White Clarke Group Usa Asset and Auto Finance Country Survey

ASSET FINANCE INTERNATIONAL IN ASSOCIATION WITH WHITE CLARKE GROUP
White Clarke Group United States Asset and Auto Finance Country Survey
UNITED STATES ASSET AND AUTO FINANCE SURVEY
White Clarke Group

White Clarke Group is the market leader in software solutions and business consultancy to the automotive and asset nance sector for retail, eet and wholesale. WCG solutions enable end-to-end credit processing and administration to streamline business practice, cut operational cost and deliver outstanding customer service. WCG has a twenty one year track record of leadership and innovation in nance technology, consultancy and new market entry. Clients value WCG industry knowledge, market intelligence and innovation. The company employs some 500 nance and technology professionals, with offices in the UK, USA, Canada, China, Australia, Austria and Germany. White Clarke Group publish the Global Leasing Report, which is part of The World Leasing Yearbook. To download a copy please go to:
http://www.whiteclarkegroup.com/knowledge-centre/category/global_leasing_report
Acknowledgements
Brendan Gleeson, group executive vice president, White Clarke Group; Pascal Bouillon, managing director, Socit Gnrale Equipment Finance (SGEF) USA; Crit DeMent, chairman and CEO, LEAF Commercial Capital; Jonathan Dodds, chief executive officer - Americas, White Clarke Group; Chris Enbom, CEO, Allegiant Partners; Gary Amos, head of Commercial Finance Americas, Siemens Financial Services (SFS); Mike Pitcher, president and CEO, LeasePlan USA; Ken Adams, vice president, Business Development Americas, White Clarke Group; Bill Verhelle, CEO, First American Equipment Finance; Jeff Berg, US country manager, De Lage Landen; Adam Warner, president, Key Equipment Finance; Rick Remiker, ELFA chairman and executive vice president and group head of Specialty Banking, The Huntington National Bank; Dave Mirsky, CEO, Pacic Rim Capital; Bill Bosco, principal, Leasing 101; Marguerite Watanabe, president, Connections Insights. http://www.whiteclarkegroup.com/ http://www.assetnanceinternational.com Publisher: Edward Peck Editor: Brian Rogerson Author: Nigel Carn Asset Finance International Ltd., 39 Manor Way, London SE3 9XG UNITED KINGDOM Telephone:+44 (0) 207 617 7830
Asset Finance International, 2013, 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.
Contents
Introduction The leasing market in United States Annual new business volumes - by organization type - by market segment - by size of organization - by business model - by origination channel - by end user industry Auto nance 04 06 06
11
Economic overview and outlook Projected GDP Business condence Global competitiveness index
13 14 15 16
Industry view of the leasing market Current economic situation - effect on equipment nance Market drivers Market challenges Growth prospects Outlook for SMEs Sector prospects Floorplan nance Industry consolidation M&A scenarios Regulatory issues Accounting for leases US view on lease accounting Bill Bosco, Leasing 101
20 23 41 25 27 28 30 30 31 32 33 34 37
Introduction
This is the second Asset Finance International survey of the US equipment and auto nance industry. A year ago, the issues that caused concern in the industry included the prospect of an impasse between the President and Congress over scal policy (the so-called scal cliff), the ongoing convulsions in the eurozone and a looming slowdown of Chinas economy. All this could have had a negative effect on the tentative US recovery, but the longer-term outlook was generally positive. Now, 12 months on, some concerns have eased but other problems have remained resolutely unresolved. The economic revival has been maintained, albeit at a moderate rate, but enough for the Federal Reserve to announce that it is considering when to start reducing its programme of quantitative easing (QE3). This in itself was enough to send a temporary shiver through the stock markets, but their overall performance this year has been strong. The Fed will start reducing QE3, but the timing greatly depends on the pace and resilience of the economic recovery. Meanwhile, the global headwinds remain, and now the US economy is undergoing further trauma following another impasse over the debt ceiling and, as this survey went to press, this has resulted in a Federal Government shutdown and only a short time to avoid an absolute worse-case scenario of default when the government borrowing limit is reached. All those outside the US, and the majority within, hope and expect a solution will be reached, but will it again be only temporary? 4
Asset Finance International, All rights reserved.
UNITED STATES ASSET AND AUTO FINANCE SURVEY Assuming such a solution is found, the seemingly insuperable differences between President Obama and some Republicans in Congress will likely continue to result in a lack of resolution of important policy issues.
Business condence None of this is good news for businesses, particularly small businesses and their customers that need economic growth and stability, and access to nance. For many of the small and medium-sized enterprises (SMEs) that form the core of the US economy, traditional sources of credit such as banks have remained difficult to tap. The asset nance and leasing market, however, is expanding ahead of the economy and is anticipating accelerating growth in the second half of 2013 and through 2014. Although this rate of growth is still only expected to move up slowly through the gears, there are signs that business condence is on the rise again, with a greater percentage of SMEs planning to make capital outlays in the near term. Many larger rms have access to pent-up capital that, given a more positive economic outlook, may be invested in equipment. Investment is likely to be encouraged further by the prospect of the Fed maintaining short-term interest rates at close to zero. It should not be forgotten that the US economy is still the largest in the world by a considerable margin, and that creates commercial opportunities and benets. The fundamentals are strong, and many features continue to make US companies enviably productive, such as strength in research and development, innovation, and exibility. The US asset nance market is also the largest globally by a wide margin, and although the recession saw some streamlining of operations, there is room for new entrants. Overall, provision of loans to business has remained muted, but there is available capital and lessors that are more willing to lend than banks. The opportunities are there for lessors, and the longer-term prospects are for the upward trend to gain momentum.
About this survey This Country Survey aims to provide a balanced view of the equipment nance and auto leasing market in the US. The survey covers the following areas: A summary of US leasing activity; The current economic climate and the incentives for and constraints on doing business; Insights from key industry gures on the market, its outlook and the challenges and opportunities that face it; and The view on the latest proposals to improve lease accounting.
The US Leasing Industry

The equipment nance sector is a signicant contributor to the US economy. Investment in equipment and software is projected to total $1.3 trillion in 2013, of which 55% ($742bn) is expected to be nanced through loans, leases and lines of credit. In 2014, the market is predicted to grow by $36bn to $778bn an increase of just under 5%, which is considerably higher than predicted GDP growth. (Source: Equipment Leasing & Finance Foundation (ELFF) Equipment Finance Market Study 2012-2013 see http://www.leasefoundation.org/IndRsrcs/MO/USMkts/) The equipment nance and leasing industry in the US is represented by several organizations, the largest of which is the Equipment Leasing and Finance Association (ELFA), which was founded as the Association of Equipment Lessors in 1961. Currently, ELFA represents around 600 member companies, including affiliates, and membership continues to grow. Given the size and diversity of the total US market, it is difficult to provide anything other than guidelines to business volumes. ELFA publishes an annual Survey of Equipment Finance Activity (SEFA) based on submissions by reporting members relating to their US business. The 2013 SEFA Report on business volumes in 2012 is the basis for much of the data in the next section. However, this data should not be taken as a representation of industry-wide gures. It should be noted that SEFA data does not include data on auto leasing (including oorplan), real estate and non-equipment nance operations. Details of the report are at http://www.elfaonline.org/SEFA
Annual new business New business volume (NBV) grew 16.4% in 2012, maintaining the growth rate achieved in the previous year. In 2012, banks experienced the greatest level of growth (22%), followed by captives (11%), while independents grew least (7%). The average gures for each business segment by size show that the larger the lessor, the greater the growth the large-ticket market segment grew most (31%), whereas the micro-ticket segment actually declined (-5%). Since the market contracted across the board in 2009, the trend has been for a greater degree of growth as the ticket size increases.
New business volumes by organization type

$105.6 bn
100 80 60 40 20 0
$90.7 bn $12.7 bn $30.1 bn
+7
.4%
$13.6 bn $33.3 bn
+1
% 0.8
+2
2.2
$58.6 bn $48.0 bn
2011 Source: ELFA Independents Captives
2012 Banks
New business volumes by market segment

$105.6 bn $90.7 bn
+4 .7% 3.1 %
$4.8 bn $30.0 bn
100 80 60 40 20
$5.0 bn $26.5 bn
+1
+1
5.8
$44.5 bn
1%
$51.0 bn
+31.
$14.7 bn
$19.3 bn 2012 Middle ticket Large ticket

