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February 26, 2020

Increase Profitability and Business Customers with Equipment Leasing


Equipment Leasing

Instead of trying to squeeze more and more from profit centers where competition is the most intense, community banks may consider offering equipment lease financing to business customers. Through equipment leasing, banks may be able to increase ROA the way some of the most profitable community banks do and add to their business customer base.

Many business customers are already looking for equipment financing. Offering equipment leasing allows a bank to expand into a business segment where there is already demand. Through equipment leasing, some of these business customers can become long-term bank depositors.

 

Many top-performing community banks offer equipment leasing.

Each year, the May edition of ICBA’s Independent Banker features “ICBA’s Top-Performing Community Banks.” With a little website research into the 2018 and 2019 top performers with over $1 billion in assets, an interesting observation is revealed: Many of the most profitable of “ICBA’s Top-Performing Community Banks”  offer equipment leasing to their business customers.

Five of the top seven highest-performing banks in the May 2018 edition offered equipment leasing and four of the top twelve top performing banking in the May 2019 edition offered equipment leasing.

From Independent Banker, “ICBA’s 25 Top-Performing Community Banks” over $1 billion in assets, May 2018 and May 2019 editions:

Bank Name

Location

ICBA’s 2018 Ranking

ICBA’S 2019 Ranking

3-year average ROA

Asset Size

Live Oak Banking

Wilmington, NC

#1

#2

3.07

$4.26 billion

Stearns Banking

St. Cloud, MN

#3

#5

2.51

$2.25 billion

Choice Financial Group

Fargo, ND

#5

#12

1.95

$2.16 billion

Crestmark Bank

Troy, MI

#6

2018 Acquired by Meta Fin. Group

2.34

$1.25 billion in 2017

First Security Bank

Searcy, AR

#7

#8

2.12

$5.51 billion

 

Why is equipment leasing usually more profitable than lending?

Because equipment users are often willing to pay extra for the benefits of equipment leasing. What benefits? 

  • Leasing preserves the cash of an equipment user (“Lessee”) for use in the company, improving the efficiency of a new equipment acquisition.
  • No down payment is required. Out-of-pocket expense to the Lessee is limited to first and last month lease payment. The cost of transportation, installation, training, maintenance, and use tax is added into the monthly lease payment.
  • Potential tax benefits. Section 179 of the United States Internal Revenue Code (26 U.S.C. § 179) allows a taxpaying Lessee to elect to deduct the payments on certain types of property as an expense, rather than requiring the cost of the property to be capitalized and depreciated. 
  • Leasing eliminates risk of technology obsolescence. The Lessee doesn’t own the equipment and either pays for the technology risk through higher lease payments in a finance lease (see below) or shifts the risk to the equipment owner (“Lessor”) in an operating lease.
  • Lease approval is often given within hours rather than days or weeks.
  • There is a perception with equipment leasing that there is a less stringent credit review.
  • Flexible payment options are frequently available, including seasonal or quarterly payments. Many Lessees make the acquisition decision by looking at the monthly payment rather than the cost of the equipment.
  • A wide range of equipment can be available for lease.
  • Off balance sheet accounting for certain qualified users. Many public companies have elected to lease equipment because a Lessee’s obligations have not historically been reflected as liabilities on the Lessee’s balance sheet.

 

Finance Lease or Operating Lease? What is the difference?

Finance leases may have credit risk, but unlike operating leases, finance leases typically have little or no reliance on the equipment’s residual value. Community banks will most likely be interested in acquiring finance leases because community banks may be better at evaluating credit risk than residual value risk.

Finance Lease Characteristics

Operating Lease Characteristics

Ownership. The lease terms provide that ownership of the equipment is transferred to the Lessee at the end of the lease term.

At the end of the lease, ownership is retained by the Lessor. The Lessor typically plans on a lease term extension or a sale of the equipment, either of which will accrue value to the Lessor’s benefit.  

Bargain Purchase. The lease terms allow the Lessee to purchase the equipment at a price anticipated to be much lower than fair-market value (FMV) at the end of the lease term.

