The U.S. equipment finance market grew to over $900 billion in 2014 according to the Equipment Leasing and Finance Association. This asset category has typically been dominated by big banks and specialized lenders, but it doesn’t have to be. There are a lot of opportunities for community banks to enter the equipment financing market and reap rewards from their existing customers at relatively little cost.
Here are three ways community banks can benefit from equipment leasing:
1. Protect and enhance the value of existing commercial relationships.
Eight of ten commercial businesses utilize equipment financing to manage their operations, according to Wheeler Business Consulting. Frequently, community banks focus on CRE lending opportunities, but they let customers go elsewhere for their equipment financing needs. There are two problems with this.
First, when commercial customers seek solutions elsewhere, your bank risks losing deposits and other treasury functions to the competition.
Second, your bank could be leaving a substantial amount of new revenue on the table from customers it knows well and who historically have been good credit risks.
2. Earn higher yields and fees.
Yields on equipment finance transactions are traditionally higher and terms are shorter than on standard simple-interest loans, which can help your bank to remain asset sensitive as it faces the prospect of rising rates. In addition, since equipment finance agreements are customarily structured as fixed-term contracts, your customers are obligated to make all payments at the predetermined yield and term, providing your bank with a hedge against a near-term drop in interest rates.
The extra rate earned on equipment finance transactions doesn’t necessarily translate into more risk. According to The Federal Reserve, delinquency rates for equipment leases rank among the lowest for all major asset classes, including for CRE. This is achieved by lending on “essential use” equipment only. In other words, the equipment in question is vital to the operation of the business, so the customer is loath to miss payments and risk repossession.
Fees can be a meaningful source of income as well. If your bank doesn’t wish to keep equipment leases on balance sheet for various reasons, it may refer deals to an independent lessor and earn referral fees. Even in a referral arrangement, a bank can address a customer need while generating revenue.
3. Increase your C&I holdings.
Community banks rely heavily on CRE lending to generate revenue, and many struggle to win C&I loans because of aggressive price competition from larger banks and the relative scarcity of high-quality C&I loans. Diversifying through C&I is desirable but not always easy to do. However, your bank’s own portfolio is often a good starting point for achieving this diversification. A simple UCC search can determine which customers currently utilize some sort of equipment financing. A “CRE customer” may still be leasing equipment for construction projects or to complete build-outs. In addition, CRE often has a furniture, fixture, and equipment component, yet banks often roll the value of the FF&E into the long-term loan. A better option may be to put those assets under an equipment lease so that your bank can obtain a quicker payback while more closely matching the financing term to the useful life of the equipment.
The best opportunity for increasing C&I loans and diversifying your portfolio is simply to ask your customers if they lease equipment. Educating your loan officers on the benefits of equipment finance will aid in customer retention and identify future opportunities for increased profits and decreased portfolio concentrations.