0
2011 Micro ticket Source: ELFA Small ticket
UNITED STATES ASSET AND AUTO FINANCE SURVEY In terms of NBV by size of organization, there was growth in all market segments. Organizations with over $1bn in NBV grew by 15%; those with NBV of $250m to $1bn rose 32%; those with NBV of $50-250m rose 16%; and the smallest segment (less than $50m NBV) actually rose by the largest amount at 39%. This would seem to contradict the previously quoted fall in the microticket segment, but the segments are not interchangeable and it should be noted that the smallest segment by NBV accounts for less than 1% of the market total.
New business volumes by size of organization 100 80 60 40 20 0

2011 Under $50m $50m-$250m 2012 $250m - $1bn Over $1bn $77.9 bn $89.4 bn
% 9.1 % 3 + 5.7 +1 % 1.8 3 + % 4.7 +1
$0.3 bn $4.3 bn $8.2 bn
$0.4 bn $5.0 bn $10.8 bn
In all, 79% of respondents saw NBV increase in 2012, an increase of 3% on 2011, and continuing the momentum built up after 2010, when the gure was only 28%.
Percentage of respondents whose new business volume grew or declined 100

28.3%
80 60 40 20 0
52.2% 75.7%
78.6%
47.8%
71.7% 24.3% 21.4% 2012
2009
2010 Grew
2011 Declined
Source: ELFA 8
New business volumes by business model 100 80 60

$30.1 bn $21.4 bn
+25
.7%
$26.9 bn
+10
.8%
$33.3 bn
40
$8.9 bn $1.5 bn
+12
.0%
6% 1%
+25.
$9.9 bn $1.8 bn $33.6 bn
20 0
+16.
$28.9 bn
2011 Direct Captive Vendor
2012 Third party Mixed
Looking at NBV by business model, where the models are dened as providing at least 60% of a companys NBV, again growth occurred in all segments in 2012. The segments that grew most were direct origination and third party origination (both at 26%), followed by mixed origination (16%), vendor origination (12%) and captive origination (11%). Moving to NBV by origination channel, total NBV originated direct and through captive and vendor programs grew 16% in 2012 over 2011. Of this, NBV via direct origination grew 21%, via vendor programs 14%, and via captive programs 11%. Transactions sourced through third party programs, although smaller in dollar terms, increased 24%.
New business volumes by origination channel 100

$8.3 bn
% 4.2 2 + % 1.3 +2
$10.4 bn
80
$30.1 bn
$36.5 bn
0.9 %
60 40 20
$22.3 bn $30.0 bn
+1
$33.3 bn
+14.1 %
$25.4 bn
0
2011 Vendor programs Captive programs 2012 Direct Third parties
UNITED STATES ASSET AND AUTO FINANCE SURVEY The business category with the highest percentage growth in 2012 was transportation, rising 48% to take 11% of the total market share. This category contained the equipment sector that had the highest growth in dollar terms trucks which had a 63% increase in NBV. This indicates that eets are being replaced after some years of low investment. Agriculture, industrial & manufacturing, and construction all lost market share but still performed relatively well in dollar terms. The category with the highest rate of decline was telecoms, which fell 26% on 2011, although that category represents less than 2% of the total market.
New business volumes by end user industry 2012/20111

Services Agriculture Industrial and Manufacturing Transportation Wholesale/Retail Finance, Insurance, Real Estate Construction Federal State and Local Government Mining, Oil & Gas Exploration, Pipelines Utilities Telecommunications Printing, Publishing, Newspapers, Periodicals Other Source: ELFA
3.2% 2.8% 1.4% 2.3% 0.9% 1.0% 7.2% 8.0% 4.5% 4.4% 4.4% 4.3% 6.9% 7.0% 6.5% 6.8% 2012 2011 8.7% 8.7% 8.7% 12.3% 12.5% 11.5% 12.4% 11.0% 21.5% 20.6%
0% 5% 10% 15% 20% Other services - includes such services as data processing, administrative support, repair services Other includes miscellaneous and uncategorized Note: Trend data is for companies who reported both years. Not all companies supplied end user data by end user industry
10
MLFI Cumulative YTD Comparison (2012/2013) $14.0 2012: $50.7 ($bn) $12.0 $10.0 $8.0 Billions (US$) $6.0 $4.0 $2.0 $0.0 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Recent new business in 2013 ELFAs Monthly Leasing and Finance Index (MLFI-25) shows that NBV in 2013 has continued to uctuate, although the trend overall remains an upward one, despite dipping at the start of the year and tailing off again in the summer. A year-on-year comparison shows NBV for the rst eight months of 2013 up by 7.7% on the same period in 2012. ELFAs Monthly Leasing and Finance Index is at http://www.elfaonline.org/Research/MLFI/ Business condence Current sentiment in the equipment nance industry regarding business conditions and prospects is optimistic on the whole, despite moderate levels of demand. The ELFF September 2013 business condence index shows around one-third of responding executives saying they believe business conditions will improve over the next four months, and two-thirds saying business conditions will remain the same over the period. Virtually none thought conditions would deteriorate. This latest index has dipped a fraction from the previous month, but this follows several consecutive months where condence has risen. (Source: ELFF, Monthly Condence Index for the Equipment Finance Industry. http://www.leasefoundation.org/IndRsrcs/MCI/index.cfm) 2013: $54.6 ($bn) % change 7.7%
11
Auto nance Data from Experian Automotive shows that 84.5% of consumers who bought a new vehicle in Q2 2013 nanced the acquisition through a lease or loan, up from 82.5% in Q2 2012, and the highest level since before the credit crunch in Q2 2008. Of all new vehicles nanced, leases accounted for 27.64% in Q2 2013, up from 24.4% in Q2 2012. Delinquencies have decreased, and consumers are showing greater condence in dealing with debt. (Source: Experian Automotive, State of the Automotive Finance Market, September 2013.)
New lease share of new consumer nancing

30% 23.79% 24.40% 27.64% 23.62%
25%
20%
17.68%
15%
10%
Q2 2009 Q2 2010 Q2 2011 Source: Experian Automotive
Q2 2012
Q2 2013
Of the total auto loan market, banks and captives held more than 60% in Q2 2013, with captives experiencing by far the biggest year-on-year increase, of over 40%. The only other category to show a y-o-y increase was nance such as leasing, at 5%.
Automotive loan share market

40% 35% Year on year change 30% 25.24% 25% 20% 15.31% 15% 10% 5% 0% Bank -12.7% BHPH
*
36.14%
50% 40.6% 40% 30% Market share 20% 14.93% 10% 0% 4.9% -10% -13.9% Captive
*
-10.7%
8.38%
-20%
Credit Union
Finance
Source: Experian Automotive
BHPH is Buy here, pay here
In addition, research by J.D. Power indicates that retail light-vehicle sales for the combined months of August and September 2013 are up by more than 10% over the same period last year a fair sign of the overall health of the industry. The seasonally adjusted annualized rate (SAAR) for retail light-vehicle sales stands at around 12.4m units, and J.D. Power affiliate LMC Automotive forecasts total light-vehicle sales of some 15.6m units in 2013. The proportion represented by eet vehicles is around 18%. 12
UNITED STATES ASSET AND AUTO FINANCE SURVEY Economic overview In the year since Asset Finance Internationals rst survey of the US equipment and auto nance industry, fears have been raised over many topics, such as: the fragility of the US economy and its revival post the recession; weakness in the global economy, particularly regarding the slowdown in China and, as ever, what is going on in the eurozone; how to deal with the budget decit, and whether Congress will simply apply another short-term solution; and how will business, and the markets, cope when the monetary tap of quantitative easing (QE) starts to be shut off? As this survey was going to press, at the start of the new US nancial year, it might seem that these issues are worryingly similar to those faced 12 months ago. Indeed, the scal cliff has not vanished, economies worldwide are still stuttering and markets remain prone to bouts of nerves, and the political situation externally (and, to an extent, internally) is a cause for concern, but there are some underlying fundamentals that should be emphasized. The US economy is growing. It is the largest economy in the world, and once again is leading the way out of recession. In the last nancial year, the Dow Jones Industrial Average has risen by more than 12%, the S&P 500 Index has risen more than 16%, and the MSCI ACWI Index of developed and prominent emerging market indices has risen over 14%. The fact that Ben Bernanke, chairman of the Federal Reserve, mentioned the possibility of reducing QE is surely an indicator that the economy is moving in the right direction, even if it is not growing as fast as some had hoped and predicted. In September, the Fed surprised markets by deciding against any imminent reduction in QE3, but the so-called tapering will have to be introduced sometime soon. There is liquidity in the nancial institutions.
United States Unemployment Rate

