asset finance united states - blank rome llp...that covers key statistical, financial and operations...

ASSET FINANCE INTERNATIONAL

IN ASSOCIATION WITHWHITE CLARKE GROUP

AUTO & ASSET FINANCE COUNTRY SURVEY 2016

United States

United States Auto and Asset Finance Country Survey 2016

2


White Clarke GroupWhite Clarke Group is the market leader in software solutions and business consultancy to the automotive and asset finance sector for retail, fleet and wholesale. White Clarke Group solutions enable end-to-end credit processing and administration to streamline business practice, cut operational cost and deliver outstanding customer service. White Clarke Group has a 24-year track record of leadership and innovation in finance technology, consultancy and new market entry. Clients value White Clarke Group's industry knowledge, market intelligence and innovation. The company employs some 600 finance and technology professionals, with offices in the UK, USA, Canada, China, Australia, Austria and Germany.

whiteclarkegroup.com

© Asset Finance International, 2016, All rights reserved. No part of this publication may be reproduced or used in any form or by any means–graphic; electronic; or mechanical, including photocopying, recording, taping or information storage and retrieval systems–without the written permission from the publishers.

http://www.assetfinanceinternational.com

Publisher: Edward Peck Editor: Brian Rogerson Author: Nigel Carn

Asset Finance International Ltd.

39 Manor WayLondon SE3 9XGUNITED KINGDOMTelephone: +44 (0) 207 617 7830

http://www.whiteclarkegroup.com


3


Acknowledgements

Gary Amos, CEO of Commercial Finance Americas, Siemens Financial Services

Bill Bosco, Principal, Leasing 101

Jonathan Dodds, Chief Executive Officer – Americas, White Clarke Group

Chris Enbom, CEO, Allegiant Partners

Brendan Gleeson, Group CEO, White Clarke Group

Dave Mirsky, Chief Executive Officer, Pacific Rim Capital

Tom Partridge, President, Fifth Third Equipment Finance

Bob Rinaldi, CEO, Commercial Industrial Finance

Alan Sikora, CEO, First American Equipment Finance, a City National Bank company

Bill Stephenson, CEO and Chairman of the Executive Board at DLL

Adam Warner, President, Key Equipment Finance

Marguerite Watanabe, President, Connections Insights

Stephen Whelan, Partner, Blank Rome LLP


4


Contents

Acknowledgements 3

The US at a glance 6

The US equipment and auto finance market 8

Equipment finance trends 8

Performance in 2015 and 2016 9

What the experts say – Market performance 11

Economic factors 13

What the experts say – Industry confidence 14

Lending trends 16

Market prospects 18

What the experts say – Industry initiatives 19

Business confidence 21

Small business hesitancy 22

What the experts say – Small business awareness 24 of equipment finance


5


Auto sector finance trends 26

Leasing bucks the downward trend 26

What the experts say – Investment in technology 29

Technology – The top priorities for auto financing 31 sources

The justification for technology improvements 31

Technology improvements most often evaluated and 31 implemented today

The key to getting ahead with technology 33

What the experts say – Lease accounting changes 34

Lease accounting rules issued in 2016 36

Overview of the impact 36

Preparing for the new standard 36

Lessor issues 37

Lessee issues 37

A look ahead 38

The legal and regulatory environment 39

True sale 39

Hell or high water 39

Bankruptcy remote? 39

Tarnished ‘golden share’ 40

An unenforceable covenant? 40


6

The US at a glanceThis new Asset Finance International country survey aims to provide a balanced assessment of the latest developments in the equipment and auto finance markets in the US.

Key areas covered and principal findings include:

ƴ Figures from the industry body, the Equipment Leasing and Finance Association (ELFA), show that new business volumes (NBV) in the US equipment leasing market grew by 12.4% to $123 billion in 2015

ƴ However, NBV in H1 2016 fell 6.6% compared with the same period a year earlier, the first drop into negative growth for six years.

ƴ Against expectations, the US economy has been growing only slowly, at a rate that has actually been trending downward. However, data on the US labour market has been much more positive.

ƴ Business investment has fallen for three consecutive quarters to mid-2016, possibly because businesses are not anticipating stronger economic growth and are therefore holding back on investing.

ƴ Data for equipment finance lending show independent lessors experienced the strongest rate of growth in 2015, although this segment still trails banks and captives for market share.

ƴ By far the largest year-on-year growth in 2015 was in the large-ticket market segment, although the middle- and small-ticket segments still have considerably higher total volumes.


7

ƴ In 2015 the equipment finance market was dominated by the transportation, IT, construction, and agriculture segments, although of all market segments only transportation, IT and construction saw any growth over the previous year, and the only significant growth was in transportation.

ƴ Forecasts for equipment investment in 2016 have been trimmed. Projections are for sluggish conditions for most segments, with the best prospects for IT and medical equipment, whilst agriculture is predicted to fall further.

ƴ Business confidence has slumped, following a general downward trend since early 2015.

ƴ Confidence among small businesses is also falling, leading to a cautious attitude to borrowing and investing in their businesses.

ƴ In the auto sector, new vehicle sales are down after 66 straight months of growth. However, fleet sales are growing, as is the volume of new vehicles financed by leasing which now accounts for around one-third of the market.

ƴ Although there has been a slight rise in delinquencies in auto financing, leasing remains very prime.

The opinions and comments of a select group of equipment finance industry leaders are provided throughout this survey. Topics under analysis are:

ƴ Market performance;

ƴ Industry confidence;

ƴ Industry initiatives;

ƴ Small business awareness of equipment finance;

ƴ Investment in technology; and

ƴ Lease accounting.

There are also special articles covering:

ƴ Technology – The top priorities for auto financing sources;

ƴ The latest developments in the Lease Accounting Project; and

ƴ Recent legal and regulatory developments in the US equipment and auto finance market.


8

Martin Nixon

The US equipment and auto finance marketSince the last Asset Finance International report on the US equipment and auto leasing industry a year ago, the sector continued to grow in 2015 but recently the rate of growth of new business volume (NBV) has gone into reverse.

The prospect of a deceleration in the market was well flagged up; however, the decline in sector growth rate and the extent of the underlying factors behind the collapse in momentum have been greater than expected.

There are, of course, many diverse elements that affect an industry as large as this in any year, but 2016 has already seen some exceptional events on the global front and domestically there is the matter of the presidential election to come.

Globally, the economy continues to grow only slowly; oil and commodities prices remain low. Central banks are tending to support national economies by keeping interest rates low or even reducing them, while in the US it is still expected that they will be raised, although the timing of the next increase is uncertain due to weaker than expected economic data.

And the US equipment and auto finance sectors, which over recent years have continually grown faster than the economy, have also been affected by a downbeat attitude.

Equipment finance trends

By the beginning of 2016 the US equipment finance sector had grown in value to an estimated US$1 trillion and it remains the largest national market in the world. Its interests are represented by the Equipment Leasing and finance Association (ELFA).

Gathering statistical information on an industry of this size is a major undertaking, but the ELFA produces an annual Survey of Equipment Finance Activity (SEFA) that covers key statistical, financial and operations information on the domestic equipment finance industry in the previous calendar year, based on responses from 100+ ELFA member companies.

The decline in sector growth rate and the extent of the underlying factors behind the collapse in momentum have been greater than expected


9

The ELFA also publishes the Monthly Leasing and Finance Index (MLFI-25) which gives information on the current market, covering key indicators with data from a sample of 25 major member companies.

Given the size and diversity of the overall market, such data, from which selected details appear below, should only be taken as a guideline to industry-wide activity rather than an accurate representation. Figures do not include data on auto leasing (including floorplan finance), real estate and ‘non-equipment finance operations’.

Details of the 2016 survey, which is based on responses from 116 ELFA member companies, can be found at www.elfaonline.org/data/sefa-survey-of-equipment-finance-activity.

Performance in 2015 and 2016

The 2016 SEFA shows equipment finance NBV increased significantly in 2015 over the year before – by 12.4% to $123 billion – reversing a decline in year-on-year growth for the previous three years.

However, the MLFI-25 figures for the first half of 2016 show that, despite a welcome uptick in June, NBV in the period totalled $44.2 billion – a drop of 6.6% compared with the same period a year earlier.

NBV growth rate

Source: ELFA (SEFA 2016, MLFI-25)

25.0%

15.0%

5.0%

-5.0%

-15.0%

-25.0%

-35.0%2008 2009 2010 2011 2012 2013 2014 2015 H1 2016

-2.2%

-30.3%

3.9%

16.5% 16.4%12.4%

9.3%6.7%

-6.6%

Year-on-year growth

http://www.elfaonline.org/data/sefa-survey-of-equipment-finance-activity

http://www.elfaonline.org/data/sefa-survey-of-equipment-finance-activity


10

The year-on-year increase in June was in fact the first positive figure since July 2015, and the latest figure for July 2016 has slumped back into negative territory with a near 17% decline on July 2015. The July total of $7 billion NBV also represents a rather alarming 30% decline from the previous month’s spike of $10 billion.

