Making a profit out of
micro-ticket leasing is hard enough in good times. Doing so when
bad debt levels are rising can be nightmarish. Despite this, there
is still money to be made in this sector.
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For most finance providers,
there is a minimum deal size below which it makes no sense to do
business. Typically the calculation starts with interest income,
fees and various other incomes, layering in direct costs and
allocations of indirect costs. For large companies in particular,
the calculation gets increasingly difficult and unpredictable, once
unsubstantiated central costs and cross-charges are added.
Let’s take a simple example. A
£10,000 (€11,660) deal spread over three years at 4 percent
delivers approximately £600 interest income over its life. Cost of
sale, including credit and documentation, plus a substantive bad
debt charge, can eat a long way into that amount. Below £10,000
(normally considered the threshold for micro-ticket transactions)
the calculation can get more challenging. Imagine the deal
economics on a £1,000 transaction, and therein lies the problem for
the truest micro-ticket players.
In the IT space, companies such as
Grenkeleasing are reported to finance assets from £500 upwards.
Credit card terminals – another favourite in the micro-ticket
market – also cost around £500, while all manner of small business
equipment can be financed at ticket sizes that would make most
finance providers wince.
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By GlobalDataThe calculation is made harder
as it is often hard to charge fees. A £500 transaction with monthly
rentals of around £20 is not likely to withstand a £100 document
fee. Insurances can also be difficult to sell, with customers often
having an insurance excess greater than the cost of the asset. As a
result, yields have to be high (over 20 percent) and the
transactions are normally minimum term rentals, with material
upside as the transaction goes into an extended term.
Bad debt experience in the
micro-ticket sector is running between okay and terrible. Merchants
acquiring a credit card terminal have to go through bank checking
processes (including Know Your Customer) at least as good as an
equivalent asset finance process, with the result that bad debt
risk is somewhat mitigated.
Crucially, an additional benefit
for the micro-ticket financier is that the bank credit checking
process reduces the funder’s operating cost burden, and while most
deals for credit card terminals are for smaller businesses, vendor
relationships result in some deals for ‘household name’ credits,
providing an unexpectedly positive spread of risk. However, there
is no doubt that many of these deals are with smaller retailers –
not a good place to fund in a recession.
In other asset categories, at this
stage in the cycle a number of funders are reportedly paying the
price for funding non-core business assets with a sharp rise in
default situations reported. The cost of recovery can be
disproportionate to the outstanding debt, suggesting that
write-offs in the micro-ticket sector may be material. One funder
indicated that any transaction in its final year with an original
equipment cost under £10,000 is immediately written off should a
default situation occur.
At the larger end of the
micro-ticket market (both in ticket size and new business volumes),
many ‘flow’ micro-ticket deals are placed by brokers into
mainstream finance providers, a number of whom have closed for new
business or restricted new business volumes.
For transactions below £5,000,
while there are a small number of specialist micro-ticket finance
providers, deals are written in a number of other ways. Some
micro-ticket deals are placed by brokers as part of a relationship
sale. The funder in this case lets it go as long as bigger
transactions are forthcoming from the same source. Others are
managed on brokers’, dealers’ or resellers’ own books, using all
manner of wholesale or working capital funding arrangements.
In both the over and under £5,000
categories, a number of funders have pulled out of the market or
reduced their activity – either directly or by withdrawing
wholesale finance – and credit is constrained.
So, does this make it a bad
business? Not necessarily, seems to be the answer, but much depends
on the operating structure of the finance company.
Micro-ticket demands a simplified
operating model with micro-management of operating costs. This is
not possible in larger organisations where cross-charging is
commonplace, with the result that it is only likely to be a market
for smaller, niche players.
Major cost element
A major cost element that
needs to be managed tightly is deal acquisition, from sales through
credit and documentation. Vendor models appear to work best and –
unlike higher profile vendor finance arrangements – it appears a
stronger partnership ethos exists, with greater value and cost
recognition placed on the various processes undertaken by the
lessor.
As with credit card terminals, the
alignment of the funder to someone else’s underwriting overcomes a
significant cost burden, but is at odds with the natural caution of
most lessors.
Equally, underwriting needs to be
quick and decisive, resulting in a ‘yes’ or a ‘no’ decision with no
room for ‘maybes’. Documentation needs to be kept to a minimum, and
streamlined (at point-of-sale, self-service or using the vendor’s
resources as much as possible). Adequate scale is important. For
players on the fringes of this market, outsourcing administration
may be part of a valid entry strategy.
In the right situation,
micro-ticket financing makes sense and, currently, there is a
funding gap in the market.
It may represent relatively small
numbers, but as the sales director of one firm commented: “With the
right assets and the right vendor, you can get amazing spreads and
really good credits.”
The author is a partner at
the consulting and services firm Invigors
