As large banks rush into the equipment leasing business, some experts are worrying that the industry may be repeating a mistake.

Mellon Bank Corp. on Tuesday became the latest banking company to enter the fray, paying $1.7 billion for USL Capital Corp.'s business equipment financing unit. It is the third U.S. bank to buy a piece of the Ford Motor Co. subsidiary since May.

The recent deals by Mellon, First Union Corp., and BankAmerica Corp. reflect the industry's search for higher-margin businesses to offset a decline in profits from traditional banking activities.

But observers point out that in the past, banks have committed time and capital to these businesses, only to exit at times of economic distress. Chase Manhattan Corp. and Manufacturers Hanover Corp. were among the banks that bought leasing companies in the 1980s only to sell their stakes by the early 1990s.

"When times are good, banks tend to buy into the leasing business, but when times are bad these are the first businesses to be sold off," said Sanjay Sharma, a vice president and analyst for finance companies at Moody's Investors Service. He said banks have tended to overpay for leasing businesses.

"Banks face a lot of risk in leasing, because it is not a traditional banking business," he warned. "It is a service business and you have to get your hands dirty by repossessing equipment. The tendency of banks when they have a portfolio of leases is to sell it rather than manage it."

And in contrast to banks, where a staid corporate culture prevails, finance companies are entrepreneurial, both in terms of business approach and employee compensation, Mr. Sharma added.

A clash of cultures is a problem banks face in managing and buying other nonbank businesses, like money management and investment banking. But the higher margins of nonbanks are tough to ignore.

"As banks review their business lines, they are zeroing in on the areas that offer the greatest profit potential," said Sandra Flannigan, a bank analyst with Merrill Lynch & Co. "A number of banks would like to increase their presence in money management and investment products, the problem is availability."

Availability, however, has not been a problem where leasing is concerned. Ford decided last year to sell USL Capital, but soon found no takers for the entire unit. Earlier this year, the automaker decided to sell it piecemeal.

In May, First Union Corp. agreed to pay $900 million for the railroad leasing unit. Last month, BankAmerica agreed to pay $1.8 billion for the transportation and industrial financing division.

These transactions followed a leasing buildup in 1995 among banks. Last year, assets held in banks leasing units grew 19% to $41.2 billion, according to Molloy Associates, an executive recruiter for the leasing business based in Ardmore, Pa.

Leasing assets can provide return of up to 30% on equity, where traditional banking businesses offer roughly 16%, analysts estimated. But higher yields also mean greater risk.

Signet Banking Corp. recently reported it gave a $323 million lease to people fraudulently posing as Philip Morris Cos. executives.

In April, Bennett Funding Group, which leased equipment to government agencies and then packaged the loans for sale to banks, thrifts and pensions funds, was charged with securities fraud.

An expert who advises the leasing industry says such scandals are rare. "These events are blips on the radar screen," said Michael Leichtling, head of the financial services and equipment leasing department at Parker Chapin Flattau & Klimpl LLP.

"If you look historically at the rate of losses in leasing, it is an excellent record," he said. "The real risk is not credit, but rate, because most equipment leases are on a fixed rate, and most leases are in the two to five year range."

For its part, Mellon would not discuss its risk management, except to say that after the USL acquisition, equipment leases would represent only 8% of its loan portfolio.

However, analyst Michael Mayo of Lehman Brothers questioned Mellon's decision to increase its lease portfolio 161% to over $2.3 billion.

In downgrading the bank to "outperform" from "buy" on Wednesday, Mr. Mayo said the acquisition would dilute earnings 3% and move the bank into a relatively unfamiliar product area.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.