9.5% 9 9%
8.9 8.7 8.5
8.5%
8.3 8.3
8.3 8.2 8.1 8.2 8.2 8.1 7.8 7.9 7.8 7.8 7.9 7.7 7.6 7.5 7.6 7.6 7.4 7.3
8%
7.5%
7% Jan 12 Source: Bureau of Labor Statistics Jul 12 Jan 13 Jul 13
13
Bernanke had previously summed up the Feds monetary outlook in a July speech, in which he said: even after purchases end, the Federal Reserve will be holding its stock of Treasury and agency securities off the market and reinvesting the proceeds from maturing securities, which will continue to put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader nancial conditions more accommodative. He added that near-zero short-term interest rates, and forward guidance that rates will continue to be exceptionally low, would help maintain a high degree of monetary accommodation for an extended period after asset purchases end, even as the economic recovery strengthens and unemployment declines toward more-normal levels. (Source: Semiannual Monetary Policy Report to the Congress, 17 July 2013.) Outlook There are reasons behind the Feds reluctance to stop the bond-buying stimulus programme, as conicting signals are coming from the data: ination remains low, as demand stays stubbornly weak; yet positive signs are coming from the labour market. Unemployment in the US, as reported by the Bureau of Labor Statistics, continued its gradual progressive decrease to 7.30% in August 2013, which compares favorably with 8.1% in August a year earlier and is the lowest monthly total since late 2008. Such a continuing decline is a good sign of a strengthening economy. The predictions of independent bodies are similar, being positive but with caveats. In a speech to US business leaders, International Monetary Fund (IMF) managing director Christine Lagarde noted that the US economy is gaining strength, stating that this is good news for the US and good news for the world economy. Lagarde said that, although growth is still modest at well under 2%, it should accelerate by a full percentage point in 2014, and she made the point that the private sector is playing a key role as the engine of growth and job creation. (Source: IMF, The Interconnected Global Economy: Challenges and Opportunities for the United States and the World, US Chamber of Commerce, 19 September 2013.) US GDP, projected change (%) 2013 Real GDP 1.7 2014 2.7
Source: World Economic Outlook Update (July 2013)
However, Lagarde highlighted three key recommendations for US policymakers: Fix public nances; Appropriately calibrate monetary policy; and Complete nancial sector reform.
The Organisation for Economic Cooperation and Development (OECD) offered a similar forecast to the IMF in its May 2013 Economic Outlook, stating the US economy should pick up noticeably in 2014. The OECD also pointed to similar areas that policymakers need to address: Budgetary consolidation is creating signicant headwinds, especially in 2013. Spending cuts should be chosen more thoughtfully than across-the-board sequestrations, and commitment to a medium-term plan to restore scal stability should be put in place. 14
GDP Growth 5 2.5 -0 -2.5 -5 2009 Source: OECD 2013
Unemployment Rate 12.5 10 7.5
Fiscal Balance 0 -5 0
Current account
-2.5
-10 5 2.5 2009 2013 -15 2009 2013
-5
-7.5 2009 2013
In its analysis, the Economist Intelligence Unit (EIU) forecasts a similar rate of growth, with real GDP growth accelerating from 1.6% in 2013 to 2.6% in 2014. In the EIUs view, The US economy is showing remarkable resilience to the 2013 scal tightening, helped by a reviving housing market. In its medium-term projections, the EIU forecasts annual average GDP growth of 2.3% in 2013-17, and ination to average just over 2% in that period. In its longer-term projections, the EIU predicts real GDP growth will remain at a steady annual average of 2.4%.
Growth and productivity (% change; annual average) Growth of real GDP per head Growth of real GDP Labour productivity growth Source: EIU 2012-20 1.6 2.4 1.4 2021-30 1.7 2.4 2.1 2012-30 1.6 2.4 1.8
Business condence Small and medium-sized businesses are the backbone and engine of the economy, and condence in the sector is vital for investment. However, as with data on the broad economy, conicting signals are coming from small business owners, as revealed by the September 2013 Small Business Optimism Report from the National Federation of Independent Business (NFIB). This shows that in August optimism was at, but at a higher level than a year ago; however, the report stressed: As calm as the Index appears, there was turmoil in the details. Job creation plans jumped seven points to levels not seen since 2007. Yet, last month rms shed the largest number of employees in months. Capital spending and inventory investment plans increased as well, all activities that would put some energy into GDP growth. But, reports of quarter-to-quarter net gains in sales deteriorated 17 points and prot trends followed, giving up 13 points. Expectations for business conditions in six months also became more negative. Yet, sales expectations improved eight points. Such contradictory gures indicate at the very least a lack of condence in economic policy, magnied by the immediate problem of resolving the debt ceiling issue. Even if, as expected, the x for this will once again be temporary, businesses will have some reassurance and expectations should improve. As noted, there were positive signs regarding investment intentions among small businesses, with the frequency of reported capital outlays over the past six months rising three points to 57%. In addition, 25% of business owners stated they plan to make capital outlays in the next three to six months, a rise of two points. 15
UNITED STATES ASSET AND AUTO FINANCE SURVEY Business climate In the 2013 edition of the World Banks (WB) annual Doing Business report, the US is ranked fourth overall out of 185 countries, which is no change on 2012. The rankings are devised to give an indication of the business environment, and the nearer a country is to number one in the ranking, the more conducive the regulatory environment is to operating a business.
How the US and comparator economies rank on the ease of doing business
United States 4 7
United Kingdom
Canada
17
Germany
20 24
Japan
Regional average (OECD high income)
29
France
34 91
China
1 Source: Doing business database Ease of doing business ranking
185
16
Mostly, as would be expected, the US ranks near the top of the separate topics assessed by the WB, although it has slipped marginally in some. This may be more a case of other countries improving rather than the US declining. However, the US is relatively low down on the issue of paying taxes the only topic in which it is below the regional average of OECD high income countries, although the situation has improved in recent years. The salient point is that on the majority of topics the US is ranked well ahead of many of the comparator economies, most of which have weak areas whereas the US is strong across the board.
How the US ranks on Doing Business topics
Starting a business (13) Resolving insolvency (16) Dealing with construction permits (17)
Enforcing contracts (6)
Getting electricity (19)
Trading across borders (22)
Registering property (25)
Paying taxes (69) Protecting investors (6)
Getting credit (4)
Competitiveness The latest edition for 2013-2014 of the World Economic Forums Global Competitiveness Report (GCI), which assesses macro and microeconomic productivity factors, views the potential consequences of a tapering and eventual halt of QE in the US as a factor that could put future economic performance at risk. Notwithstanding this challenge, the report pointed out positives, stating: After having declined for four consecutive years in the ranking, the US reverses its downward trend, rising by two positions to take fth place this year and overtaking the Netherlands and Sweden. While the economy is getting back on track, the deleveraging process in the banking sector continues to show positive effects on the stability and efficiency of the countrys nancial markets. Improvements were noted in a number of the GCI rankings, although areas of relative weakness include: trust in politicians remaining weak (in 50th position); concerns about the governments ability to maintain arms-length relationships with the private sector (54th); and a general perception that the government spends its resources relatively wastefully (76th). However, the single basic requirement in which the US is seriously decient is the macroeconomic environment, which continues to be the countrys greatest area of weakness (ranked 117th), which is affected by the level of government debt and the budget decit, although the report notes that the decit is narrowing for the rst time since the onset of the nancial crisis. The national credit rating remains strong.
17
Stage of development
Institutions Innovation Infrastructure
Business sophistication
Macroeconomic environment
Market size
Health and primary education
Technological readiness
Higher education
Financial market development
Goods market efficiency Labour market efficiency
United States
Innovation driven economies
Source: Global Competitiveness Report 2013-2014 World Economic Forum, Switzerland
US position in the Global Competitiveness Index, 2013-2014

