LeaseQ’s Vernon Tirey explains how rate cards are going the way of the airplane smoking section, as automation becomes the new norm in equipment financing.
When I was a kid, people smoked on airplanes. When I was in college and flying to Europe on a regular basis to visit my girlfriend, now wife, airlines began introducing “non-smoking” flights. It was an awkward transition. But today the idea of smoking on a plane seems almost unimaginable. Non-smoking flights are the norm.
In the small ticket equipment financing world, the smoking section is the rate card, and risk-based pricing and instant quotes will become the norm. In many vertical markets, like office imaging or materials handling, the rate card was the answer. Rate cards enable equipment sellers to calculate and quote a monthly payment in less than a minute and say, “It only costs (fill in the blank) a month. When will you be able to take delivery?” The rate card has served lenders well, but when we combine risk-based pricing and instant quoting, the rate card becomes obsolete.
Every equipment finance lender knows he can help a vendor sell more equipment with instant finance quotes. Large and medium ticket lenders have made the transition and might say, “Wait a minute, all we do is risk-based pricing, so what’s the big deal here?” The big deal is that combining risk-based pricing and instant quoting means that lenders not only have to trust the credit bureau and trust the credit department, but trust the technology. Trusting new technology can create new norms that disrupt entire industries.
Change is never fun. So, to start, let’s remind ourselves where the rate card falls short:
Borrower – The rate card is unfair to the best credit customers. Rate cards use a blended rate so the A credit customer subsidizes the B credit customer. That’s not the best way to reward good credit.
Vendor – The rate card partially solves the instant quote problem, but hurts the equipment seller in a number of other ways. Although the A and B credit customer gets financed quickly, the C credit customer gets what we call the “false close.” Mistakenly, the C credit customer is quoted a monthly payment. Then the news goes from bad to worse. First they learn that they did not qualify for financing. Then they learn that they have fallen off a rate cliff and that all the finance options are unfavorable. Compounding this problem, the equipment sales rep tries to avoid finance turndowns and unhappy customers by pre-screening customers for financing. When a vendor tells me they have no declines, I know the sales team is using a crystal ball to prescreen and the vendor is losing sales. Vendors need an A-D risk-based pricing solution to serve 100% of the market.
Lender – The rate card does not solve all of the lender’s problems and actually creates new problems. Equipment vendors are constantly pressuring lenders to make exceptions and finance higher risk customers at the low rate card price. Because competition is fierce, lenders undercut one another with promises to go deeper and offer a bigger credit box. In turn, vendors pit lenders against one another to get lower rates. Consequently, rate cards have actually compressed lender margins and, although loss ratios would suggest differently, we all know that the use of rate cards is increasing portfolio risk.
At the ELFA Annual Conference this year, Salim Ismail, the acclaimed technology strategist, gave a terrific keynote address on how moving from an analog world to a digital world often drives the cost of products and processes down and creates new business challenges and opportunities. As he spoke about how photography, transportation, retail and healthcare industries are being transformed, I couldn’t help but think about equipment financing. Ismail did not focus on industry leaders that failed to catch the next technology wave and are now gone. Instead, he focused on the simple idea that we are only limited by our own creativity. He said that, unburdened by how things worked in the past, the next generation sees how new technologies can serve customers and do the job faster, better and cheaper. He gave us some amazing examples.
So I asked the team here at LeaseQ to give me the top three things they would like to automate. To put this in context, our tech team makes up less than a third of the company, but our entire staff is involved in automation. We have 15 employees, lots of 20-somethings and a few 50-somethings, with an average age of 35. I would encourage every manager to ask the same question of their team. The ideas that came back were terrific and all touched in some way on underwriting, risk-based pricing and/or instant quotes.
As a quick aside, when our head of business development joined LeaseQ from a leading lender, he was shocked to learn that automated underwriting is the exception among lenders, not the rule. Here at LeaseQ we partner with hundreds of vendors and almost 100 lenders, so we have a good feel for where the industry is. Consequently, it wasn’t surprising that each LeaseQ team member came back with at least one idea that required automated underwriting. As a small ticket marketplace, risk-based pricing and instant quotes are a starting place, not a destination — so what will happen if they become the norm?
The New Norm
With automated underwriting there is significantly more data, smarter risk models and a credit speed up that will get “actuarial” by providing underwriting R&D on the front end and review and sign off on the back end.
Instant Quotes will provide borrowers with pricing transparency, capital planning tools that automate integration of business and personal financials and equipment market value information. Instant quotes will also shift the process from credit driven to customer driven.
Then there’s A-D risk-based pricing, which will lead to new vendor strategies, market share shifts and opportunities for innovative niche players.
Finally, performance optimization would increase for all. Borrowers will get the finance solution that meets their business need, equipment sellers will get accurate instant rates with no credit cliffs for customers A-D and lenders will get maximum portfolio return, optimized to hit risk/reward targets.
It is early yet. We can count less than 10 top-tier small ticket lenders that have automated credit adjudication and four B-C credit small ticket lenders that provide instant quotes and risk-based pricing. That only leaves about 900 small ticket lenders who haven’t yet adopted risk-based pricing with instant quoting.
I see risk-based pricing and instant quotes starting to take off now. So please buckle your seat belt and observe the no-smoking signs, it may be a bumpy ride.
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