The Market View

What Business Do I Want to Be in and with What Customers?

Companies should review this frequently as a routine matter. A declining number of companies want to be or can be in the actual leasing business and offer a leasing product. Do you want to be in the lending/margin business? Do you want to be in the leasing/residual and services business? Those companies that are in leasing have selected customers that value the benefits of leasing. Those benefits are worth something to the customer and channel partners, and most will continue to exist. Your customers and channel partners need to understand this and how the benefits will work, and they have to get that message! We know that most lessees value other benefits well ahead of off-balance-sheet financing. Cash flow, flexibility, tax liability management, asset-related services, and other benefits provide and can continue to provide value to customers and channel partners.

The risk and rewards mix may be adjusted in your business model, but if you are going to offer the lease solution, a new accounting standard does not prevent it. In fact, capitalization of leases may offer some unintended financial benefits that should be discussed with customers.

Many equipment finance companies have decided that retaining asset risks related to offering a product in the leasing business is simply not worth it any longer. The new required lessor financial accounting compliance may reinforce that view, and more companies may opt for being in an equipment lending business. This decision by some will create opportunities for others.

Another part of this discussion involves the market segments you are in. For a small-ticket company, a certain level of compliance must be planned, but the market will not be affected very much. For a middle-ticket company, compliance must be planned, but also the marketplace must be addressed. Many transactions in this size segment are residual oriented. Finally, companies in the large-ticket size segment will lose the leveraged lease classification with its beneficial lessor accounting. Many of the latter may exit the leasing business if they have not already done so for other reasons. However, lessees of large equipment still value benefits such as tax incentive realization and residuals from their side of the transaction, and the creative companies here will find the structures that can deliver those benefits and still allow the leasing company to remain within its capital requirements.

What business will you be in is a key decision.

What Does the Customer Need and Value?

Focus on the customer and channel partner. When was the last time your sales team members were out there having a meaningful discussion with each customer? The time to have these meetings is now. It would be a mistake to let customers and channel partners receive pessimistic or wrong information about the business implications of the changes to lease accounting. Let them hear from you first. In addition, don't let them concentrate only on compliance. Actually, compliance for the lessee is much easier than for the lessor.

Your company's message to its customers and channel partners must show that comparisons between compliance with the new standard and the benefits received from the lease can still favor the benefits of the lease. Will specific provisions of leases change to deliver the benefits? Most likely, yes.

• Lease terms may be shorter in some situations to minimize capitalization.
• Customers are going to pay much closer attention to options and end-of-lease provisions. Business models that are based on the expectation of the whole evergreen family of lease extensions or renewals should be adjusted.
• The automatic use of contingent rents, particularly at the start of the lease, will receive closer attention and some push-back from lessees who want the regular lease term to begin at the inception of the lease rather than at a quarter or some other date convenient to the lessor.

Representatives of leasing companies must be out there with their customers and channel partners explaining how the solutions to their needs are still available. In fact, some of the opportunities that will be available include services related to assisting the lessee with its compliance requirements, particularly on issues related to the lease term ' longest possible term that is more likely than not to occur. In addition, lessors can offer assistance with the required periodic review of an asset's value. Lessors also should be prepared to provide billing that can separate the lease component cost and any service component cost for the lessee. Provide what is important to the customer and your channel partner.

There is no question that the new accounting standard will remove some of the “smoke and mirrors” from how lessors go to market. There will be greater transparency; lessees may even get “smarter,” but they still want the premium product value-add that the lease can offer them.

In relation to the last point is the probable shift in contact person(s) and decision making in the customer. The decisions now are capital expense decisions; and personnel on the financial side, a CFO or other, will make or be directly involved in making the acquisition and financing decisions.

How Can Our Company Make Money in this Business and What Will We Have to Do?

Your company has to make money. Your revenue and profit are the value you get back from the value you have delivered to your customer. They have to match. Leases can provide the value-add to customers and receive value in return. See Table 1, below.

[IMGCAP(1)]

However, your company must decide whether you want to do, and can do, what will be necessary to make money as shown in the “value received” column of Table 1. This is the Performance Obligation Lease, and while the Exposure Draft does provide some rigorous record keeping, calculations and financial accounting, it is required if you want to be in a business where you make money from more than just the margin that goes with simple secured lending.