MLFI-25 NBV and monthly comparison

Source: ELFA, Asset Finance International

On the first-half figures, ELFA president and CEO Ralph Petta remarked that the performance “appears to reflect the trend toward continued slow economic growth and volatile equity markets in the US, as well as troubling international events that are causing business owners to approach capital investment decisions with a wary eye. A decline in portfolio quality contributes to a narrative of an equipment finance market trying to gain its footing in the face of a volatile economy amidst a recent period of uncertain political and social unrest.”

Aug-14

Oct-14

Dec-14

Feb-15

Apr-15

Jun-15

Aug-15

Oct-15

Dec-15

Feb-16

Apr-16

Jan-16

35.0 %30.025.020.015.010.05.00.0-5.0-10.0-15.0-20.0

$bn 14.0

12.0

10.0

8.0

6.0

4.0

20

00

–

NBV (£ billion) Monthly y-o-y change (%)


11

What the experts say – Market performanceAsset Finance International asked industry leaders in US equipment and auto finance for their views on a number of current issues

The first topic for discussion concerned the fact that the rate of growth of the US leasing industry is proving to be slow in 2016. Is the downward momentum set to continue, or will it pick up in the coming 12 months?

A year ago, the industry outlook was reasonably optimistic, at least that growth in leasing would outstrip that of the overall economy. Now, there are questions over the direction of the economy after the forthcoming elections, and whether business regulation will change.

Bill Stephenson of DLL, and current chairman of the ELFA, provided an overview: “The downward momentum we have seen can be attributed to a number of factors, including slow growth in the global economy, a contraction in trade, heightened political uncertainty and continued low energy and commodity prices. I expect this trend will continue into 2017 until we have further clarity on the outcome and effects of the US presidential and congressional elections and a better understanding of how aggressive the Federal Reserve will be in pursuing rate hikes.”

For Bob Rinaldi of Commercial Industrial Finance, it all depends on the election, with a Democrat victory meaning “the hostile attitude towards business and finance via regulations and nationalizing of some corporate profits (via fines and levies) will continue. The result will be more of the same slow growth caused by a real unwillingness of businesses to expand their employee base or invest in plant and equipment other than for replacement.” He concluded: “In essence, the business community in the US has been informally boycotting this administration from the start.”

On the other hand, if there is a Republican victory, he said, “then 2017 will continue the same course until the business community starts to see real evidence that there is a paring back of the regulation factory and hostile attitude towards anything not related to government.”

Other participants in the debate were cautious about the outlook. Tom Partridge of Fifth Third Equipment Finance commented: “There has been an overall lack of growth year over year, which is somewhat surprising given that bonus depreciation remains in effect,” adding: “In my opinion there continues to be a lack of new business investment. I think this trend could continue until there is more clarity on the direction of overall business regulation. Many clients remain wary of the direction of the US economy as well as regulatory trends.”

And in the view of Adam Warner of Key Equipment Finance, “In the US, it is starting to feel like the end of a positive growth cycle. The forecast for industry activity is down and I don’t believe there will be a major turnaround in buying and financing in the coming year. We are also starting to see a small deterioration in portfolio quality largely driven by a correlation to energy industries.”

In the US, it is starting to feel like the end of a positive growth cycle

Adam Warner, Key Equipment Finance


12

Sector involvement can affect a company’s outlook. As Alan Sikora of First American Equipment Finance (FAEF) said, “Declines in a handful of sectors like agriculture, oil and gas have been driving negative trends while other industries like healthcare and alternative energy are robust. In the industry segments that First American serves, we are experiencing growth and expect it to continue over the next 12 months.”

There remains optimism that things will pick up, especially once the uncertainty around the elections is resolved. Chris Enbom of Allegiant Partners stated: “I am optimistic that once the election is finished business investment will pick up a bit next year compared with this year. Class 8 truck purchases were so strong in 2014 and 2015 that when the oil boom faded and transportation overall dipped a bit it caused a slump in 2016, but I think we are starting to pull out of the slump. Overall we still see businesses being pretty conservative but we also see them doing pretty well and needing to continue to replace equipment.”

Dave Mirsky of Pacific Rim Capital concurred, saying: “It is my opinion that the business environment in the US will improve in the coming months. We are already seeing an increase in demand. The economists that we follow are projecting mild growth in the year ahead and I agree with them.”

A final positive spin came from Gary Amos of Siemens Financial Services (SFS), who noted that leasing and finance companies remain strong, despite continuing political and fiscal uncertainty. “There remains an opportunity for organizations to play an important role in helping with economic recovery and supporting necessary equipment investments,” he said.

He concluded: “Although the rate of growth is slower than 2015, equipment replacement demand will continue to drive investments. As businesses further recognize their capacity to meet operational demands, their equipment investing activities will be increasingly focused on replacing ageing or outdated assets.”

Overall we still see businesses being pretty conservative but we also see them needing to continue to replace equipment

Chris Enbom, Allegiant Partners


13

Economic factors

It is certainly true that the world’s largest economy has suffered from a bout of volatility, with conflicting data regularly coming out regarding growth and employment, all of which has an unsettling influence on businesses’ investment decisions.

Against expectations, the economy has been growing only slowly, at a rate that has actually been trending downward. Meanwhile, data on the US labour market has been much more positive with unemployment stable at a perfectly manageable level of around 5% and employment levels generally strengthening.

US GDP growth rates

Source: U.S. Bureau of Economic Analysis

These contradictory signals have led to some confusion, particularly regarding when the US Federal Reserve will raise interest rates again, as has been widely anticipated to happen before the end of the year. It has been expected through 2016 that the economy will pick up in line with employment trends; however, there is an alternate view. Data from the U.S. Bureau of Labor Statistics showing sluggish growth in earnings and hours worked may in fact indicate that momentum in the labour market could fall away and that the GDP trend is the more realistic.

Perhaps there is no need for an increase in interest rates so soon. Inflation has been circling the 1% level throughout 2016 but remains far from the nominal 2% target. The real driver of economic growth in the first half of 2016 has been consumer spending, and this may not be sustainable.

And while overall job numbers have increased, productivity growth is down if not actually falling. A big problem is weak investment: business investment has fallen for three consecutive quarters to mid-2016, and this may be because businesses are not anticipating stronger economic growth and are therefore holding back on investing.

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

0.0%

-1.0%

-2.0%

Y-o-Y change Change over previous quarter

Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2013 2013 2014 2014 2014 2014 2015 2015 2015 2015 2016 2016


14

What the experts say – Industry confidenceThe next topic for consideration by the panel of industry experts concerned the seeming crisis of confidence in the US concerning the political and economic outlook, which is reflected in leasing industry confidence levels. Asset Finance International asked their views on this lack of confidence, its origins, the main constraints of leasing growth, and what might be the drivers going forward.

As in their earlier comments, the panel’s concerns pivoted round the presidential election, regulation and a low-growth economic scenario, both domestic and global.

First off, Adam Warner of Key Equipment Finance commented: “The level of political and legislative uncertainty is always higher during an election season. This presidential election, however, has caused an even greater divide between and within the political parties. This political fraction causes concern about effective governance and economic stimulus initiatives at the Federal level. Those sentiments effectively translate into decreasing confidence from both businesses and consumers. A healthier global economy that drives manufacturing, along with a more stable geopolitical climate, would bolster the sale and financing of US goods.”

Slower than expected economic growth is a primary contributor to lack of confidence, in the opinion of Fifth Third Equipment Finance’s Tom Partridge. “A lot of change has been placed on the business community over the past several years, whether it is increased regulation, universal health care, or unknowns around a changing marketplace,” he said, adding: “Many clients want to maintain strong balance sheets in case we experience another downturn.”

Dave Mirsky of Pacific Rim Capital provided a forthright opinion: “The lack of confidence stems from our very divided government and the differences in opinion running through our population.” He continued: “The party that is most likely to win the election is using hostile rhetoric in reference to business and free trade. Therefore,

most thoughtful organizations are being cautious until they can see the lay of the land and can get a better understanding of what policies a new administration will actually cause to happen.”

Gary Amos of SFS concurred, saying: “Economic uncertainty and today’s regulatory environment are causing customers to pull back and delay capital expenditures from already modest equipment acquisition budgets.”

A small uptick in the August MCI-EFI index is an encouraging sign for DLL’s Bill Stephenson, although he noted there remain various factors weighing on business investment and asset acquisitions.

One such factor is jobs. “Although we continue to see employment growth, the pace slowed again in August and continues to paint an inconsistent

The lack of confidence stems from our very divided government and the differences in opinion running through our population

Dave Mirsky, Pacific Rim Capital

14


15

recovery picture,” Stephenson said, adding: “Oil prices continue to hover at or below $50, which has a pervasive effect on many industries, not just the energy sector. Commodity prices are not yet rebounding with price levels on wheat, corn and dairy heavily impacting the US agricultural sector and pushing farm debt to income ratios to levels not seen since the mid-1980s.”

This was taken up by FAEF’s Alan Sikora, who observed: “Underperforming sectors like agriculture, oil and gas may be impacting the confidence levels of some industry executives.” However, he has hopes for the future: “As these sectors improve and overall economic conditions strengthen, the leasing industry will benefit.”