Rank/148 Score/7 GCI 2013-2014 005 5.5 GCI 2012-2013 007 5.5 GCI 2011-2012 005 5.4 Basic requirements (20.0%) 039 5.1 Institutions 035 4.6 Infrastructure 015 5.8 Macroeconomic environment 117 4.0 Health and primary education 034 6.1 Efficiency enhancers (50.0%) 001 5.7 Higher education and training 007 5.8 Goods market efficiency 020 4.9 Labour market efficiency 004 5.4 Financial market development 010 5.3 Technological readiness 015 5.7 Market size 001 6.9 Innovation and sophistication factors (21.3%) 006 5.4 Business sophistication 006 5.5 Innovation 007 5.4 Source: Global Competitiveness Report 2013-2014, World Economic Forum, Switzerland
18
UNITED STATES ASSET AND AUTO FINANCE SURVEY The most problematic factors for doing business, as perceived by the Global Competitiveness Report respondents, remain in much the same order as last year, although concerns about tax are rmly to the fore. Issues with inefficient government bureaucracy move from top of the list to third. After these, as per the previous year and still viewed as a consistent problem, is access to nancing. One solution to this issue is, of course, nancing through leasing.
The most problematic factors for doing business

Tax regulations Tax rates Inefficient government bureaucracy Access to nancing Restrictive labour regulations Inadequately educated workforce Poor work ethic in national labour force Policy instability Ination Insufficient capacity to innovate Inadequate supply of infrastructure Corruption Poor public health Government instability/coups Crime and theft Foreign currency regulations 16.3 15.4 14.0 08.7 07.3 06.8 06.2 05.7 04.8 04.3 03.1 01.7 01.6 01.4 01.4 01.2
0 5 10 15 Percent of responses 20 25
Source: Global Competitiveness Report 2013-2014 World Economic Forum, Switzerland
19
Leaders insights
Asset Financial International interviewed prominent industry leaders and senior executives at major equipment and auto lessors in the US for their analysis of the current state of the market, the opportunities and challenges it faces in the near and medium term, and the direction of market trends.
The effect of the current economic situation on the market It is ve years since the collapse of Lehman Brothers marked the start of the global nancial crisis, which affected all markets as it unfolded and from which the worlds largest economy had no immunity. Access to capital was seriously limited and, in the leasing market, volumes declined as lessors had less capital available and customers postponed equipment purchases. In the US, recovery in the asset nance market has been aided by the pick-up in the overall economy. However, as economic growth remains muted, leasing volumes have only slowly climbed back to previous levels.
Pascal Bouillon, managing director, Socit Gnrale Equipment Finance (SGEF) USA Commenting on the economy in general, Pascal Bouillon, managing director, Socit Gnrale Equipment Finance (SGEF) USA, said: The US economy is in its strongest position since the 2008-2009 recession, but growth remains subpar. While there are some signs of improvement (recovery of the housing market, inexpensive natural gas, nancial markets are performing quite well), there are still multiple headwinds (high oil price, weak growth, uncertainty of scal reforms).
Crit DeMent, chairman and CEO, LEAF Commercial Capital Opinion among the interviewees was broadly optimistic about the recovery in the asset nance sector, although not always excited by the pace. Crit DeMent, chairman and CEO, LEAF Commercial Capital, commented: Weve recovered to a point that is just about where we were when the recession started ve years ago. In my opinion that is indeed a recovery, but certainly not a very exciting one.
20
Chris Enbom, CEO, Allegiant Partners Others registered satisfaction in the recovery, perhaps laced with a degree of relief. Chris Enbom, CEO, Allegiant Partners, stated: I would say it is completely recovered from the global nancial crisis. The barrier to entry for new companies is relatively higher than before the crisis, but for rms that weathered the storm, business is as good as ever. And Dave Mirsky, CEO, Pacic Rim Capital, said: From our viewpoint, the industry has recovered well and most providers are experiencing increases in volume.
Gary Amos, head of Commercial Finance Americas, Siemens Financial Services (SFS) Gary Amos, head of Commercial Finance Americas, Siemens Financial Services (SFS), observed: The asset nance industry in the US, having been in a holding pattern following the nancial crisis and unable to grow signicantly, appears to be steering clear of any looming crises and has recently demonstrated considerable growth. Leasing and nance companies are strong, coming off reasonably good years; however, political and scal uncertainty continue to hang over the economy.
Mike Pitcher, president and CEO, LeasePlan USA An assessment of the state of the market from point of view of the auto leasing sector was provided by Mike Pitcher, president and CEO, LeasePlan USA, who said: The industry appears to be healthy and growing. Liquidity, which was a major issue for our industry during the nancial crisis, is no longer a problem.
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Jonathan Dodds, chief executive officer - Americas, White Clarke Group Jonathan Dodds, chief executive officer - Americas, of software solutions and consulting services provider White Clarke Group, added: Downsides of the recession included high rates when capital markets could be accessed; impacted customers ability to make payments, leading in turn to higher delinquency rates and potential write-offs; and portfolios shrinking as purchasing decisions were delayed. All these issues were managed successfully, however. Comparing leasing with other funding options such as bank lending, Amos continued: Banks are increasing market share in the equipment nance sector because most know their cost of funds for the next few years. Banks have come to understand and view equipment nance as an important part of their business since equipment leases fared better during the downturn than nearly any other asset class.
Bill Verhelle, CEO, First American Equipment Finance The nance sector overall has shown resilience despite a collapse in public opinion ratings and has, on the whole, pulled back faster than other sectors. In the opinion of Bill Verhelle, CEO, First American Equipment Finance, a City National Bank company, The US equipment nance industry, and the broader bank lending industry, have both recovered rapidly since 2008/2009. Banks and nancial services rms have generally outperformed other rms during the recovery.
Jeff Berg, US country manager, De Lage Landen The need for focus was stressed by Jeff Berg, US country manager, De Lage Landen, who said: Asset nancing is recovering modestly and we continue to nd pockets of growth where we can focus our attention, adding Beyond economic conditions, the asset nance industry offers convenience and speed when businesses need it.
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Adam Warner, president, Key Equipment Finance Also looking at the recovery across the sector, Adam Warner, president, Key Equipment Finance, added: I believe that equipment nancing has recovered at a greater pace than traditional business loans due to the pent-up demand for equipment coming out of the recession. Still unimpressed by the rate of recovery, DeMent added that there are aftereffects of the recession that continue to inuence nancial decision making: In terms of why the recovery and subsequent growth curves are so lethargic, there are many contributing factors, but I dont necessarily think that they relate to different forms of equipment nancing. The reality is that businesses are still cautious (what happened ve years ago is still a fresh nightmare) when it comes to capital investment. So this kind of sluggish market affects every form of nancing, not just equipment leasing. However, Amos concluded: There remains an opportunity for leasing companies to play an important role in helping the US economic recovery and supporting necessary investment in equipment albeit in a relatively slow growth environment.
Market drivers When asked to comment on the near- and medium-term drivers of the US equipment and auto nance markets, the element that was generally agreed upon was that much depends on how the improving economy will affect business conditions. Adam Warner summed up: There are several drivers for asset growth in the US, most stemming from the general economic growth of the nation as often measured by GDP growth, adding: We closely watch durable goods orders and the purchasing manager index to determine the likelihood of the need for asset nancing.
Rick Remiker, ELFA chairman and executive vice president and group head of Specialty Banking, The Huntington National Bank Rick Remiker, ELFA chairman and executive vice president and group head of Specialty Banking, The Huntington National Bank, explained: Leasing accelerates in economic expansion periods, where commercial concerns are investing in new business lines or adding capacity, thus increasing capex budgets. These periods are usually correlated with a rising or higher interest rate environment, which favours equipment leases that provide lower payments and cash ow relief in tight cash ow periods. 23
Dave Mirsky, CEO, Pacic Rim Capital To this, Dave Mirsky added: The main drivers are interest rates, business conditions and expectations for the future, along with equipment utilization needs and expectations of obsolescence. Gary Amos concurred, saying: There are three main factors driving improvements in the equipment nancing industry: modest easing of lending standards, combined with historically low interest rates; the need to replace ageing equipment; and a gradual improvement in companies end-market demand, which supports a moderate increase in expansionary equipment investment. The straightforward need to replace equipment was commonly cited, with the knock-on effect of expectations for growth. Chris Enbom made this point: The primary driver continues to be replacement equipment, but we are starting to see some expansion. Jeff Berg agreed, stating: There is growing need for updated capital equipment. We, lessors and customers included, have all held on to assets for a prolonged period and now is the time to make some strategic choices. This pent-up demand will naturally lead to an increase in sales in the near and medium term. In the auto sector, Mike Pitcher agreed that asset replacement is returning slowly as condence improves, and sees product quality and customer discernment as key elements: Business are slowly growing and expanding again. The quality of the vehicles is improved, and clients are getting more out of their vehicles than they did in the past. There was an uncertainty in the market for the past few years that has seemed to ease a bit, and clients are replacing older vehicles. Bill Verhelle had a specic viewpoint, stating: We see specialization and customization as a differentiator in the US commercial equipment nance marketplace. Otherwise, cost of funds and economies of scale are the most common competitive strategies in an increasingly crowded, and increasingly competitive, marketplace.
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UNITED STATES ASSET AND AUTO FINANCE SURVEY Behind all this lies the basic fact that the main driver is economic growth, with investment in capital goods at the forefront. Businesses need to have condence in economic growth being sustained, allied with assurance in monetary and regulatory policy. Crit DeMent elaborated: Not to oversimplify the issue, but in my opinion its all about condence. Whether were talking about businesses investing capital or consumer spending, as long as there is uncertainty, there is a reluctance to invest and spend. There are still a lot of unresolved issues and some new ones that are keeping businesses on the sidelines. Regulatory issues and the state of the economy are topics that even today keep business executives up at night and that inhibit investment decisions. He continued: The fact is, however, that there is still demand, and demand represents opportunities for growth. Demand is held in check because companies remain cautious. Its easier and less risky to wait and see instead of acting now. But there is plenty of capital available and the equipment leasing industry remains strong. As business executives and consumers become more condent, demand will increase at a greater rate and we will then be able to make up for lost time and grow at a more favorable rate.
Market challenges This leads to the main challenges for the market in the near and medium term, which are often related to market drivers economic conditions being a case in point. When Asset Finance International asked about the main challenges a year ago, one overriding concern was the global economy and the risk that uctuations and restricted growth could adversely affect the rate of growth in the US, and that remains a major concern today. Conditions in the eurozone were a major issue 12 months ago, and these were commonly mentioned this year, along with slower growth in China, which is becoming increasingly inuential on the global economy. As Adam Warner said, A main challenge for growth in the US stems from slow global economic growth. The impact of growth in China and Europe, specic to imports, continues to be a concern for US manufacturers. Aside from challenges posed by the global economy, constraints in the nancial sector at home were frequently referred to, such as access to credit and competition pressure. For Dave Mirsky, the main issues revolve around liquidity and value: The main challenges are availability of capital, pricing pressures and commoditization. The lessor must show a compelling reason that they are unique and can add value to get the conversation away from price alone. Rick Remiker stressed the knock-on effect of low overall growth on purchasing options: Low GDP or economic growth environments reduce capex budgets, and thus leasing opportunities. Deationary periods create lower equipment residual assumptions, which reduce the pricing power of leasing. Finally, low debt usage creates more emphasis on buying rather than leasing, due to competitive loan rates and borrowing capacity.
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UNITED STATES ASSET AND AUTO FINANCE SURVEY Access to credit affects small and medium-sized enterprises (SMEs) more than larger corporates, and SMEs that were stung by the recession remain cautious, as well as being more vulnerable to any lack of economic stimulus. The possibility that the recovery will be long and protracted was raised by Chris Enbom: The US economy, while much improved, is still not recovering as well as it has at this point compared with other recessions. I see many parallels with the early 1990s. The credit markets really fell apart in the late 1980s, and it was not until 10 years later the market really began its signicant growth trend again. This may be the case with the 2008 recession we do not see the economy fully mended until 2018. The need to boost condence, especially among SMEs, is obvious. Lessors need to be exible and adaptable, and prepared for a period of merely modest growth. Current excess capacity is a challenge mentioned by several industry experts, which could lead to an over-competitive environment. Competition for asset nance providers in the specic form of more banks entering the equipment nance marketplace was brought up by Bill Verhelle, and the possibility of the market overheating was described by Crit DeMent: The main challenge is that as an industry, we are accustomed to much greater demand, so now we nd ourselves ghting over the scraps of whats left. We as an industry need to be smart about how we adapt to the new reality of a 6% growth rate. When things start to heat up and become increasingly competitive, lenders rst tend to ddle with interest rates, and then start to relax credit standards. Thats what happened in the run-up to the scal crisis and accompanying recession in 2008 and look how that turned out. The important point was made by Jeff Berg that lessors report to shareholders, who will want to see performance maintained during tighter conditions: The biggest challenge is that, despite demand, we have to run our organizations leaner than weve done before in order to recognize our protability goals and meet the expectations of our shareholders. He explained: Continuous improvement is the new norm, we cannot keep doing business the way we always have and expect the same result. Our customers have greater expectations than ever before and we need to meet those expectations while looking ahead at the same time. These points were endorsed by Pascal Bouillon, who said: Flight to quality continues, with competition ghting aggressively for the safest transactions, driving pricing down. Similarly, there have been new entrants to our equipment nance market, as the economy is improving. As such, margins are going down, and there is also increased competition in hiring talent. DeMent concluded: The biggest risk now is that if we start doing the same things all over again, well have exactly the same results, except that this time there will be no bubble to cushion our fall. So the biggest challenge is to be able to facilitate growth without being reckless, or worse.
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UNITED STATES ASSET AND AUTO FINANCE SURVEY Accounting changes Another potential constraint that was commonly cited was the ongoing issue of the proposed changes to lease accounting. The latest exposure draft from the International Accounting Standards Board (IASB), developed through a joint project with the US Financial Accounting Standards Board (FASB) in the light of criticisms that the existing accounting model for leases fails to meet the needs of users of nancial statements, while making some improvements, has caused concern this topic is covered later in this section and in much greater detail in the following section of this survey. The buzz-phrase is accounting convergence, and on this Adam Warner noted: The proposed global lease accounting convergence has a negative overhang on nancing as lessees and lessors attempt to identify negative consequences of all operating lease assets being added to balance sheets, as well as the management and administration of a much more complex standard. These various challenges and the immediate effect on the market were encapsulated by Gary Amos: The economic uncertainty and an onerous regulatory environment are causing customers to pull back from already modest equipment acquisition budgets. To this he added: The industry also faces a challenge to recruit talent, so there are certainly opportunities for companies that can offer a global reach and have demonstrated nancial strength throughout the recession. One nal obstacle, which serves to re-emphasize the overarching importance of condence when it comes to investment, was pointed out by Warner, who said: US Federal Government policy uncertainty around spending, decits, debt increases and tax reform is weighing heavily on consumer and business condence.
Growth prospects With growth in the economy forecast to remain at modest levels over the coming 12-18 months, the consensus was that the asset nance sector should at least grow at a higher rate. As Gary Amos of SFS said: Conditions in the equipment leasing and nance industry appear to be improving at a faster rate than the broader economy in the US. Predictions from the interviewees for the sector as a whole ranged mainly around the 3-6% level, progressing from nearer the lower rate in 2013 toward the higher rate in 2014. The ELFA had suggested 6% for 2013, but that has been revised down to 4.8% due to lower than expected investment growth in the rst half of the year. Interestingly, an exception to those expecting leasing growth to be ahead of GDP was ELFAs chairman Rick Remiker of The Huntington National Bank, who repeated his concern over the constraint on leasing volumes due to lack of capital expenditure, commenting: We expect equipment nance volumes to lag US GDP growth estimates, due to limited investment prospects for capex spending. However, some were more optimistic. Crit DeMent of LEAF Commercial Capital still thought 6% not unreasonable over 2013/2014, and First American Equipment Finances Bill Verhelle thought 6-7% at best. At the top end of forecasts was a condent Dave Mirsky of Pacic Rim Capital, who stated: We are planning for 10% increases for this year and next but will be disappointed if we dont achieve far more.