Provide higher perceived value, receive higher value ' provide nominal value, receive nominal value. The choice is yours. In addition to working with clients on how to engage customers and channel partners, I see people in the industry evaluating their capabilities now to do what they will have to do under the new lease accounting standard. This includes:

• Asset management capabilities, including asset value assessments; lease term probability related to technology; maintenance and supply channel management; and remarketing;
• Business practices, including use of contingent rent; and end-of-lease practices;
• Document audits and business processes, including pricing models, risk assessment, booking and billing/invoices; and
• Funding strategy.

Conclusion

Assuming that your company can and is willing and able to do what is necessary to offer a competitive leasing or lease-like value to your customers and channel partners, you should engage your customers and channel partners now. If you do not, they may receive negative or misinformation about the full impact of the new financial accounting standard. Even worse, your competitor may be out there now showing your customers and channel partners how it can continue to provide value.

Speed to market is respected. Customers and channel partners are shown you are on top of things and care. There is no substitute for that in the marketplace.

Michael J. Fleming is a principal of The Alta Group, LLC, a global consultancy serving equipment leasing and finance companies, investment professionals, manufacturers, banks, and government organizations. For more information visit www.thealtagroup.com.

Speed, smart speed, still wins in competition. Unfortunately, I find too many company executives are not heeding this reality when it comes to the changes in financial accounting for leases. Their outside accounting firms tell them something to the effect that this new proposed standard is going to take a while to finalize and make effective. This is the technical view, the compliance side. Finance and leasing company executives should pay attention to the market view.

Lessees are already receiving information about the proposed standard from the business media and their accounting firms. Again, this input will be on the technical side ' you must do this, and you cannot do that, and this is what you will look like, and so on. This kind of input causes alarm and may lead to push-back against leases and lease-like products. Some observers are already stating the self-fulfilling prophecy that there will be a reduction in leasing. That reduction may happen, and it certainly will happen unless finance and leasing company executives become proactive in the marketplace and do it now.

Let's accept three realities.

1. There will be a new standard, and lessors and lessees will have to comply.
2. The amount of actual Fair Market Value (“FMV”) leasing, operating leasing, however it is labeled, has been in decline for years as the industry has commoditized and matured. Most business is already a secured loan product. FMV and similar solution-oriented products will continue to be available and have benefits for lessees and lessors.
3. Change creates opportunity! A reality that accompanies this is that not all can or will seize opportunity; that is the opportunity, and opportunity does not wait.

Change is creating an opportunity for you and your company. This must be the first thought on each executive's mind. Why? Because change puts in place a proactive state of mind that leads to review, innovative thinking and eventually to action. For equipment leasing and finance company executives, this state of mind should lead quickly to address these big three questions:

What Business Do I Want to Be in and with What Customers?

Companies should review this frequently as a routine matter. A declining number of companies want to be or can be in the actual leasing business and offer a leasing product. Do you want to be in the lending/margin business? Do you want to be in the leasing/residual and services business? Those companies that are in leasing have selected customers that value the benefits of leasing. Those benefits are worth something to the customer and channel partners, and most will continue to exist. Your customers and channel partners need to understand this and how the benefits will work, and they have to get that message! We know that most lessees value other benefits well ahead of off-balance-sheet financing. Cash flow, flexibility, tax liability management, asset-related services, and other benefits provide and can continue to provide value to customers and channel partners.

The risk and rewards mix may be adjusted in your business model, but if you are going to offer the lease solution, a new accounting standard does not prevent it. In fact, capitalization of leases may offer some unintended financial benefits that should be discussed with customers.

Many equipment finance companies have decided that retaining asset risks related to offering a product in the leasing business is simply not worth it any longer. The new required lessor financial accounting compliance may reinforce that view, and more companies may opt for being in an equipment lending business. This decision by some will create opportunities for others.

