IAA-advisory chief executive Lindsay Town on market challenges for lessors in the future.
I was prompted to think about the path of the leasing industry when looking at the attendee makeup of the American Equipment Leasing and Finance Association (ELFA) conference in the US.
The focus of this conference concerns the funding of leasing companies, and showcases those that wish to acquire leases or source funding.
Attendee numbers have been over 500 with nearly 50 different funding sources, which made me think on where our UK market is heading.
I believe we are experiencing a potential watershed period in the industry, as seen from the narrow perspective of the UK, and it is interesting to speculate on what the ‘winners’ may look like.
The return of liquidity post-crash
As we came out of the financial turmoil of 2007/8 the industry suffered, along with many cash hungry businesses, a lack of liquidity. As is so often the case, the industry coped. Liquidity returned, and there is now probably more liquidity seeking a home in our industry than ever before. Yet, as many are finding, liquidity alone is a poor resource if it is not accompanied by risk appetite, and that is a very different raw material.
As the financial world realigned, we also saw a reassessment of the attractiveness of our industry by several participants, leading to exits, reappraisals, realignments and some sales.
Perhaps inevitably, external investors and the plethora of "challenger banks" showed interest and from small starts we have seen a continual series of moves to realign the landscape predominantly through disposals and acquisitions. I doubt that this trend is anywhere near over, and we still see potential further changes among major bank players as the impact of capital and risk rules continue to put pressure on resources and strategies. The real challenge for the both sides is to truly understand where sustainable value is created, not just historically, but where it is likely to be derived from in the future. That applies not solely to long term strategy but to near-term tactical decisions and enterprise valuations.
An obsession with SMEs
The market seems to be developing a financial version of Darwinian evolution. But there are other forces at work that make the evolution more complex. The leasing market is verging on obsession with providing funds to the SME market and it is apparently the goal of almost all new entrants as well as existing players. The perceived encouragement from government; the often-referred-to absence of risk flexibility from current and previous major players; the historic view that risk adjusted yield is superior – all combine to make the broad sector seem attractive.
It can be argued that pricing and risk competition for the most straightforward transactions is reaching levels that are very thin for all but the most cheaply funded providers. In my view, a market share fight is a risky strategy without very tight risk control and accompanied with stakeholder returns that make sustainable sense.
The broader market is arguably catching up with the behaviour of areas such as vehicle contract hire and focussing on service and asset management. The trend is reinforced by the recent IFRS16 accounting changes and this will in my view be one of the most defining aspects of the industry in the medium term.
I see a dual industry developing in the mainstream markets (I exclude here the world of high value and structured asset finance). On the one hand, there are the asset finance providers who are providing finance (‘vanilla’ providers); on the other hand, the providers who embrace a wider service and asset management scope.
The ‘vanilla’ providers will see increasing competition driven by price and also by risk appetite, the latter being the more challenging aspect. Here I see that their competitive advantages will be driven by risk management, asset and sector specialisation, and systems, as well as pricing policies. Their routes to market will be as they are now: predominantly intermediary or parent bank driven. But as intermediaries continue to be acquired by funded participants, the risk is that available volume will decrease, leading to further competition to maintain promised volumes.
The ‘vanilla’ market, especially when integrated within a bank, will in the longer term risk losing the distinct characteristics of the wider industry, unless it develops the asset or sector specialisation to a sufficient degree to remain attractive to its stakeholders.
The other ‘branch’ of the industry will most likely face an increasing education process to attract adequate and acceptable funding and risk resource but the contract hire market, to mention but one example, has done well at making itself understood to external funders. The defining features here will be around asset management, strong alliances with manufacturers and vendors and a deep understanding of the asset life cycles and values.
The competitive landscape will not be an easy path but a focus on a deep understanding of the use and life cycle of specific asset classes and a wider than UK outlook will be hallmarks of real success, in my opinion. I see the continuing development of support for manufacturers and vendors as a major potential for the future, whether it be by way of formal captive, white label or otherwise.
Importance of data
Data in all its guises will be vital; in quality, quantity and speed of access. Education of investors and funders will be more in depth, more testing and intrusive. Risk management, especially in an environment where we move from "pure" finance will need to take on a far more holistic stance, something that regulatory bodies may find challenging unless we spend time educating them properly.
We need to invest in developing people in all areas of our industry, again irrespective of the ‘branch’ of the family. Some of the recent initiatives on apprenticeship schemes are to be applauded, but we also need to focus on mid and senior level leadership to ensure that we develop every level of our industry for a changing environment.
I do see a material divergence in the development of the mainstream of our industry over the next few years, but I am confident that there will be winners, whether they be those that deal with the finance only side and develop highly cost efficient and rigorous processes or those that decide to embrace the wider "managed services" side and show deep understanding of their asset class and risk models.