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UNITED STATES ASSET AND AUTO FINANCE SURVEY Outlook for SMEs and large corporates When considering the prospects for businesses by size of organization, opinions varied although growth was assumed for both SMEs and large corporates. Those interviewees that offered estimates kept to the middle of the single-digit range across the board. SMEs are seen to have great potential; however, they are coming from a reduced base since they were hit hardest by the recession. Larger organizations have easier access to nance during a fallow period through better credit ratings and also via their own resources, and are generally able to benet quicker when credit conditions improve. Rick Remiker explained the size advantage: Large corporates are best able to take advantage of low growth periods, where they have the pricing advantage in a status quo market, but he went on to point out that, When expansion occurs, upstarts take market share from the established players through investment in new business lines. The SME disadvantage of lack of reach was pointed out by Dave Mirsky: Smaller companies tend to sell in local markets and to the larger companies. Large multinationals can take advantage of international opportunities and will have more avenues to create growth than SMEs will have. However, the fact that SMEs tend to concentrate on local markets was viewed by Jeff Berg as having benets: The advantage for small to mid-sized companies is that they can more easily penetrate into their local markets and rapidly adapt their models to the local environment.
Sector prospects Assessments of where the best opportunities lie for this year and next were also mixed, depending in part on lessors main areas of expertise. However, certain sectors were mentioned more often in particular, energy, construction, technology and healthcare. Other sectors with potential that were highlighted are plant & machinery, including agricultural equipment; and transportation, including trucks and rail. Specic predictions varied, of course, but the construction and energy sectors were both rated for double-digit rates of growth by several interviewees. The reasons behind the enthusiasm for these two sectors are easy to see, given the recovery of the housing sector and the booming domestic fracking industry. Growth in one sector can have a benecial knock-on effect elsewhere: the pick-up in construction should benet the plant & machinery and transportation sectors; and the renewable energy, or green, market is boosted by growth in the overall energy sector. The consensus was that the medical sector has good prospects, notwithstanding the ongoing political turmoil surrounding the implementation of President Obamas healthcare reforms, the Affordable Care Act popularly known as Obamacare, mainly due to the inevitable fact that an ageing population will require greater levels of healthcare provision. One effect of the recession, added to by the current global political uncertainty, according to Key Equipment Finances Adam Warner, has been to focus on efficiency and security: Growth is likely to come from sectors that might benet in some way on negative economic factors. We see commercial clients investing in technology as a way to better manage costs. With a highly volatile environment in the Middle East, continued investing in alternative energy sources and energy efficiency equipment is likely.
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UNITED STATES ASSET AND AUTO FINANCE SURVEY Although several experts thought highly of the prospects for the technology sector, opinion diverged somewhat over which sub-segments would grow. An important point was made by Pascal Bouillon of SGEF USA, who said: Hightech equipment is seen to become a slower growth segment due to the adoption of tablets and smart phones. In addition, he expected High-tech nance specialists to become more aggressive in order to offset slower growth and increased competition. De Lage Landens Jeff Berg could see technology needs in healthcare making that sector attractive, and the needs of a growing global population creating strong prospects for the food and agriculture sector, but he emphasized: Regardless of the specialty area, the benets of use over ownership include the ability to reuse and recycle assets. We are actively working with several partners to design products in such a way that they can be safely disassembled and recycled at the end of the products life. There was plenty of support for the energy sector. Speaking from the point of view of a niche specialist, Chris Enbom of Allegiant Partners said: I am on the board of an energy efficiency nance company and we certainly see great opportunities in this sector. Berg saw this as a sector with great potential, stating: The potential for growth within the clean technology sector, compared to traditional asset nance sectors, is exponential. We are ultimately drawn to the sector because we believe in the promotion of sustainability and reducing our carbon footprint. The alternative green energy market was generally viewed as being a good prospect, if perhaps in the longer term, once technology improves and pricing stabilizes. This is an important area of potential growth in the auto sector, although it is slow in gaining acceptance among consumers. LeasePlans Mike Pitcher summed up: The take rate (acceptance) of alternative fuel, and electric vehicles in particular, is slower than many industry experts predicted. An overview of the problems for lessors in anticipating market trends was provided by Crit DeMent: Its hard to say what sectors offer the best future prospects. I think that when you try and get too granular while peering into the crystal ball of the future, its pretty easy to go off on a tangent that might not represent the best course of action. Growth in any given sector is a function of the management skill, marketing expertise and overall creativity of the companies that make up the sector. The equipment nance industry cant control that, nor can we really shape it. Our job is to spot demand as it ramps up, and then to position ourselves to capitalize on it. DeMent continued: With that said, I think the key is to look for convergent technologies that will ultimately lead to what Ill call hybrid sectors. For example, one could argue that telephony and computers have moved into a hybrid sector. I think that the ability to spot this type of convergence and then to adapt your business to take advantage of it is crucial.
Considering so-called new markets, such as renewable resources and technology, DeMent stressed the need to work through existing channels, whether the business is in solar panels or resource-efficient office equipment. He concluded: In both cases, the nance company is best served by working with existing channel partners to identify and explore green applications of their products and services, rather than setting out to open up an entirely new channel.
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Floorplan nance
Auto nance specialist Marguerite Watanabe examines the current situation regarding the auto nance wholesale (inventory or oorplan) lending environment in the US
Wholesale oorplan nancing allows dealers to borrow against retail inventory. The dealer then repays that debt as their inventory is sold and borrows against the line of credit to add new inventory. After facing a number of challenging years during the most recent economic crisis, the wholesale market has recovered robustly and is now a vibrant one. This renewed vitality can be seen in the numbers: vehicle sales are very strong, for both new and used cars and light trucks. A major facilitator of this growth has been that capital is again readily accessible. There is not only strong support for wholesale lending within captive nance companies (supplying both new and old vehicles) and banks to franchised dealers, but also from both traditional dealer funding sources and new market entrants that are providing oorplan funding to independent (i.e. used vehicle) dealers. Following the recent hard years, the funder-dealer relationship has strengthened, as dealers are very appreciative of their wholesale nancing sources, especially those who continued to support them during the crisis. However, challenges still exist, rst among which is the intensifying competition for dealer customers which is beginning, and will continue, to put pressure on margins. A second challenge concerns regulation and compliance. Close scrutiny is being kept on how the emerging regulatory and compliance requirements may impact the wholesale side of the business, though the current target of regulators is the retail (consumer nancing) side of the business.
Opportunities There are denite opportunities for business growth for wholesale lenders, including, as mentioned, the funder-dealer relationship, and the ties between wholesale and retail (consumer nancing) programmes will continue to help grow a lenders business. In addition, the development of new technologies and business processes are providing lenders with the tools to reduce operating expenses while providing greater value and service to their dealers. With the lending environment shifting to a buyers (i.e. dealers) market, the key factor for success as a lender is to be able to increase dealer satisfaction. To achieve this, the funder must understand that providing not just adequate, but enhanced reporting, including self-servicing reporting, to dealers is crucial. Another factor for funders to be aware of is that sharing dealer performance in an easily accessible format for dealers will become more important, especially in a more rigorous regulatory environment. Finally, the rapid deployment of nancial plans and programmes to dealers which allow exible payment options will enable a lender to differentiate itself from its competitors.
Marguerite Watanabe is president of independent consultant Connections Insights and has been in the auto and auto nance business for over 25 years. Connections Insights has worked since 2006 with international clients, including auto nancing sources, auto manufacturers, software and data providers, business processing outsourcers, consulting rms and trade associations. Tel: +1 678-520-3385 marguerite@connectionsinsights.com
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Industry consolidation
The aftermath of the recession has seen some realignment in the market, with smaller independents and some bank-owned lessors seeking strategic alliances. Established lessors also took the opportunity, or were forced, to make cost-saving measures and the streamlining of operations inevitably led to reductions in executive manpower. An outcome of this was that, instead of the market contracting across the board, there have been new independents set up by former, experienced management teams. This now sets up a market where there are enticing merger and acquisition (M&A) possibilities, either for large, established businesses with acquisition funds, or again for building strength through alliances in a market which is otherwise expanding at only a moderate rate. The situation was described by Gary Amos: There is a strong possibility of M&A activity post-recession in the US. Throughout the recession, we saw large numbers of established industry leaders displaced and, as a result, these lenders reduced headcount and staff positions at all levels. Over time, the more senior talent re-emerged and created new leasing companies with alternative sources of debt and equity. These new entities serviced relationships and partnerships established over the years. Some of these stronger performing new entities could become targets for larger nance companies looking for asset growth through M&A. Pascal Bouillon agreed, adding: There are many more independent leasing companies in the equipment nance market in the US compared to Europe, where a vast majority of players are bank owned. While these independent players suffered a lot during the recession, as they had difficulties getting renanced, the current improving economic environment should strengthen their nancial performance and in addition be favorable to the arrival of new players. Bouillon continued: Banks should continue to be the most aggressive buyers of independent leasing companies, taking advantage of their low cost of funds, although he pointed out the possible cost constraint in the current environment, concluding: However, while there is theoretically real potential for an increase of M&A activity, price expectations of sellers may be a drag on M&A activity. For Chris Enbom, future bank purchases alongside the arrival of new independents are also likely: The banks will purchase the few remaining independents, and we will once again see a number of new independents come into the market. For Bill Verhelle at First American Equipment Finance, this has already become a reality, as he explained: The 23rd largest bank in the US [City National Bank] acquired our medium-sized, independent equipment nance company a little over a year ago. We have seen more acquisitions recently, and there is high interest in future deals. In his opinion, The reason for many of the acquisitions has to do with banks having excess capital to invest. Some equipment nance business produce above market returns.
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UNITED STATES ASSET AND AUTO FINANCE SURVEY M&A scenarios These issues were raised by others. Dave Mirsky commented: I fully expect to see more mergers and acquisitions among lessors and banks because of the difficulty that lessors have nding capital and the difficulty that banks have in gaining greater yield. These competing needs create a natural match. In addition, some lessors are having problems due to pricing pressures. Such unprotable lessors will be excellent M&A targets if they have decent portfolios. Rick Remiker provided some more detail, highlighting three main factors behind the increasing likelihood of greater M&A activity, the rst being regulatory and compliance: Small banks are challenged to maintain enterprise risk management programmes and meet compliance regulations, which limits their growth and business prospects, thus merging enables economies of scale to set up proper controls. Small independent lessors will be faced with similar issues as banks going forward. The next factor is funding capacity and pricing: Capital markets and bank funding is primarily available for larger independents, thus merging is a way to build funding capacity. For banks, the cost of funds is critical to competitiveness in the industry, thus the larger rms have an advantage pushing more rms to merge. The nal factor listed by Remiker was what he termed The ageing of industry leasing experts are retiring and the industry is producing less experienced leasing personnel, requiring acquisitions to obtain talent. Another viewpoint came from Adam Warner, who observed that regulation might restrict larger banks appetite: Banks in the US continue to hold a major amount of the equipment nancing space. M&A activity among large US banks is less likely due to the regulatory environment so I dont believe we will see much merger activity in that sector. In addition, Warner put forward a potential development in the manufacturers captives sector: A probable scenario could be that manufacturers consider divesting portions of their captive nance arms but we havent seen this play out as of yet. Warners point about larger banks was agreed with by Jeff Berg, who said: I dont think there is a great likelihood of increased M&A in the US. Larger institutions are equipped to meet Basel III and equity requirements, and have the necessary infrastructure and resources to weather the headwinds of the greater economic environment and appropriately address an increasingly complex regulatory environment. The subdued economy and the fact that the leasing market is yet to return to dynamic growth have meant the market remains cautious. As put by Ken Adams: The fundamentals are returning and there has been some activity in the past year, but the drive for M&A is still not that strong. The willingness to invest is being held back by uncertainty, especially over federal policy.
A nal comment came from Crit DeMent, who noted: As nancing companies chart their long-term strategies, growth through M&A is clearly a strategic alternative. When volume is a prime concern, as it always is, you can only generate so much business by manipulating rates. Beyond that, easing credit requirements can be risky, so an M&A strategy gets the leasing company around both of those hurdles. He also pointed out that M&A is a rigorous process that is fraught with potential pitfalls: Of course, merging with or acquiring another company presents its own unique set of challenges, so its not something that a nance company can or should just jump into.
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UNITED STATES ASSET AND AUTO FINANCE SURVEY Regulatory issues Asset Finance International asked for comments on the current situation regarding taxation legislation and regulation in the US. Once again, the concerns that were raised were centered on uncertainty as to what direction federal policy will take. An important point to note, as made by Rick Remiker, is that the tax code benets lessors: Tax is a signicant driver of the leasing product; thus any changes will affect business models for lessors. Taxes are high now, so that actually supports lease pricing. An issue raised by some relates to possible limits on deductions. Adam Warner explained, stating: There are concerns among US lessors about what comprehensive tax reform for US businesses might look like. For the US to have a more competitive corporate tax rate as compared to other large global economies, tax deductions will need to be minimized. Important deductions that encourage capital formation are the interest expense and depreciation deductions, adding that, We are spending time educating legislators that changes to those deductions would have negative impacts for manufacturers and nancial providers. Corporate tax reform was also brought up by Chris Enbom, who said: We are concerned about talk amongst legislators that would limit interest deductions for corporations if comprehensive tax reform is passed. Enbom also voiced the concern over policy uncertainty affecting the market: Otherwise, the games being played by congress are slowing the economy due to uncertainty. Others tended to agree that if taxation is a problem, it is one suffered by all. As Bill Verhelle said: Tax legislation and regulation generally affects all competitors equally, so it is not really a big competitive factor in the US (although it is often discussed). Regulation does not have too much impact on well-capitalized businesses lending to larger, highly creditworthy borrowers. Concerning more thinly capitalized institutions, and with lending to high-risk businesses, regulation has limited some marketplace activity. Crit DeMent agreed, saying: Tax and regulatory issues tend to suppress volume growth because of the uncertainty that they bring into capital investment decisions. And when business executives are uncertain about whats happening, they typically sit it out and wait for a better day. The only thing we can really do is to make sure we understand whats going on, what the implications are, and then work with our customers to help them make good equipment investment decisions. Jeff Berg commented: Right now we are facing several, major national issues, regardless of what is also occurring at the state and local level. Certainly, regulatory issues are very real, and a constant in our business, so we have to thoroughly understand the implications and respond accordingly. Legislation adds an extra layer of complexity to operations. DeMent summed up: Tax legislation and regulatory issues in general are a normal part of our business landscape and need to be taken in our stride. Flying an airliner in turbulent weather is not necessarily easy but if you want to be an airline pilot, its part of the job. Similarly, adapting and adjusting to tax and regulatory issues is not easy, but it is a part of our job and something that we just have to deal with.
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Accounting for leases