Bill Stephenson agreed, adding: “I think once we get the elections behind us, and start to see some rebound in oil and commodity prices, business investment will follow.”

And Chris Enbom of Allegiant Partners sees signs of a turnaround, stating: “I think some confidence indicators have increased again. After the political uncertainty is over, the biggest uncertainty will be with regards to rates, but I think rate uncertainty will affect the equity markets more than the equipment finance markets.”

Further factors affecting leasing industry confidence were suggested by Gary Amos: “An oversupply of lenders is creating rate compression

and increasing challenges to maintain profitability levels. The industry also faces a challenge to recruit talent, so there are certainly opportunities for companies, such as SFS, which can offer a global reach and have demonstrated financial strength throughout the recession.”

Finally, in his view, “The drivers going forward will be the financial providers that can apply industry expertise with market understanding to offer tangible solutions for customers. Instilling trust in our service offering and the return it can have for end users will be critical for all lending institutions moving forward.”

The drivers going forward will be the financial providers that can apply industry expertise with market understanding to offer tangible solutions for customers

Gary Amos, SFS


16

Market share of NBV by type of lender (%)

Source: ELFA (SEFA 2016), Asset Finance International

Lending trends

According to the SEFA report, banks remained by far the largest type of lender of equipment finance in 2015, increasing volume by 12% to $73 billion – a jump that was aided by Wells Fargo’s acquisition of GE Capital portfolios which had previously been categorized in the ‘independent’ segment. However, despite this the banks’ share of total NBV slipped marginally compared to the year before.

Furthermore, independents increased lending by 60% year-on-year to nearly $13 billion, thereby increasing market share regardless of the Wells Fargo/GE Capital deal. NBV provided by captives, however, only increased by 3% year-on-year to $37 billion, leading to a slide in market share to under 30%.

In terms of NBV by deal size, by far the largest year-on-year growth was in the large-ticket market segment which leapt by 34%, although the middle- and small-ticket segments still have considerably higher total volumes, at $58 billion and $41 billion respectively in 2015.

100

90

80

70

60

50

40

30

20

10

0

20152014

Independents

Captives

Banks

10.4

29.932.5

59.860.2

7.2

%


17

Businesses with growing vs declining NBV (%)

Source: ELFA (SEFA 2016)

NBV by market segment

Source: ELFA (SEFA 2016), Asset Finance International

It is noticeable that there has been a downward trend in recent years in the percentage of finance providers whose NBV has grown, from nearly 80% in 2013 to 65% in 2015, although it’s still a positive factor that nearly two-thirds of finance providers have experienced growth.

%

100

80

60

40

20

02011 2013 2014 2015

28.3

75.7

65.0

71.7

2012

35.0

69.0

31.0

78.6

21.424.3

Growing Declining

80

60

40

20

0

Large ticket Middle ticket Small ticket

4.0%

30.0%

20.0%

10.0%

0.0%

2014 ($bn) 2015 ($bn) Change (%)

$ bn

17.8 23.8

33.9%

12.4%

51.457.8

2.8%

39.941.0


18

Market prospectsThe Equipment Leasing & Finance Foundation (ELFF) publishes a quarterly projection of likely equipment and software investment, the Equipment Leasing & Finance U.S. Economic Outlook. It is sobering to see how the outlook has changed since the end of 2015, at which point the outlook was for “around 4.4% growth in 2016”, similar to if not a little higher than the level in 2015.

However, by April 2016, in its Q2 Outlook, the ELFF had revised down its projection: “We expect equipment and software investment to expand 2.7% this year, somewhat slower than the 3.8% growth rate in 2015.”

And in the Q3 Outlook of July, the forecast was much bleaker: “Given recent data and current momentum, we expect equipment and software investment to increase by just 0.9% this year, significant slowdown from last year’s 3.8% growth.”

Regarding specific market segments, ELFA figures for 2015 show that the equipment finance market was dominated by the transportation, IT, construction, and agriculture segments – no change from previous years, although of all market segments only transportation, IT and construction saw any growth over the previous year, and the only significant growth was in transportation.

Agriculture witnessed a particularly steep fall, from over 12% of the total to just 9%, and industrial & manufacturing equipment continued to slide and now has well under 4% of the market.

Equipment finance by sector, 2015

Source: ELFA

Transportation

IT & related services

Construction

Agriculture

Medical equipment

Office machines

Industrial/Manufacturing equipment

Materials handling

Energy

2.5%2.8%3.7%

4.2%

4.7%

9.1%

11.5%

29.7%

21.3%


19

Industry projections for 2016 are for sluggish conditions for most segments, with the best prospects for IT and medical equipment, whilst agriculture is predicted to fall further. Growth in transportation and construction is expected to remain subdued until the economy shows signs of real expansion, and energy will continue to suffer from global pressures on oil prices.

Financial institutions have been tending to tighten credit standards, with the MLFI-25 showing credit approval ratios to have eased from over 80% of decisions submitted in December 2015 to below 76% in July 2016.

What the experts say – Industry initiatives Asset Finance International sought the equipment leasing industry leaders’ views on what initiatives or changes the new administration might introduce following the election that would benefit their business and that of their clients.

Once again, the consensus was that over-regulation has been a brake on progress and relaxation of this would be seen as a positive signal and definitely beneficial for business.

Such a change can’t come too soon for Bob Rinaldi of Commercial Industrial Finance, who said: “If there was evidence that government’s grip on everything starts to loosen and the new regulations implemented over the past eight years start to be repealed then real economic progress will take hold due to a more positive confidence.”

It was widely agreed that the outcome of the elections will influence the future tone of a regulatory environment that has, in the words of DLL’s Bill Stephenson, “clearly been a challenge for our industry in recent years.”

Naturally, anything that encourages investment in capital equipment would be welcomed, and a lift in confidence to make such investment commitments would be helped by greater unity in government following a divisive campaign.

The new administration could start with tax reform, as proposed by Adam Warner of Key Equipment Finance: “In addition to working to heal the wounds from this election process, the US Congress needs to unify on comprehensive tax reform that would encourage capital formation.”

To this he added: “The continuation of tax incentives for clean energy sources is paramount to bolstering the sale and usage of solar panels, wind energy, fuel cells and other clean energy products.”

On this topic, Allegiant Partners’ Chris Enbom commented: “At the end of 2015 Congress passed new Section 179 legislation and alternative energy legislation that is good for five years, so we don’t expect any major changes to these tax laws unless there is sweeping tax reform – which is unlikely next year.”

However, in his opinion, the biggest issue the industry is facing is that of free trade. “Many equipment manufacturers in the US rely on free trade agreements for their supply chains and to


20

Paul Gogolinski CEO, Total Fleet Solutions, Poland

Bill Stephenson CEO and chairman of the

executive board, DLL

sell their products around the world,” he said, “and Trump talks about wanting to start trade wars, which would be pretty disastrous for many companies in the short term.”

Enbom continued: “In the longer run there is a lot of talk in Congress about overhauling the tax code, which I think would be harmful to the economy in the short term due to the uncertainty created around the new tax rules. The government cannot lose tax dollars, but would change the system – so new winners and losers would be created with the new tax system.”

Trading conditions and tax policy were also at the forefront for Dave Mirsky, who commented: “Pacific Rim Capital operates internationally, so we prefer anything that will make it easier to transact business across borders. On the other hand, if US manufacturers build more factories within the country, we will probably benefit from the increased purchases of material handling equipment. Tax policy also has a large impact on leasing and lease pricing, both to the good and the bad.”

He concluded: “As lessors, we will always prefer those policies that promote business investment. Entrepreneurial companies have to thrive under

any conditions, and as a result, we strive to remain flexible and responsive.”

And for Fifth Third Equipment Finance’s Tom Partridge, a period of stability after several years of increasing regulatory burden would benefit businesses. “We need a period of time where the business community will not experience great change so they can focus on the growth of their business as well as focusing on productively improvements through increased capital spending,” he remarked.

We need a period of time where the business community will not experience great change so they can focus on the growth of their business

Tom Partridge, Fifth Third Equipment Finance


21

Business confidence

A long-standing indicator of the equipment finance industry’s view of business conditions and expectations for the future is the ELFF’s Monthly Confidence Index for the Equipment Finance Industry (MCI-EFI).

The latest index for September 2016 stands at 53.8, a long way down from where it stood 18 months earlier on 72.1, and marking a continuation of a general downward trend that began back in March 2015.

MCI-EFI, Jan 2015-Aug 2016, with trendline

Source: ELFF MCI-EFI, http://www.leasefoundation.org/research/mci/; Asset Finance International

75

70

65

60

55

50

45

Jan-

15

66.3

63.0

66.1

62.6

67.4

58.7

54.0

51.6

59.1

55.1 53.8

52.3 52.5

48.3

61.1 60.2 60.2

72.4 70.7

67.5

Jan-

16

Feb

-16

Mar

-15

Apr

-15

Oct

-15

Nov

-15

Sep

-15

Aug

-15

Jul-1

5

Jun-

15

May

-15

Feb

-15

Dec

-15

Sep

-16

Mar

-16

Apr

-16

May

-16

Aug

-16

Jul-1

6

Jun-

16

54.8

Executives responding to the MCI-EFI question about how they see conditions for their business over the coming four months were split evenly, with 19% believing conditions will improve and 19% believing they will deteriorate, whilst the bulk of 62% are not expecting any change.

