Time may be ripe for return to leasing; openings developing for banks, but risks have to be managed.

Openings Developing for Banks, But Risks Have to Be Managed

STAMFORD, Conn. -- Preoccupied with bad real estate, leveraged buyout, and Third World loans, banks in the late 1980s pulled out of the equipment leasing market. But now that they're healthy enough to get back into the business, the big question for bank CEOs will be: Is time on our side?

The key to success for lessors -- whether banks or other companies -- is to avoid getting stuck with equipment whose value depreciates when the lease ends. As technology advances at a rapid pace in the 1990s, time will not be on the side of banks that don't carefully manage this risk.

Perhaps the best mentors are those who lease computers, such as IBM Credit Corp. and Bank of Boston. After all, probably no product today is more susceptible to obsolescence, let alone depreciation, than the mainframe or personal computer.

Captives' Clear Advantage

Why should banks get involved in equipment leasing at all? After all, the captives clearly have an advantage over banks. Not only do they generally possess a greater expertise in their particular field, but many times they offer a variety of leasing products, like operating leases, that banks rarely can match.

Also, captives offer maintenance and management services. They can provide invoicing and track the mileage of trucks and othe vehicles they lease.

Perhaps the most significant advantage is that captives aren't stifled by the same regulations as banks. There are, for example, limits on the amount of risk that banks can take.

Furthermore, statistics show that banks are losing money when they lease equipment. In 1992, banks experienced a 5.4% decline in income received from leasing, according to the Department of Commerce.

Receivables Decline

Also, banks' lease financing receivables dropped 5.1% in 1992. (Figures for last year are not yet available.)

Nevertheless, the reasons not to enter the equipment leasing business are outmatched by the positives. For starters, 80% of corporate America leases its capital equipment, according to the Equipment Leasing Association. Obviously, the demand for service is out there.

Because they want to avoid obsolescence, companies would much rather lease equipment than own it. This explains why, according to the Commerce Department, the volume of leasing transactions grew from $85 billion in 1986 to almost $130 billion last year.

Furthermore, captive finance companies are downscaling and sometimes eliminating areas where they have run into competition with banks.

Back on Track

Consider Chrysler Finance Corp., which stopped financing leveraged buyout loans and credit for non-auto industries, when its core car business began to run into trouble.

Chrysler had been financing the purchase of equipment for nuclear power plants. Now, the company focuses exclusively on automobile leasing.

"That's what we do best," said Paul Knauss, director of vehicle asset management at Chrysler Finance. "A lot of times there's a lot of things in vogue like 'we're going to diversify.' A lot of companies diversified and figured out that that wasn't necessarily the thing to do."

Mutual Fund Spinoff

Chrysler isn't the only captive in retrenchment mode. So is IBM Credit Corp., which securitized and marketed $1.4 billion of commercial leases last year.

In what has become a controversial move, the company intends to sell to Fleet Financial Group of Providence, R.I., the mutual funds it offers to employees IBM's 70,000 shareholders are scheduled to vote on the $14 million sale to Fleet before a special meeting on June 15.

But John Bogle, chairman of no-load mutual fund giant Vanguard Group, maintains that his company can manage the funds less expensively for shareholders than Fleet can. IBM Credit was so anxious to get out of the mutual fund business, it may now face a proxy battle.

This retreat by captive finance companies offers opportunity for banks. "I think the banks are going to reenter these arenas," said Richard Schmidt, managing director of the financial institutions group at Standard & Poor's Corp.

"Some are coming back with a more sober view of what's out there. Now the rush is [leasing] to the middle market," Mr. Schmidt said.

Bank Membership Grows

In fact, the banks made up 23% of the membership of the Equipment Leasing Association in 1993, up from as low as 19% in 1989.

Last year's figure, however, still did not reach the peak in the 1980s when banks made up 26% of the membership. But clearly, the numbers show a gradual movement by banks back into the leasing business.

Times have changed, and the risk of equipment depreciating as a result of technology improvements is now greater than ever.

In its 13-year history as a wholly owned subsidiary of International Business Machines Corp., IBM Credit Corp., has managed risk as well as anyone. In fact, one company representative was bold enough to dismiss risk as a factor.

Appetite for Risk

In an interview at his office in Stamford, Conn., John Callies, vice president of customer financing, marketing, and services for IBM Credit, spread his arms wide over his desk and imparted his view on risk. "Give me more of it. I want it," he declared.

With more than $6 billion in assets, IBM Credit is the third-largest finance company in the United States behind General Electric Capital Corp., also based in Stamford, and Chrysler Finance.

Last year IBM Credit Corp. took on $1 billion of residual value risk, which is the gamble it makes on equipment depreciating before the lease ends. Unlike its parent, IBM Credit Corp. made money last year, raking in $220.2 million in 1993, up $1.2 million over 1992.

Banks should take advantage of their unique relationship with this captive finance company that leases computers and related equipment to IBM customers, including almsot every money-center bank in New York and to most regional banks. The company makes an excellent case study.

Declining Demand

"If IBM had done as well as the credit corp. had done, they would have made a lot of money," remarked Sam Albert, a former IBM executive and a computer consultant in Scarsdale, N.Y.

When it comes to residual value risk, IBM Credit Corp. appears to know what it's doing, given that it has not shown losses in the face of declining demand for mainframes.

Almost 75% of the volume of IBM Credit Corp.'s computer leasing was mainframe computers in 1988. Today that volume is less than 40%. "The mainframe computers and equipment that ties into data centers is becoming less and less important," Mr. Callies conceded.

But IBM Credit has shown flexibility, leasing fewer mainframes and more PCs. More important, the IBM finance unit knows how to hold on to a lease and breathe new life into it. The company regularly upgrades the computer before the lease ends.

"I know how to upgrade in a financially viable manner," Mr. Callies said. "There is much more involved with those who want to purchase, finance, and lease than just getting the lowest finance," he added.

Tapping the Customer Base

Bank of Boston's equipment leasing division, which was born when the bank acquired an equipment leasing company seven years ago, had $300 million in new equipment financing last year. a third of that income came from computer leasing, according to Patrick Kelly, division executive.

One key to successful leasing for banks is going after their own captive customers.

"We've been able to compete with [IBM Credit Corp.] successfully by focusing on the bank's customer base," Mr. kelly said. The bank capitalizes on its existing relationships because its staff knows the companies and the industries they're in, he added.

Expanding Relationships

About 75% of the equipment leasing division's customers are also Bank of Boston customers.

The same goes for Bank One in Dallas, Dale Peters, president most banks in the business offer equipment leasing independent of the bank and are constantly searching for customers. That's a mistake, he said.

"In our case, we believe in working closely with our bank customer base and offering those customers a broader commercial banking relationship. We have a competitive edge over someone doing that independently," he said.

Banks are definitely coming back with a competitive posture against some of the captive finance companies. "That having been said, the fact that the captives can be experts in their own equipment probably gives them an edge against banks," Mr. Peters said.

But Mr. Kelly insists that by going after the bank's customer base instead of outside customers, Bank of Boston understands the credit risks involved: "We know these customer relationships. We know the principals."

So even if the captives do know their equipment, banks can counter with their own expertise: an inside track to the client.

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