The nal topic for discussion was the proposed changes to lease accounting standards, an issue that has been exercising the minds of the accounting standards organizations for some considerable time. The latest Exposure Draft (ED) produced by the Leases Project conducted by the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) seems to have claried some points but created more problems elsewhere. This is covered in detail in the next section of this survey, in which the industry view, and objections, are put by the ELFA. The consensus among interviewees for this survey was uniformly of the opinion that the latest proposals would not improve the situation and will not ease uncertainty in the sector, adding unnecessary complexity and likely to have a negative impact. A summary was given by Pascal Bouillon: Among other concerns, the conceptual basis of the IASB/ FASB proposals remains unclear and the complexity of the proposed model is still high and raising signicant operational issues. More specically, regarding proposals affecting operating leases, Gary Amos commented: The recommendation has caused requests from users of nancial statements and other stakeholders to change the accounting guidance so that lessees would be required to recognize assets and liabilities arising from leases. If approved, this change could reduce the percentage of operating leases utilized, as obligors would be required to include the assets on balance sheet, creating additional uncertainty around nancial fundamentals and underlying covenants. The comment from Dave Mirsky was direct: We anticipate that the proposed changes will be damaging to the interests of our industry and will cause more uncertainty in the sector. However, not all opinions were that strongly opposed. Mike Pitcher saw some potential for a positive outcome: While it was something that our industry was very concerned about, the latest delays with regard to an exposure draft and implementation time line have eased some of these concerns. In addition, it does seem that industry input and concerns are being considered in the process. To this, Jeff Berg added that, whilst believing that the proposed changes will bring additional complexity to our already fragile external environment we still have a way to go until approval and will only fully understand the implications when applied in tomorrows economic context. The nal view on the uncertainty factor came from Crit DeMent, with a sporting analogy: If youre playing a football game in the rain, you cant wait until the rain stops to put your offense on the eld. You go on offense when you get the ball. When it comes to accounting standards and regulatory changes, I think that business works much the same way. If you wait until there are no more changes in sight to get down to work, youll go out of business before you can even begin. The only thing that you can do is to take these things in stride, make adjustments as necessary, and then keep moving forward. He concluded: Uncertainty is a state of mind and the best antidote for it is a healthy dose of reality. The game will continue whether you choose to play or not, so its best to just dive in and do your best. Benjamin Franklins lines on federal policy are often quoted: Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes. Perhaps in modern times those two certainties can be augmented by the addition of accounting. 34
The US view of the Leases Project