At the end of the lease term, the equipment ownership is retained by the Lessor. If the Lessee wants to retain the equipment through purchase or lease extension, FMV will be paid to the Lessor.   

Equipment’s Economic Life. The lease term and planned extension periods represent substantially all the equipment’s remaining economic life.

The lease term is for less than the anticipated economic life of the equipment.   

PV of lease payments. At the start of the lease, the present value (PV) of the lease payment stream is substantially all of the equipment’s value.

At the beginning of the lease, the PV of the lease payments is meaningfully less than the equipment’s value.

 

The majority of leases originated by bank leasing companies will be finance leases, but some bank leasing companies offer both finance leases and operating leases. Non-bank regional leasing companies will be more likely to offer only finance leases.

 

Equipment Lease Process

Whether the Lessee is identified by an equipment vendor or directly by the staff of an equipment leasing company, the life of an equipment lease usually follows a process something like this:   

  1. A lease application is completed by a prospective Lessee.
  2. Credit is evaluated and underwriting is completed.
  3. The lease is documented and UCC filings are done.
  4. The lease is funded by the Lessor or a funding source arranged by the Lessor.
  5. The lease is serviced during the lease term.
  6. At the end of the lease, there may be equipment remarketing or title conveyance.

If the Lessor is a bank leasing company or a major non-bank leasing company, internal funding will likely be prearranged, and an outside funding source will not be needed. But if the Lessor is a regional non-bank leasing company, the funding may not yet be arranged and is often needed by the Lessor.

 

How can a community bank get started in equipment leasing?

  1. Do some independent research to confirm the profitability of equipment leasing.
     
  2. Check out how equipment leasing has benefited some of the highest ROA community banks in the country by carefully reviewing the above table, “ICBA’s 25 Top-Performing Community Banks” over $1 billion in assets, May 2018 and May 2019 editions. These $1 billion-plus-asset-size banks probably perform all five of the above equipment lease processes internally.
     
    Even though the high ROA examples are community banks over $1 billion in assets, banks under $1 billion in assets can take steps to move into profitable equipment leasing; proving the concept before jumping in with both feet. This may be done with minimal increase in bank overhead because a bank’s lending staff may be used to begin the transition.
     
  3. From the above Equipment Lease Process, consider providing only the lease funding (#4). Most non-bank regional leasing companies perform Equipment Lease Process steps 1, 2, 3, and 5 (lease application, credit evaluation & underwriting, documentation & UCC filings, servicing and end-of-lease remarketing) but rely on community banks and other outside funding sources for step 4, the lease funding. The lease funding step becomes an opportunity for a community bank to do its own credit evaluation and underwriting prior to approving the lease, receiving an assignment of the lease, and funding the lease. Leases originated by non-bank regional leasing companies will usually be comprised of Lessees that are outside a community bank’s business area. When a community bank begins to originate its own leases, the bank can originate leases in business areas of its choice.
      
  4. Do a little research and identify regional non-bank leasing companies that may need lease funding. Some of these companies are continually looking for funding sources and will provide an acceptable yield to a community bank willing to fund leases being originated.
     
  5. When regional non-bank leasing companies have been identified, a community bank could continue its due diligence by (in any order):
    • Checking out the details of their application review, underwriting, approval, and servicing process to be sure bank standards are being met.
    • Reviewing sample documents.
    • Calling their other funding company references and asking for lease funding examples.
    • Reviewing a few sample leases.

 

Summary

By offering equipment leasing, a community bank may be able to expand into a business segment where there is already demand, add business customers, and increase bank profitability the way some of the top performing banks do it.  

 

____________________

 

About the Author: Prior to joining FPS GOLD as VP of Sales in 2015, Rock Ballstaedt worked 13 years in the equipment leasing business. For 10 of those years, he operated Alpha Technology, Inc., a Salt Lake City-based equipment leasing company he co-founded, financing over $25 million/year of equipment lease transactions. rockb@fpsgold.com, 801-201-2525

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