic unforeseen events: “Mr. Customer, events can happen quickly that can materially
alter a company’s profitability, liquidity or access to bank lines. Events such as COVID and the resulting supply chain crisis, the financial crisis
resulting in bank failures and a major pullback in commercial lending by many regional banks, the price of oil rapidly going from $130 to $30 a
barrel that bankrupted many energy-related companies or rapidly changing tariff policies that can significantly increase costs or lower demand.”
2. Pointing out factual observations from your deep dive into their historical financial statements: “Mr. Customer, I see from your audit that your bank waived financial covenant violations a few years ago. Good thing that didn’t happen during the regional bank crisis when they may not have been so accommodating;” or “I see you had some NOL’s from a significant loss years ago and understand that was from losing a big contract with one of your largest customers. Did that come as a surprise to your team?”
3. Sharing real-life stories about your experiences working with other companies: “I worked with a company in your industry that relied solely on their bank for all their financing needs, but when the financial crisis hit, their bank would not finance a crucial new piece of equipment. After we financed that equipment purchase, I know the CFO was happy to diversify his sources of capital;” or “A customer agreed to an FMV Lease with me five years ago because it offered the lowest monthly payment, but I will tell you they were concerned about the FMV purchase option. We just negotiated the FMV purchase, and the CFO told me it was handled reasonably and professionally which makes sense because we are interested in long-term relationships.”
If you are successful in planting the seeds of uncertainty, many of their objections to leasing will begin to soften, opening the door to explain why a true lease is the best product to protect their business from these uncertainties. You can do so by highlighting the benefits and features below that will resonate with their concerns about liquidity or cash flow during specific times of the year, balance sheet leverage, reliance on their bank, ability to fully utilize 100% bonus depreciation or the duration they may need the equipment.
• Conserves working capital; 100% financing including delivery & installation costs
• Flexible payment terms with skip payments or lower seasonal payments
• Leases with meaningful residuals offer lower payments than loans
• Provides after-tax financial benefits (100% of lease payments are deductible)
• Companies can acquire equipment and stay below leverage covenants
• Lower Right of Use Asset and Lease Liability (not debt) recorded on balance sheet
• Predictable operating lease expense recorded on income statement
• Sales tax charged on monthly rents avoids paying sales taxes upfront.
• Preserves bank credit lines and gets expertise from equipment finance specialists
• No covenants or cross-collateralization
• Protects against equipment obsolescence as Lessor takes downside residual risk
• Matches equipment expense and term to specific contract revenue and length of contract
• Offers flexibility with end-of-term options to purchase, renew or return the equipment based on their need for the equipment at end of term, which is far more relevant than how long they originally thought they would need this equipment
TRUE LEASES TAKE EFFORT — BUT THEY PAY OFF
Look, selling FMV leases is hard. That’s why they represent a small percentage of many leasing company portfolios. Set realistic goals for growing FMV leases in your portfolio to unlock future new revenue streams. Based on my experience, please know that true Leases with EBOs (early buy-outs) or capped end-of-term purchase options (not to exceed “X”), first amendment leases and TRAC Leases are still more profitable than loans. If you pass the EBO point, you now have an FMV lease, and based on discussions with many in the industry, fewer than half of lessees exercise their EBO on the EBO date. How you structure EBO deals (Pro tip: Offer it no sooner than two years from lease expiration if possible), and how you respond to customer requests to exercise EBO can generate new revenues. Push to finance the EBO into a new loan or offer a lease extension to a new lower residual and syndicate the new lease economics to a third party who can now take 100% bonus depreciation, generating syndication fee income.
I really hope some of these ideas will help your team increase your true lease volume. I’m confident that more true leases (avoiding outsized residuals on single assets) will increase the long-term profitability of your portfolio. If you are part of a bank, true leases will differentiate your equipment finance group from the C&I lenders and give you a value-added product to offer clients.
If interested, reach out to the ELFA to discuss having me train your team at your site with either the one- or two-day version of the Principles of Equipment Leasing & Finance workshop. •
Scott Kiley is a seasoned equipment finance professional with over 35 years of experience in capital markets, indirect and direct originations, and syndications. As an in-house instructor for the Equipment Leasing and Finance Association (ELFA), he provides industry training, equipping professionals with the knowledge and strategies needed to excel in equipment leasing and finance. Kiley spent more than two decades at Fifth Third Bank, where he led the Equipment Finance Capital Markets Group as a Senior Vice President. Prior to that, he spent 21 years as a Vice President of Indirect Originations. His early career at GE Capital involved managing sales teams and driving tax lease sales for middle-market companies.