None of the executives expect more access to capital to fund equipment acquisitions over the next four months, a decrease from 13.3% the month before.

Taking a six-month viewpoint into the start of 2017, just 6% of the respondents at this stage believe that economic conditions in the US will improve, with 19% believing conditions will worsen and the remaining three-quarters expecting no change from the present.

http://www.leasefoundation.org/research/mci/


22

The collective wisdom of millions of small business owners is to hold off on borrowing and investing in their businesses

Small business hesitancy

A leading indicator of economic performance and business confidence among small businesses is the Thomson Reuters/PayNet Small Business Lending Index (SBLI). The July 2016 index figure of 121.5 represents a sharp drop from 139.2 in June, and is 16% down on the same month a year earlier, the largest decrease since October 2009. The general direction of the SBLI over recent months shows small businesses taking a more bearish view of the economy.

The companion Thomson Reuters/PayNet Small Business Delinquency Index (SBDI) for July 2016 shows the percentage of loans that are 31-90 days past due was at its highest level since December 2012. Compared to one year earlier, delinquency increased by 13 basis points, the largest year-on-year increase since December 2009.

As William Phelan, president of PayNet, Inc. commented on the release of these figures: “It’s too early to call a change in the business cycle, but the collective wisdom of millions of small business owners is to hold off on borrowing and investing in their businesses,” adding: “This all means greater risk for the underlying credits and most likely rising defaults of private companies over the next 12 months.”

Caution certainly seems to be the watchword amongst small businesses. Results from California-based direct lender Balboa Capital’s Q2 2016 small business owner survey reveal a decline in revenues after a strong first quarter but optimism for the future. “The slight downturn is somewhat consistent with what we are seeing among the small business owners we work with. They are continuing to invest in their companies, but are taking a more strategic and cautious approach,” says Jake Dacillo, marketing director at Balboa Capital.

Elsewhere, a snapshot of Midwestern businesses’ attitude to equipment finance comes from a September 2016 article in the Milwaukee BizTimes, which notes that slow economic growth has tended to make firms rein in spending, and where capital outlay has been necessary – primarily to replace equipment rather than for expansion – companies have been using cash that has been accumulating. Businesses have also been using excess cash to reduce their debt loads.

https://www.biztimes.com/2016/09/05/when-push-comes-to-shove-companies-are-investing-in-equipment/


23

However, while lending levels have been fairly static it may be the need to increase efficiency that encourages investment, a view expounded by Tom Rude, first vice president of Equipment Finance at First Business Bank-Milwaukee. “There’s a cautiousness, there’s still uncertainty, but there comes a point when companies need to make the investments in their business to stay current with technologies, to stay current with productivity,” he says.

A considerable influence on this cautious outlook is the deadening effect of the build-up to the presidential election, with businesses putting investment decisions on hold as the result is too close to call. And in truth the result when known may not ease the hesitancy.

The ELFA’s Ralph Petta summed up the sentiment that has been building in the industry back in May when he said: “Erosion in business confidence due to misgivings about the November presidential and congressional elections and what they portend for the future direction of the nation, an unexpectedly negative May unemployment report, an economy barely growing, and a series of violent events both here and abroad provide a negative backdrop for business owners considering making capital investment decisions.”

There’s a cautiousness, there’s still uncertainty, but there comes a point when companies need to make the investments in their business to stay current with technologies, to stay current with productivity


24

What the experts say – Small business awareness of equipment financeIt seems that many smaller businesses still lack awareness of the benefits of equipment finance and are reluctant to invest in relevant new technology. Asset Finance International asked the panel of industry experts for their views on how the industry can improve this situation.

Reactions to this were varied, with current ELFA chairman Bill Stephenson and past chairman Bob Rinaldi defending the association’s work, particularly through the Guest Lecture Program.

Stephenson commented: “One of ELFA’s core efforts this year was to continue to increase awareness of the industry amongst both prospective customers and employees. The Guest Lecture Program, for example, not only serves to educate young professionals about the career opportunities that exist for them, but also informs the future business leaders of America about the enabling role the equipment finance industry plays in the economy and business community.”

And Rinaldi observed: “Due to the weak economic conditions, demand for borrowing is down while the supply of funds is high. This may be contributing to a lack of growth in the industry for the small business sector. But having said that, the industry can and is increasing its outreach to the business community, more specifically the emerging business people of tomorrow. The ELFA is doing that by expanding the Guest Lecture Program and having more of our members deliver the GLP to finance, accounting and masters and undergraduate students at universities and colleges across the US.”

However, Tom Partridge thought that more could be done: “The industry needs to do a better job of educating the client on technology improvements and how these improvements can lead to increased productivity. The industry also needs to do a better job of explaining the true cost of leasing to the client.”

Others on the panel were strong advocates of the importance of technology adoption. Adam Warner stated: “The most effective way to educate small businesses on how lease financing can enable them to acquire needed technology is to ensure that technology salespeople are discussing finance options at the beginning of their sales process. This means that lessors active in the technology vendor finance arena need to continually provide training on how to introduce financing as the primary way for customers to acquire technology solutions. With the movement to SaaS, cloud and services financing, this training becomes even more critical.”

Chris Enbom cited his own company as an example that many small businesses are well aware of technology, saying: “We are a small company and we invest very heavily in technology.”

He elaborated on this: “I think there are many more managed/cloud services that businesses use, and companies are becoming more comfortable in some situations with a bigger ‘managed services’ component to their businesses. I think it is creeping into many small businesses (think of reservations systems for restaurants like Open Table) that tech companies take a big share of the new business. Equipment finance companies need to be thinking about this new model as well (we certainly are!).”

Gary Amos took this up, stating: “With the internet of things changing the landscape of how we do business, smaller organizations now find themselves managing marketing automation and customer relationship management tools by a more virtual approach. Equipment financing can


25

enable organizations to adopt the technology and platforms required to more successfully conduct business across a variety of industries.”

He continued: “Organizations need to be more transparent about the benefits they can provide to end users, and how they can help them through the most cost-effective means. Through transparency and properly educating our target audiences we will find more willingness for smaller businesses to adopt our offerings in the future.”

Technology specialists Brendan Gleeson and Jonathan Dodds of White Clarke Group stressed the importance for small businesses not only to adopt innovation but to adopt the right innovation. “Business owners know the world is shifting increasingly online, and companies are scrambling to keep up with the sudden dash for digital,” said Gleeson. “What matters most is getting the best fit for their requirements, and for small businesses this means technology that adapts as conditions change and the business grows.”

“In a situation where there is uncertainty regarding economic growth, smaller businesses are going to be extra cautious about capital outlay,” added Dodds. “Lessors and vendors need to

demonstrate to the customer how efficient and flexible their offerings are, and that financing can accelerate business growth.”

As Alan Sikora said, “Equipment finance can be a powerful strategy for small businesses to acquire the technology they need,” adding that “Leasing companies must engage with small businesses to understand their needs and provide the tools and resources necessary to ensure entrepreneurs make informed decisions.”

Business owners know the world is shifting increasingly online, and companies are scrambling to keep up with the sudden dash for digital

Brendan Gleeson, White Clarke Group


26

Auto sector finance trendsThe US auto sector has been in robust health in terms of sales and growth in finance in recent years, but even here the current year has seen a plateau and a deceleration.

In fact, according to a monthly sales forecast by J.D. Power and LMC Automotive, the seasonally adjusted annualized rate (SAAR) for new-vehicle retail sales for August 2016 is expected to be down by 6.5% at 13.2 million units compared to 14.2 million units in August 2015.

Likewise, the SAAR for total sales of passenger cars and light commercial vehicles is expected to fall by 5.2% to a projected 16.8 million units in August 2016, down from 17.7 million units a year earlier.

This will be the fourth decline in sales in six months, which comes as a shock following 66 straight months of growth.

However, fleet sales are expected to exceed 223,000 in August 2016, a 3% increase year-on-year, thus accounting for 15.0% of total light-vehicle sales.

The above SAAR projections are broadly in line with predictions from the National Automobile Dealers Association (NADA). According to NADA’s chief economist, Steven Szakaly, trends that could slow down vehicle sales growth in the coming years include: “The ageing vehicle fleet discourages long-term vehicle sales; average loans terms for new vehicles have risen to 68 months; and new-vehicle transaction prices are continuing to rise, up about 3% this year, while wages remain stagnant.”

On the other hand, he highlights the main factors that will continue to grow and drive sales as rising employment, low gasoline and diesel prices, and leasing, adding: “Leases are increasing, which now accounts for more than 34% of the market.”

Leasing bucks the downward trend

This assessment of the value of leasing equates with that provided by Experian’s State of the Automotive Finance Market report for Q2 2016, which shows a year-on-year increase in the percentage of new vehicles acquired with financing, from 85.8% in Q2 2015 to 86.5% in Q2 2016. The proportion of new vehicles financed by leasing has grown more impressively, up from 26.9% in Q2 2015 to 31.4% in Q2 2016.