Bill Bosco outlines why the ELFA believes major changes are needed to the latest Exposure Draft produced by the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB)
The Equipment Leasing and Finance Association continues to support the project to improve lease accounting. We think that current generally accepted accounting principles (GAAP) does work well but we respect the notion that, to a going concern, operating leases create enforceable obligations that are unique liabilities (not debt) and need a special form of balance sheet presentation. We think that only minor changes to current GAAP are needed to achieve the original objective of the project that is, to put the value of the obligations on the balance sheet. We think the second Exposure Draft (ED) of the Leases Project went too far in overhauling both lessee and lessor accounting where changes were not necessary and fails the cost benet test. We think the changes proposed are not improvements over current GAAP, as follows. Lessee issues: Lessee lease classication breaks from the traditional alignment with the US commercial laws and income, property and sales tax rules. It is no longer based on the substance of the transaction, especially as the proposed rules apply to equipment leases. We must retain a risks and rewards-based classication methodology that is the same regardless of the nature of the leased assets. The proposal treats equipment leases differently than real estate leases despite the fact that they are legally and in substance the same types of contracts. Lenders and credit analysts, especially those who serve small and medium-sized enterprises (SMEs) and non-investment grade companies (NiGS), will have less information that is key in their bankruptcy risk analysis of a lessee as the capital and operating lease assets and liabilities are commingled with no information provided to unwind the new awed accounting. We think equity analysts do not follow the majority of companies that lease equipment (SMEs and NiGs) and their needs are unique to their particular analytical objectives such that they should not be a driver in how the day-to-day accounting is done for leases to serve the many compliance needs of preparers and the information needs of their lenders. We think that operating lease obligations are not debt in bankruptcy and that the Boards need to keep in mind the common everyday usage of the term debt by lenders and credit analysts when deciding to change GAAP and create a new liability. If analysts think operating leases have debt-like qualities, they are not saying they are in fact debt. When lenders create debt limit covenants, their purpose is to limit the preparer from issuing new debt instruments that will be a competing claim on the preparers assets that survive bankruptcy. We think there are two types of leases capital leases and operating leases (executory contracts). Capital lease accounting works well today. Operating lease accounting also works well from a P&L (straight line average rent is the expense for a lease that is an executory contract or rental) and cash ow presentation perspective, so only the value of the lease contract should be reected on the balance sheet with no other changes. The value of the leased asset and lease liability for an operating lease on the balance sheet should always be equal (the contract is the 35
UNITED STATES ASSET AND AUTO FINANCE SURVEY unit of account) except for impairment and initial direct costs. We think that the hurdle that the lessee must meet to unbundle a bundled billed lease is too high in that it requires a lessee to nd market evidence of comparable contracts pricing. Lease and service contracts are most often unique and are not public information. Our recommended relief is to allow reasonable estimates to be used to avoid overcapitalizing the lease portion of the contract. We disagree with the proposed sale leaseback accounting in the ED where sale treatment is negated if the seller/lessee is granted a purchase option at an amount less than the sales price. This also is a break from the US commercial law and tax rules. It also means there will be assets and debt displayed on a lessees balance sheet that are not considered assets and debt in a bankruptcy. This also means that lenders and credit analysts will not have the information needed to evaluate credit risk. We cannot understand why the accounting results are not the same for a new lease with a no-bargain purchase option versus a sale leaseback with a nonbargain purchase option.
Lessor issues: We think there should not be symmetry in lessee and lessor accounting. The lessees view is based on risks and rewards do I own the asset or am I merely renting the asset to acquire a temporary right of use? On the other hand, in the same transaction, the lessor could be an operating lessor or a nancial lessor. The operating lessor views the asset as its stock-in-trade and will continue to lease that same asset multiple times over its life as it comes off each lease, incurring maintenance, insurance and tax costs. The nancial lessor views the lease as a discreet nancial investment, only buying the asset subject to a lessee commitment to lease and intending to sell it, often at auction, when the asset is returned at lease expiry. The lessor accounting should reect the nature of the lessors transaction; as such, lessor classication should be based on business model. We think that current leveraged lease accounting and accounting for tax credits in lease revenue (not tax expense per the ED) should be retained on the basis that it reects the economics of the transactions. We think that all types of residual guarantees and residual insurance convert residual assets from physical assets to nancial assets.
Cost benet: We think the FASB/IASB claim that there is a nancial reporting benet is not reected in the comment letters from key stakeholders including the major accounting rms and FASBs Investors Advisory committee (IAC). We think the costs to transition and to comply far outweigh any benet, even if the issues regarding the aws cited above are corrected. A major overhaul of lease accounting is not needed. Remember that included in the initial goal was saving the costs of analysts and lenders from calculating the as-if capitalized values of operating leases. This is a simple PV calculation using reliable, audited footnoted operating lease obligations that is done on an infrequent, as-needed basis. Instead, the ED imposes complete and costly changes to both lessee and lessor accounting, requires continuing reassessments, and requires complex asset level transition calculations. Those costs are great and we think they have not been accurately measured. Without any analysis one should conclude that the current system is effective
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UNITED STATES ASSET AND AUTO FINANCE SURVEY and involves little cost on the part of investors. Some comment letters point out that investors will always make adjustments as they have unique needs. Some changes appear to be change-for-the-sake-of-change. No changes should be made to current GAAP where current GAAP works and the changes are cosmetic.
Feedback received by the Boards The FASB and IASB have received over 600 comment letters to the second Exposure Draft of the Leases Project. An analysis of the comment letters reveals substantial opposition to the proposal. Some 80% of the letters were negative, 10-15% were partly positive but pointed out serious concerns, and the remaining 5% were fully positive. The Boards have also conducted outreach sessions with analysts and roundtable meetings with attendees who wrote comment letters to get in depth views. The common themes in the negative comment letters and at the roundtable meetings are in line with the views of the ELFA. The Boards report that their outreach to analysts indicate that most analysts agree with the project as they think operating leases create obligations as debt-like obligations. They take that as a 100% endorsement of the ED and its details, yet the fact is that it is not all analysts that agree and the devil is in the details. The FASBs own IAC issued a comment letter stating that the ED it is not an improvement to current US GAAP lease accounting. The reasons for their rejection include keeping current classication tests, P&L and cash ow treatments the same, or else analysts will not have enough information to do their analysis. The fact that the analysts also say that lease liabilities are debt-like and not debt is an important distinction they seem to gloss over.
Conclusion The ELFA cannot support the ED. Throughout the project, now in its seventh year, the association has provided the Boards with constructive feedback and reasonable alternatives to some of the decisions they have made on both lessee and lessor accounting. And, we continue to do so. The Boards should provide users with an accurate capitalized value of lessee operating lease obligations, be it on balance sheet or in nancial statement disclosures, while keeping the rest of current GAAP intact.
37
Bill Bosco is a member of the ELFA Financial Accounting Committee. He has been on the committee since 1988. He has been selected to the FASB/IASB Leases Project working group as a representative of the ELFA. He can be reached at wbleasing101@aol.com, www.leasing-101.com or +1 914-522-3233. The ELFA website is www.elfaonline.org.
Executive summary of the Leases Project Exposure Draft