Another part of this discussion involves the market segments you are in. For a small-ticket company, a certain level of compliance must be planned, but the market will not be affected very much. For a middle-ticket company, compliance must be planned, but also the marketplace must be addressed. Many transactions in this size segment are residual oriented. Finally, companies in the large-ticket size segment will lose the leveraged lease classification with its beneficial lessor accounting. Many of the latter may exit the leasing business if they have not already done so for other reasons. However, lessees of large equipment still value benefits such as tax incentive realization and residuals from their side of the transaction, and the creative companies here will find the structures that can deliver those benefits and still allow the leasing company to remain within its capital requirements.

What business will you be in is a key decision.

What Does the Customer Need and Value?

Focus on the customer and channel partner. When was the last time your sales team members were out there having a meaningful discussion with each customer? The time to have these meetings is now. It would be a mistake to let customers and channel partners receive pessimistic or wrong information about the business implications of the changes to lease accounting. Let them hear from you first. In addition, don't let them concentrate only on compliance. Actually, compliance for the lessee is much easier than for the lessor.

Your company's message to its customers and channel partners must show that comparisons between compliance with the new standard and the benefits received from the lease can still favor the benefits of the lease. Will specific provisions of leases change to deliver the benefits? Most likely, yes.

• Lease terms may be shorter in some situations to minimize capitalization.
• Customers are going to pay much closer attention to options and end-of-lease provisions. Business models that are based on the expectation of the whole evergreen family of lease extensions or renewals should be adjusted.
• The automatic use of contingent rents, particularly at the start of the lease, will receive closer attention and some push-back from lessees who want the regular lease term to begin at the inception of the lease rather than at a quarter or some other date convenient to the lessor.

Representatives of leasing companies must be out there with their customers and channel partners explaining how the solutions to their needs are still available. In fact, some of the opportunities that will be available include services related to assisting the lessee with its compliance requirements, particularly on issues related to the lease term ' longest possible term that is more likely than not to occur. In addition, lessors can offer assistance with the required periodic review of an asset's value. Lessors also should be prepared to provide billing that can separate the lease component cost and any service component cost for the lessee. Provide what is important to the customer and your channel partner.

There is no question that the new accounting standard will remove some of the “smoke and mirrors” from how lessors go to market. There will be greater transparency; lessees may even get “smarter,” but they still want the premium product value-add that the lease can offer them.

In relation to the last point is the probable shift in contact person(s) and decision making in the customer. The decisions now are capital expense decisions; and personnel on the financial side, a CFO or other, will make or be directly involved in making the acquisition and financing decisions.

How Can Our Company Make Money in this Business and What Will We Have to Do?

Your company has to make money. Your revenue and profit are the value you get back from the value you have delivered to your customer. They have to match. Leases can provide the value-add to customers and receive value in return. See Table 1, below.

[IMGCAP(1)]

However, your company must decide whether you want to do, and can do, what will be necessary to make money as shown in the “value received” column of Table 1. This is the Performance Obligation Lease, and while the Exposure Draft does provide some rigorous record keeping, calculations and financial accounting, it is required if you want to be in a business where you make money from more than just the margin that goes with simple secured lending.

Provide higher perceived value, receive higher value ' provide nominal value, receive nominal value. The choice is yours. In addition to working with clients on how to engage customers and channel partners, I see people in the industry evaluating their capabilities now to do what they will have to do under the new lease accounting standard. This includes:

• Asset management capabilities, including asset value assessments; lease term probability related to technology; maintenance and supply channel management; and remarketing;
• Business practices, including use of contingent rent; and end-of-lease practices;
• Document audits and business processes, including pricing models, risk assessment, booking and billing/invoices; and
• Funding strategy.

Conclusion

Assuming that your company can and is willing and able to do what is necessary to offer a competitive leasing or lease-like value to your customers and channel partners, you should engage your customers and channel partners now. If you do not, they may receive negative or misinformation about the full impact of the new financial accounting standard. Even worse, your competitor may be out there now showing your customers and channel partners how it can continue to provide value.

Speed to market is respected. Customers and channel partners are shown you are on top of things and care. There is no substitute for that in the marketplace.

Michael J. Fleming is a principal of The Alta Group, LLC, a global consultancy serving equipment leasing and finance companies, investment professionals, manufacturers, banks, and government organizations. For more information visit www.thealtagroup.com.