27

Leasing – auto market share, with trendline

Source: Experian Automotive, Asset Finance International

Looking at the share of the market by lender type, the ‘finance’ segment, which includes leasing, has fallen back from 13.4% in Q2 2015 to 11.6% in Q2 2016 of all vehicle sales, and has slipped to below 5% of the market in new vehicle sales.

Meanwhile, the captive segment has increased share of all vehicle sales from 26.8% in Q2 2015 to 27.7% in Q2 2016, marking a gradual upward trend over recent years. This segment has also increased share of new vehicle sales to well over half the market total.

Auto finance market share by lender type, Q2 2016

New & used vehicles

Source: Experian Automotive

New vehicles

35.0

30.0

25.0

20.0

15.0

10.0

5.0

0.0Q2 2011 Q2 2012 Q2 2013 Q2 2014 Q2 2015 Q2 2016

%

Finance Bank Captive Credit Union BHPH (Buy Here, Pay Here)

34.8%

11.4%

27.7%

18.7%

7.1% 11.6%

31.7%

0.2%

4.6%

52.2%


28

Leasing penetration by age group, Jan–Apr 2016

Source: Edmunds.com

In addition, Experian data reveal that 30-day delinquencies have increased across all lenders apart from credit unions, with the total market rate for loans and leases standing at 2.22% in Q2 2016 (2.19% in Q2 2015).

The Experian report notes that “leasing remains very prime as more consumers across all risk tiers choose to lease”. The Q2 2016 figures show prime and super-prime accounting for close to 75% of new leases, but there continues to be a gradual increase in risk in auto leasing, with sub-prime lending rising to a recent high of 7.4%.

Further industry information from online resource Edmunds.com shows that the number of vehicles leased in the first half of 2016 totalled 2.2 million, double the total for the first half of 2011 – an impressive rate of growth over five years.

The Edmunds.com research indicates non-traditional categories such as pick-up trucks and compact cars are leading lease volume growth. The attractions that leasing offers of low monthly payments and ease of ownership have been taken up particularly by older buyers, with leasing penetration increasing by 74% over the last five years among buyers aged 75 and above, although proportionately the age group with the highest leasing level is the millennials.

The research also reveals that while new vehicle purchasers are much more likely to be male than female (58% to 42% respectively), the pattern changes for vehicles acquired through leasing with a higher percentage of lessees being female.

36.0

34.0

32.0

30.0

28.0

26.0Millenials 35-44 45-54 55-64 65-74 75+

Ages

%

32.4%31.7%

30.0% 29.9%

32.3%

34.2%


29

Finally, there should be mention of the alternatively fuelled vehicle sector, which includes electric vehicles and hybrids. As in many countries the concept is slow to gain a footing in the US, particularly with fuel prices continuing to be low if not actually falling in recent months.

It is initially encouraging then, to note that in the first half of 2016 sales of alternatively fuelled passenger vehicles grew 18% on the same period the year before – a striking rate of growth until the actual numbers reveal total H1 2016 sales to be fewer than 64,000 (Source: EV-Volumes).

So despite plug-in hybrid electric vehicle (PHEV) sales achieving a record market share in June 2016, this was still just shy of 1%. Estimates are for 150,000 sales in 2016, a sector high and surely one that will continue to grow, if slowly.

What the experts say – Investment in technologyAsset Finance International asked the panel of equipment finance industry leaders whether it is valid to assert that US lessors are themselves guilty of underinvesting in technology. Should the industry be investing more in technology to deliver smarter solutions for customers?

The panel did not see underinvestment as an issue – certainly not in relation to their own operations – but was appreciative of the risks of not investing.

According to Bob Rinaldi, for some lenders lower investment in technology may have been a case of prioritizing other demands following the financial crisis. “Many lessors have invested more in compliance which has gobbled up most of their budgets,” he said, adding: “Moreover, the very low interest rate environment has compressed net interest margins severely on equipment loans while also making equipment leasing less attractive due to these low borrowing costs. So, in short, expense up, margins down, and a weak economic growth climate leading to less demand or willingness to spend on technology.”

Dave Mirsky stated: “Leasing is a low margin, competitive business that should be driving all lessors to become as efficient as possible. In addition, the business customer is demanding ever more rapid and mobile solutions to leasing concerns which should provide an impetus for the industry to invest more into technology. Pacific

Rim Capital has invested heavily into technology in recent years and has focused on analyzing and improving our systems with the goal of becoming more efficient while maintaining and improving our already excellent customer service. Every lessor should be doing the same.”

For Adam Warner there are several trends that warrant deeper investment in technology solutions by US lessors. “First,” he said, “there has been

In short, expense up, margins down, and a weak economic growth climate leading to less demand or willingness to spend on technology

Bob Rinaldi, Commercial Industrial Finance

29


30

a drive over the past few years to provide self-service options for business clients. Second, there is a clear movement to get data through mobile devices, even for businesses. Finally, as businesses look for more options to pay for usage and access rather than equipment, lessors need more robust variable financing options.”

In addition, he noted, “The need for a lessor to increase its technology spend will depend largely on the industries and clients the company serves. For example, lessors that largely serve smaller businesses will see a greater demand for mobile solutions, as their clients’ behaviour is closer to that of a consumer.”

There is also a small but growing challenge to established lessors from alternative sources of funding, provided by new, agile companies that use cutting-edge technology. “This dynamic group of finance providers,” said White Clarke Group’s Jonathan Dodds, “such as peer-to-peer funders and crowdfunders, are taking a lead in technology use and development – partly because they are already solely online platforms. They are making it easier for start-ups and small companies to raise capital through their flexibility. They are fast, responsive and smart.”

And his White Clarke Group colleague Brendan Gleeson added: “Company formations are on the increase again – the Kauffman Index of Startup Activity, which measures new business creation,

has registered its biggest upswing since before the financial crisis in 2015 and 2016 from a 20-year low in 2014. There are entrepreneurs who are looking for equipment finance and they’re often going to look to new, tech-savvy funding methods.”

For Alan Sikora the outlook is straightforward. “Clients demand and deserve both personalized service and convenient digital experiences. To thrive in the years ahead, equipment lessors must make technology investment a priority,” he said.

Bill Stephenson’s view is that, while overall investment in technology has been high, the industry has been slow to innovate when it comes to creating new, more efficient ways of doing business, but he sees that starting to turn around. He said: “Our business models are being challenged by alternative forms of financing, and while it’s yet to be decided whether these microfunders and fintechs have a viable business model, the uncertainty is enough to cause concern. This pressure is forcing lessors to pay attention to where the industry is headed.”

He continued: “We also need to look at the equipment supplier side of the equation because technology will disrupt many of the traditional distribution channels used today to sell equipment to customers, and in turn, will disrupt how leasing and finance solutions are introduced to these customers at the point of sale. Our partners and customers want to conduct business with us in new ways, and we need to meet their requirements or risk losing the relationships we’ve built. We no longer have an option when it comes to investing in technology.”

Finally, Gary Amos observed that “acquiring new technology is the right solution for business if the return is greater than the initial investment.” He continued: “The right investment opportunity, coupled with the proper financial solution, truly showcases the value that new technology acquisitions can provide.”

He also pointed out that “equipment financing and leasing companies will find greater success if they more clearly educate their respective industry stakeholders on the returns that investing in new technology can have for their business.”

This dynamic group of finance providers are making it easier for start-ups and small companies to raise capital through their flexibility

Jonathan Dodds, White Clarke Group


31

Technology – The top priorities for auto financing sourcesAuto finance specialist Marguerite Watanabe looks at technology improvements in this sector

Ask any auto finance executive about their strategic goals and technology improvements will be one of them. In fact, for the American Financial Services Association (AFSA) Vehicle Finance Advisory Board, Technology Improvements (e.g. new systems and software, eContracting, reporting tools) has been selected as the number one opportunity for five straight years. Technology improvements can be further classified as replacing legacy hardware, adding or replacing software, applying new tools and analytics or introducing new plug-ins or, more frequently, developing apps, all having a consequential impact on the business.

The justification for technology improvements

The rationale as to why technology improvement is identified as a top priority is very easy to understand. Generally speaking, technology not only enhances operational capabilities, but often workflow and cost efficiencies can be gained. The reasons apply across the industry regardless of corporate ownership (public, private equity, privately owned), size (large to small), geography (national, regional, local), credit spectrum (prime, near prime, non-prime) or dealer focus (franchised, independent).

All auto financing sources must replace their ageing legacy systems at some point, though many try to put off doing so for as long possible. This could involve a replacement with a completely new platform from a new service provider, an upgrade to a new platform with the same provider or a move from in-house to hosted platforms with a new or current provider. Another case could be that the old platform can no longer be supported by the provider or internally with outdated programming or need for greater security. Or it could be that change is necessitated as a result of a merger and acquisition situation.

By and large, the expansion of functionality is the most common reason for captives, banks and auto financing companies to introduce new technology. This could be to improve operational processes and efficiencies or reduce costs, but it could also be to maintain a competitive advantage, fulfil compliance requirements or improve dealer or customer satisfaction.

