Community banks are stepping up efforts to expand into equipment financing.
The business, once viewed as cost-prohibitive for smaller banks due to the financial commitment required to build in-house teams, has become more attractive because of opportunities to work with outside firms. A greater ease of entry, however, means more competition.
"Banks want access to the earning assets of an equipment lease and be able to service their customer so someone else doesn't pry the relationship away," says John Deane, chief executive of The Alta Group. "But these banks also don't typically have a critical mass that justifies putting a full department in place."
Some banks have started working with lease brokers and leasing companies. A broker typically brings equipment financing transactions to a bank. The bank underwrites the deal and is responsible for servicing, Deane says. With this method, banks still need to have the staff, technology and systems in place to service the lease or outsource those tasks.
Popular Community Bank is rebuilding its equipment financing unit after exiting the business in 2009. Popular chose to reenter the space after the Durbin amendment's limit on interchange fees hit fee income, says Michael McCracken, Illinois region executive for the $9 billion-asset bank. Popular is a unit of the $36 billion-asset Popular Inc. in San Juan, Puerto Rico.
The bank hired Dale Kluga, a former LaSalle National Bank executive, to lead the group and work with brokers he has known for years, McCracken says. The bank plans to hire two sales representatives and will assign a dedicated underwriter to the unit. Popular will keep the servicing rights to generate fee income, though it will likely outsource the actual servicing.
Once a deal closes, Popular will determine how much of the lease to sell to investors, which could include community banks looking to diversify revenue, McCracken says. "I liked this method because it is not very capital intensive," he says. "It is a low-risk, but high-return, scenario."
Community banks could also opt to work with leasing firms that secure deals and provide back office support for tasks such as filing taxes and invoicing, says Geoff Peters, vice president of syndications at leasing company TIP Capital in Bloomfield Hills, Mich. These firms sometimes invest in leasing deals.
"Banks are looking to augment their revenue," Peters says. "Many of those banks are heavily focused on commercial real estate. That hasn't been hot right now."
Before working with a small bank, TIP provides sample documents to help banks understand the structure of its deals, Peters says. Banks outline what they deem an acceptable amount of risk, taking into consideration factors like geography, a borrower's creditworthiness and the equipment involved, Peters says. TIP delivers deals that match a bank's considerations; the bank must then make a decision about financing the deal.
Working with leasing companies and brokers often lets small banks get started with minimal staffing costs, industry experts say. Community banks still need to have enough in-house expertise to understand the business and underwrite deals, says Terry Keating, managing director at Amherst Partners in Chicago.
"At the end of the day, it's the responsibility of the bank to determine the creditworthiness of a borrower," adds Thomas Rutherford, TIP's chief operating officer.
Banks must do their homework researching any broker or leasing firm, including a review of a potential partner's reputation and financials. Due diligence is needed to make sure a firm has staying power, especially if it provides servicing, industry experts say.
Banks face reputational risk if an outside firm violates usury laws with late fees or by failing to properly disclose information, Deane says. It is critical that banks understand the documentation and processes for instances where a borrower misses payments. In the case of a default, banks need to clearly understand which party is responsible for taking possession of leased equipment and deposing of it.
"Banks can't let themselves go to sleep," Keating says. "They need to have an active, ongoing participation in these relationships."
Some banks, including First Eagle Bank in Hanover Park, Ill., limit funding to short-term leases. First Eagle's leases average about 36 months, for prime borrowers, says Richard Burns, a senior vice president at the $387 million-asset bank.
First Eagle, which has offered equipment finance for about a decade and works with two dozen leasing firms, essentially "underwrites the leasing company, too," Burns says. The bank reviews the leasing company's financials, funding sources, history and guiding principles.
First Eagle usually requires three years of financials from lease applicants and it reviews analyst reports and investor information, when available. If an applicant is privately held, the bank asks for references and reviews the applicant's accounting firm.
"We do a significant amount of due diligence on all of the sources we buy leases from," Burns says. "We are not actually out there working with the customers leasing the equipment so there is some risk in that."
The economics of any partnership must make sense, and banks need to make sure working with a vendor is worth the risk once fees and other costs are added in, Deane says. Banks should also watch out for outside firms that steer the best deals to certain clients. It is also good to know which leasing companies invest in deals, Keating says.
Taxes on leases are often more complicated than those for traditional loans. Banks need to make sure they file sales and use tax and property tax since because, under the terms of a lease, they essentially own the equipment. Banks also need to make sure the lease servicer is an expert in taxation and is fulfilling those responsibilities throughout the year.
BancVue aims to provide such back-office support to small banks through its recent purchase of BancLeasing. Small banks would originate and fund the leases, and BancLeasing would handle administrative tasks such as invoicing and tax collections.
BancVue, which completed the purchase late last year, has spent recent months integrating the operations, including changing its registration for tax filings. BancVue, which has met with about nine banks, touts the service as a way for small banks to offer another product to their best commercial customers.
"The reality is that mega banks are the guys who finance equipment deals throughout the country and this will help our clients compete," says Don Shafer, BancVue's founder.