With all these solid arguments for investment, it would seem a straightforward justification for new and improved technologies. There are just as many explanations, however, as to why technology projects don’t get off the ground. The most common of these is that getting proper prioritization on an IT project list, especially in large companies, can seem like it would take an Act of Congress or Parliament. There are simply too many other things that always seem to have priority for one reason or another. Another is that the new technology may have too great of an impact on legacy systems or it could interfere with a larger ongoing technology project. And sometimes it is merely too hard to justify the project because it is a challenge to adequately show the return on investment or to clearly demonstrate the need versus the want.

Technology improvements most often evaluated and implemented today

The functional viewIn the area of risk management and account acquisition or originations, there is a great amount of activity. For all the reasons named above, there have been multiple auto financing sources that have had loan origination and servicing system updates and replacements over recent years, many featuring more flexibility and configurability.


32

Newer technology advancements are focused more on greater workflow efficiencies, optimized decisioning and pricing, deal structuring and application and contract data verification. eContracting, though not new, continues to grow and evolve with a greater emphasis on validation. And, more and more, auto financing sources are wrestling with how to meet the needs of the online or digital consumer seeking to apply for financing with either instantaneous approvals, ‘pre-screens of one’, or pre-qualifications, the key being that it shows up as a soft, not hard, inquiry on the credit report.

With respect to account servicing and payment processing, there have also been a number of replacements and updates with legacy servicing systems. Moreover, there have been many payment processing providers seeking to allow their auto financing clients to offer their customers ways to pay anytime, anywhere, in any way desired – i.e. on the customer’s terms. More recently, there have been many auto financing sources also looking to improve their communication channels with their customers, including via text and social media. “Today’s customer expects lenders to be always available. Customers want active control and expect lenders to provide the right science and technology to assist them in their decision-making process and in communicating with the lender.” says Ken Kertz, Director, Auto & Motorized Segment at FICO.

Within the loss management domain, optimized collections has always been a focus for auto financing sources as well as workflow improvements with the goal to be top of mind of the delinquent customer for their share of wallet. Using technology and analytics to accomplish this objective is a never-ending task, but one that has become more refined over time with the use of data, analytics and tools.

Finally, in the area of wholesale financing, a number of dealer financing sources – captives, banks and independent dealer financing lenders – have been upgrading their core systems and looking at ways to improve their audit processes. With dealer financing proving to be a growing way to increase the ‘stickiness’ in the dealer-finance source relationship, technology that focuses on building dealer

satisfaction becomes even more important. Auto financing sources can provide insights and analysis on dealer performance and customer management opportunities. Technology enhancements can also mean improved lead generation programs that take into consideration the learning from a financing source’s data analysis.

The enterprise viewDue to the pressure and demand for more accountability and due diligence from regulators, shareholders and funding sources, staying on top of compliance reporting requirements and preparing for exams and audits is crucial. This has led to added emphasis on monitoring internal performance metrics and external benchmarking measurements. Anticipating the need for enhanced and automated reports would be the next step. Being able to modify and remedy processes quickly and seamlessly also requires improved technologies. Other enterprise compliance areas in which new technology is being implemented include training of executives and employees at all levels and managing third-party service providers.

The need for greater fraud protection and cyber security is another key area in which new technologies are being considered. For defence against threats which include ID theft, spam and phishing, hacking, malicious software, malvertising, drive-by downloads, ransomware, DDoS attacks and botnets, financing sources, auto and other, are fortifying their systems and data walls. It seems that this area, too, will soon be regulated.

Finally, there is data, big and small. Auto financing sources are looking to maximize the analysis and use of their own valuable data such as applications, bookings versus approvals, payment history and lease returns. They are also looking to incorporate non-traditional data (e.g. non-traditional credit reporting, utilities, social media) along with the traditional (e.g. traditional credit reporting, vehicle values) into more effective decision-making by layering risk with more sophisticated data analytics and tools. According to Nikh Nath, CIO of Nationwide Acceptance, a non-prime auto finance company operating in 24 states, “The new generations of data tools and services that


33

can mine the vast realms of public and corporate data are ubiquitous. The application of predictive analytics to the entire lifecycle of a loan from originations to loss mitigation could have the largest impact on the lender’s bottom line.”

The key to getting ahead with technology

If auto financing sources want to truly work toward breakthrough improvements with technology for the benefit of their companies as well as for their customers, they will need to place more energy into improving those technologies that can significantly result in building transparency with the consumer, reducing time to fulfil the financing offer and providing enhanced options to the consumer.

For internal benefits, auto financing sources must seek to enhance their business effectiveness without compromising current production levels or dealer and customer satisfaction. “At Toyota Financial Services, we are exploring blockchain technologies and have recently joined R3CEV LLC’s blockchain consortium. We believe distributed and shared ledger technology can greatly boost efficiencies and may have huge potential applications in auto financing,” says Ann Bybee, vice president, Corporate Strategy, Toyota Financial Services.

Using technology to improve the customer experience is still relatively untapped. While a number of auto financing sources offer online and mobile payment options today, future technology improvements will focus on the loan origination process. New market entrants with mobile financing platforms that offer the consumer the desired transparency into the financing process, greater consumer-facing options, time savings and improved customer satisfaction are being introduced. As it was back in 2001 when the dealer financing platforms, DealerTrack and RouteOne were introduced in the US, soon the introduction

for consumer financing platforms that engage the customer without alienating the dealer will become widespread.

While the debate between franchised and direct vehicle sales channels will continue, it is likely that dealers will remain a vital and valuable choice for consumers. We know that ‘disruptive technologies’ (e.g. Amazon, Netflix and Airbnb) have impacted other industries in remarkable ways. Though we have seen the start of it in the automotive industry with ride sharing, autonomous vehicles and connected cars, auto finance hasn’t yet experienced its ‘disruptive’ episode. According to Serge Vartanov, CMO of AutoGravity, a FinTech (financial technology) company that enables customers to access auto finance offers on their smartphones, “The potential of emerging technology to reinvent the auto finance experience is unprecedented. Digitally savvy customers are seeking convenience, transparency and empowerment – all in the palm of their hand. Rapid migration to smartphone-based auto financing will be transformational for lenders and dealers who embrace the technology.”

There is much interesting and meaningful dialogue to look forward to around technology in our industry. What ‘disruption’ could bring to auto finance organizations offers an exciting future.

Marguerite Watanabe is president of independent consultant Connections Insights. Connections Insights has worked since 2006 with international clients, including auto financing sources, auto manufacturers, software and data providers, business processing outsourcers, consulting firms and trade associations.

+1 678-520-3385

[email protected]


34

What the experts say – Lease accounting changesFinally, Asset Finance International asked the panel of experts for their views on the new lease accounting rules and their implications. Are lessors (and lessees) up to speed with the changes after such a long period of deliberation from the lease accounting Boards, and should more be done to ensure the changes are widely understood and correctly put into practice?

First, it was generally acknowledged that the ELFA has initiated a major educational drive to ensure lessors are aware of the new rules. However, opinion varied as to how widely they are understood by lessees.

FAEF’s Alan Sikora commented: “We are finding that lessees are aware that the accounting rules are changing, but may be uncertain about the impact on their specific organization. As lessors, it is crucial that we educate our clients on the lease accounting changes and the benefits of leasing beyond accounting treatment.”

Adam Warner of Key Equipment Finance agreed, saying: “I believe most lessors understand both the impacts to them as a lessor and to their lessee clients,” but added: “The understanding of the new rules by lessees varies widely. Larger corporations that lease millions of dollars of equipment seem

to be more up to speed on the changes, and a lot of that education is coming from their accounting firms. Smaller businesses may be a bit behind their larger counterparts because the impact might not be as significant to them.”

This last point was taken up by Chris Enbom of Allegiant Partners: “Our company works mostly with very small companies which mostly do loans. I think larger companies are beginning to look at the new rules, but there is a lot of education that needs to be done.”

He added: “Companies like ours that do mostly equipment finance agreements will move to using primarily loan accounting so they can continue to amortize up-front costs.”

And Bob Rinaldi of Commercial Industrial Finance highlighted the fact that the new rules won’t apply to all leases by any means. “As the convergence date gets closer to reality, lessors will start to pay closer attention,” he said. “The thing to keep in mind, though, is that roughly only 10% of total equipment financing is done in the form of operating leases. So, many of those lessors that are not in that business aren’t really paying attention to it at all since it doesn’t apply to them.”

In the opinion of Fifth Third Equipment Finance’s Tom Partridge, “Lessors are making progress on understanding the new standards. That being said, more work needs to be done. More organizations are going to have to adapt their sales strategies which will require a better understanding of the accounting changes.”

It is crucial that we educate our clients on the lease accounting changes and the benefits of leasing beyond accounting treatment

Alan Sikora, FAEF


35

As an executive committee member of the Board of the ELFA, Dave Mirsky of Pacific Rim Capital gave the association his full backing for the work it has done in educating the leasing community, adding: “I would hope that the details are well understood by lessors. I think that the implications for business are yet to be seen and will depend on the reaction of lessees to the new accounting rules and whether the increased administrative burden will affect overall demand for leasing.”

And DLL’s Bill Stephenson, the current ELFA chairman, concluded: “At this point, I believe lessors are up to speed with what the changes mean for our industry, but I expect we will be continuing to educate and support our partners and customers over the next couple of years.”

He continued: “The ELFA has developed a multitude of documents and communications materials to assist members in their preparations.

The most important thing to remember is that, while the balance sheet treatment of some financial structures may be changing, all other benefits of leasing will continue to exist for lessees (e.g. capital conservation, managing obsolescence).”

I expect we will be continuing to educate and support our partners and customers over the next couple of years

Bill Stephenson, DLL


36

Lease accounting rules issued in 2016Bill Bosco, advisor to the ELFA, provides an update on the latest developments in the lease accounting project

The Lease Accounting Project has finally concluded as the International Accounting Standards Board (IASB) issued their version in January 2016 (IFRS 16) and the Financial Accounting Standards Board (FASB) issued their version in February 2016 (ASC Topic 842). This paper focuses on the FASB version and points out key differences from the IASB version. For US public companies the transition will occur in 2019 in financial statements for periods beginning after 15 December 2018. It should be noted that the SEC requires three years of comparative income statements and two years’ comparative balance sheets. This means that for public companies 2017 is the start for capturing data for reporting in 2019. For private companies the transition year is one year later, or 2020.

The lease accounting change project began as a joint project with an objective of converging on a worldwide set of rules. The idea of convergence was dropped when the FASB and IASB took different views on whether all leases were the same for lessee accounting. They did continue to meet jointly and the rules are not too far apart in most other areas. The major objective of capitalizing most operating leases was achieved in both standards. The two standards have major differences in lessee accounting but lessor accounting is substantially converged as they adopted existing GAAP for lessors with a few changes. One difference in the versions of lessor accounting is the FASB decided to incorporate concepts from the new revenue recognition standard for determining when a sale takes place in sales-type leases, whereas the IASB did not.

Overview of the impact

Although for lessees there will be a dramatic change in assets and liabilities, the resulting financial ratios and measures and the work to account for leases, there should not be a major change in the propensity of US companies to lease. The business reasons for leasing in the US remain strong. Also the accounting

presentation and cost recognition for operating leases by US companies will be favourable as the FASB recognized that operating leases should be accounted for differently from finance leases. Only the present value of the operating lease payments goes on balance sheet – not the full cost – and the liability is not classified as debt. The operating lease cost remains as the straight line average of the lease payments. US lessees will continue to want operating lease classification but there will be an increased emphasis on keeping the amount capitalized as low as possible. The IASB version is not so true to the substance of operating leases as the liability is classified as debt and the cost pattern is front loaded just like a financed purchase of the asset.

Preparing for the new standard

It is important for both lessors and lessees to plan ahead for the new lease accounting standard. Lessors will have only minor changes to systems since the lessor models are retained with few changes. Lessors may be motivated to tweak product offerings but there is time to do that. Lessees should be more concerned with transition due to the immensity of the project and the added complexity in accounting for the operating lease on balance sheet. They’ll need a lease accounting system. They will also need to gather all their existing lease documents and begin extracting key data on rent payments, variable lease payments, separating elements of gross lease payments, and renewal and purchase options. They also should be thinking of changing their leasing strategies to minimize the capitalized value of future leases and sale leasebacks that they are working on. This is a large project for big companies and merits a project team and plan.

Lessees will also have to develop a process for accounting for new leases with internal controls. Since operating lease obligations were only reported in the footnotes, existing processes are inadequate.


37

More information will be required regarding the determination of the lease term and lease payments. Lessees will need to evaluate renewal and purchase options to determine if any are reasonably assured of exercise. They will need to determine if any payment is likely under residual guarantees it is providing to lessors. They will need to track variable rents based on an index (such as CPI) or a rate (such as LIBOR) and possible payments under residual guarantees.

There are concerns regarding how preparers and their audit firms will deal with judgment areas under the new rules. Because operating lease payments will be capitalized there will be more scrutiny on lease payments and the lease term. Examples of areas of concern are: defining the lease term where renewal options exist (especially synthetic leases); and estimating the lease and non-lease portions of gross billed leases with services (full service leases).

Lessor issues

As for lessor classification, both Boards agreed to retain their respective lessor models. IASB lessors will look to the IAS 17 model for classification while the FASB will retain their FAS 13 model with minor changes. The FASB dropped the 75% useful life and 90% present value bright lines from the actual classification tests, but formally stated that those values could continue to be used as guidance. Overall, the decision to maintain the basic lessor models is viewed as good news because it means lessors can continue to use their current lessor accounting systems with minor changes.

The new rules changed the definition of initial direct costs (IDC) to be incremental costs of a lease that would not have been incurred if the lease had not been obtained. This excludes most legal costs and all internal allocations of overhead. Sales commissions are still included. This is a major change for those lessors that allocated overhead associated with originating leases under the existing rules for IDC. Also, the IDC is included in the implicit rate to amortize lease revenue making it clearer as to how IDC is amortized.

The FASB included Investment Tax Credits (ITC) in the definition of the implicit rate. This is good news as ITC, although only allowed for alternate energy assets, can now be included in lease revenue and amortized.

The FASB decided to conform certain issues to the new Revenue Recognition concept of control to define whether a sale has occurred. As a result, sales-type classification is only allowed under the FASB version where the terms of the lease alone transfer control to the lessee. This approach ignores any third party involvement such as a residual guarantee or residual insurance to increase the cash flows considered in the present value (PV) test. Third party involvement would still be a consideration in determining if a lease is a finance or operating lease. The difference is if third party involvement is needed to increase the PV to qualify as a finance lease, it is not a sales-type lease and the ‘gross profit’ is deferred and amortized as lease/interest revenue. Said another way, the implicit rate used to recognize lease revenue is very high as it considers the asset cost as the investment amount in the implicit rate calculation. This change impacts US vendors and dealers who have used residual insurance to achieve sales-type lease treatment. They will have to evaluate their options under the new rules as the timing and presentation of revenue will change dramatically. To preserve gross profit presentation they may have to sell their leases to a third party or a non-consolidated partnership.

Sale leasebacks with purchase options will need careful review and structuring to avoid loss of sale treatment and operating lease treatment for lessee customers. The FASB does provide additional guidance versus the IASB to determine if a sale has taken place in a sale leaseback when a purchase option is included in the lease terms. The FASB allows sale treatment where the purchase option is at fair market value and the asset is not specialized and is readily available in the marketplace. Both the FASB and IASB do not allow sale treatment if there is a fixed purchase option in the leaseback even if they are non-bargain options.

Leveraged leases will be grandfathered for US lessors but leveraged lease accounting will not be allowed for new leases commencing after the transition date. This impacts only large ticket transactions and the market will adjust to other structures like partnerships to achieve almost the same benefits as in a leveraged lease.

Lessee issues

The FASB and IASB versions differ as to when a lessee must adjust a lease for changes in variable


38

payments due to a change in an index or a rate. The IASB requires lessees to adjust lease accounting when the contractual rents change. To simplify compliance, the FASB requires recording a change only when an action by the lessee modifies the lease, changes the lease terms, elects an option or does something in its control to change whether it is reasonably certain to exercise an option.

Bank and securities regulators have not opined on the regulatory capital treatment of the new capitalized operating leases. There is a concern as their policy generally is to follow GAAP. It is not the intent of the FASB to drive economic activity so it will be up to the leasing industry and regulated lessees to fight to retain the same ‘no capital needed’ treatment afforded operating leases as they are executory contracts that have no impact on a liquidation.

US investment grade lessees will not see much change on the ratios and measures as their analysts and lenders are sophisticated and ‘get into the numbers’ in detail. Small and medium-sized companies many have to assist their lenders, which often are smaller banks and finance companies (possibly not as sophisticated as those that deal in the investment grade market) with calculations, especially in treating the operating lease liability as a non-debt liability. Return on assets (ROA) will be the most important measure lessees will focus on and try to improve through lease structuring.

The IASB one lease model will cause most ratios and measures to change for the worse. IFRS companies will see the ratios and measures deteriorate for three reasons: more assets on balance sheet (reduced ROA, quick ratio); accelerated costs (reduced ROA); and permanent lost equity (increased debt to equity). Strangely, EBITDA increases as above-the-line rent

expense is replaced by below-the-line interest and amortization.

It is likely the market will adjust to the new rules as an accounting change like capitalizing leases should not change the financial strength of a company. In addition, the change in lease accounting will impact all companies. One concern is that there will be more significant changes to the financial statement of those companies that have longer-term leases and/or lease more assets than their peers.

A look ahead

The US market should see little impact when the rules take effect because of the FASB’s decision to retain the two lease model where capitalized operating leases are separately reported in ways that reflect their substance. The business reasons for leasing remain strong as lessees lease for reasons of preserving bank lines and capital, low-cost 100% financing/liquidity, managing tax benefits, managing assets (need, use and obsolescence), outsourcing service, and convenience of point of sale financing. The accounting reason for leasing will remain to the extent that only the present value of the asset is on balance sheet, the liability is not debt and the lease expense matches the use benefit (straight line). The regulatory benefits should remain if we successfully advocate with the regulators.

Impact to lessee ratios and measures

Key Ratios/Measures FASB version IASB version

EBITDA No change Better: rent replaced by amort/interest Gross Margin No change No change Operating Efficiency Ratio No change Better: rent replaced by amortizationCurrent Ratio* Worse: asset not current/additional liability Worse: asset not current/additional liabilityQuick Ratio* Worse: additional liability Worse: additional liabilityNet Worth No change No changeLiabilities to Net Worth* Worse: additional liability Worse: additional liabilityDebt/Equity Ratio No change Worse: additional liability + eroded equityReturn on Assets (ROA) Worse: additional asset Worse: additional asset + front-ended costsReturn on Equity (ROE) No change Worse: front-ended costs

*It can be argued that including operating lease liabilities that disappear in a liquidation is not correct

Bill Bosco is the Principal of Leasing 101, a member of the ELFA Financial Accounting Committee since 1988, and a member of the FASB/IASB Leases Project working group.

Note: For the latest updates, visit the ELFA lease-accounting web page at http://www.elfaonline.org/industry-topics/lease-accounting

38

http://www.elfaonline.org/industry-topics/lease-accounting

http://www.elfaonline.org/industry-topics/lease-accounting


39

The legal and regulatory environmentStephen Whelan assesses recent developments in the US equipment and auto finance market

The year 2016 has witnessed several noteworthy developments in equipment and auto finance from various courtrooms. This article will discuss some notable decisions.

True sale

In In re Dryden Advisory Group, LLC, a bankruptcy court in Pennsylvania considered whether a factoring agreement functioned as a true sale of accounts receivable or constituted a secured financing agreement. The court upheld the purchase contract and security agreement as a nonrecourse sale of accounts, concluding that the arrangement constituted a true sale because, even though the seller continued to bill and collect for receivables (as agent for the buyer), the receivables were not commingled with the seller’s general operating funds but rather were to be held in trust for, and to be immediately turned over to, the buyer whenever payment on any account was received. The court cited the buyer’s ability to demand payment directly from account debtors, as well as the absence of recourse against the seller (except in very limited circumstances), as support for its finding that the transaction was a sale. This decision bolsters the desired result for structuring securitization and portfolio sales of pools of equipment leases and auto loans.

Hell or high water

In AEL Financial, LLC v. Sheppard, the lessor sued the lessee of a medical treatment table for failure to pay rent. The lessee argued that the equipment was never delivered and that he had mistakenly signed a certificate of acceptance for the table. He further argued that under his mistaken expectation of future delivery, he made $30,000 worth of payments to the lessor under the lease, for which he argued that the equipment supplier should be liable.

An Illinois circuit court awarded summary judgment in favour of the lessor, holding that (1) the lease was a ‘finance lease’ under the U.C.C., (2) the lessee’s execution of the certificate of acceptance constituted ‘acceptance’ of the decompression table, regardless of whether the table had been delivered, (3) the lessee’s acceptance of the table made his obligations under the lease ‘irrevocable and independent’ under U.C.C. section 2A-407(1), and (4) the lessee’s failure to make required payments under the lease agreement constituted a default, entitling the lessor to recover damages. The appellate court affirmed summary judgment in favour of the lessor and supplier, concluding that because the defendant’s obligations under the lease were ‘irrevocable and independent’, he was liable to the lessor without regard to whether the supplier delivered the decompression table.

Bankruptcy remote?

In re Lake Michigan Beach Pottawattamie Resort LLC, decided in April 2016 by a bankruptcy court in Chicago, upheld the filing of a bankruptcy petition despite the refusal of a lender to the LLC, as a ‘Special Member’ of the LLC, to authorize such a ‘Material Action’, as required by an amendment to the operating agreement of the LLC. The amendment had been demanded by the lender (whose loan was collateralized by a mortgage on the resort property of the LLC) as a condition to its forbearance from pursuing remedies following the LLC’s default on the loan.

When the LLC again defaulted on the loan, the lender commenced foreclosure on the resort property. On the day before the foreclosure sale was to have occurred, the LLC petitioned for relief under the Bankruptcy Code, thereby blocking the sale and any other action which the lender might take to enforce its rights against the LLC or its property. All of the


40

LLC members, except the lender (as Special Member) consented to filing of the petition. The lender sued to dismiss the bankruptcy case on the grounds that the LLC had not complied with its operating agreement requirement for all members to approve such a Material Action.

The court conceded that the law of the state where the LLC was organized permits an operating agreement to require a supermajority vote for certain actions, but then interpreted that local law as requiring LLC members to “consider the interests of the entity and not only their own interests.” The court construed the Special Member section of the operating agreement (“written for the express benefit of the Lender”) as lacking the “essential playbook for a successful blocking director structure…the director must be subject to normal director fiduciary duties” and able to “vote in favor of a bankruptcy filing, even if it is not in the best interests of the creditor that they were chosen by.” Instead, the operating agreement language provided that “the Special Member shall be entitled to consider only such interests and factors as it desires [and] shall have no duty or obligation to give any consideration to any interests or factors affecting the Company or the Members.” The court observed that Illinois law requires an LLC manager to discharge its duties “in a manner the manager reasonably believes to be in the best interests of the limited liability company”, and ruled that the Special Member provision was void. The bankruptcy petition hence was duly authorized and the lender’s motion to dismiss was denied.

Tarnished ‘golden share’

In In re Intervention Energy Holdings, LLC, the LLC defaulted on its $200 million of notes issued to a lender. In exchange for its forbearance, the lender demanded an amendment to the LLC operating agreement under which a) it would be issued one common unit in the LLC and b) the approval of all common unit holders would be required “prior to any voluntary filing for bankruptcy protection for the Parent of the Company.” The LLC previously had issued 22 million common units to various individual and corporate investors. Noting the disparity

between the amount of units previously issued and outstanding, and the single ‘golden share’ issued to the lender for a cash price of $1, the bankruptcy judge in Delaware concluded that the blocking arrangement constituted nothing less than “an absolute waiver by the LLC of its right to seek federal bankruptcy relief”, observed that “Federal courts have consistently refused to enforce waivers of federal bankruptcy rights” and ruled that the bankruptcy proceedings were validly authorized by the LLC, notwithstanding the refusal of the lender to vote its common unit in favour of that action.

The Lake Michigan and Intervention Energy decisions demonstrate the need for experienced counsel to prepare documents intended to enable creditors to exert a restraining hand on a borrower’s ability to seek Bankruptcy Code protection. Otherwise, a lender found guilty of over-reaching will be disappointed and will have wasted time and money.

An unenforceable covenant?

A well-structured asset-backed securities (ABS) financing will try to limit the possibility of an involuntary petition against the special purpose entity (SPE) issuer of the ABS, by writing the transaction documents so that the SPE only deals with a limited universe of counterparties, consisting of the seller and servicer of the assets, plus the indenture trustee and purchasers of the ABS. Each of those entities will be required, in the transaction documents which it signs, to agree to a so-called ‘non-petition’ covenant, under which the parties agree not to join in the filing of an involuntary petition against the SPE, for at least one year after the ABS have been repaid. Investors and rating agencies insist upon these non-petition clauses.

Late in 2015, an SPE issuer, Zohar CDO 2003-1, Ltd., defaulted on principal and interest payments due to its ABS noteholders. Bond insurer MBIA, pursuant to its financial guaranty insurance agreement with Zohar, paid principal and interest to senior noteholders at the November 20, 2015 maturity of the notes, and hence became the controlling creditor of Zohar, entitled to sell the assets of that SPE by reason of Zohar’s default


41

in payment of the notes. On November 22, 2015, Patriarch Partners XV, LLC, as the largest holder of the remaining, subordinated notes, filed an involuntary petition against Zohar, alleging that protection under the Bankruptcy Code was necessary to prevent MBIA from foreclosing on Zohar’s collateral (much of which consisted of loans to companies which were controlled by an affiliate of Patriarch).

Patriarch argued that there is no support in the Bankruptcy Code for non-petition clauses. At a January 2016 hearing on Zohar’s motion to dismiss the involuntary petition, the bankruptcy court concluded that a further hearing was needed to determine whether Patriarch’s non-petition covenant

could be enforced specifically or whether its breach simply would subject Patriarch to an action for damages. Ultimately, Patriarch withdrew its petition against Zohar before the court could issue a definitive ruling on enforceability of the covenant, thereby leaving the question unanswered.

Stephen T. Whelan is a partner in the New York City office of law firm Blank Rome LLP ([email protected]) and a member of the ELFA Board of Directors.

mailto:[email protected]

The dash for digital.

whiteclarkegroup.com

Adapt to the digital world with

our award winning omni-channel

digital solution for retail, fleet and

wholesale finance businesses.

End-to-end auto and asset finance software

http://www.whiteclarkegroup.com/

asset finance united states - blank rome llp...that covers key statistical, financial and operations...

Documents