Estimated timeline New ED issued May 16, 2013. Comment period ended September 13, 2013 with over 600 mostly negative letters received. Re-deliberations that will begin late in the fourth quarter and, due to high volume of letters, will continue on into 2014. This means the new rules will not be issued until 2014. Transition date has not been announced, but is likely to be no sooner than 2017 possibly slipping to 2018. Lessee accounting Capitalize all leases at the PV of estimated payments. Some leases, aka Type A, (most equipment leases) will have a P&L pattern that is front ended rent expense replaced by amortization and imputed interest, now called Type A (formerly called Interest and Amortization (I&A)) leases. Some leases, aka Type B, (mostly real estate and some long-lived equipment leases with relatively short terms (possibly 10% of the original life) will have straight line rent expense, now called Type B (formerly called Single Lease Expense (SLE)) leases. Real estate leases are presumed to get straight line expense unless the lease term and PV of rents are meet similar tests as current GAAP while equipment leases are presumed to get front ended costs unless the lease term and PV of rents are insignicant compared to the original useful life and current fair value of the leased asset. Insignicant remains to be dened. Lease term = substantially the same as current GAAP denition. Variable rents based on a rate (i.e. Libor) or an index (i.e. CPI) are booked based on spot rates with adjustments booked when the rate change changes contractual lease payments. Variable rents based on usage or lessee performance (e.g. sales) not booked unless a tool to avoid capitalization (disguised minimum lease payment). Estimated payments under residual guarantees are booked with review and adjustment at each reporting date. Short-term leases, including most short-term renewals, can elect to use operating lease method with additional disclosure. Lessor accounting Two methods identied for lessors The Type A method (formerly called the receivable & residual (R&R) method) (much like the current GAAP direct nance lease method) used for most equipment leases, and the Type B (existing operating lease accounting) which will cover most real estate leases and some (few) equipment leases. There is a short-term lease election to use current GAAP operating lease method. The classication tests will be the same as those for lessees (see above) meaning Type A will be treated as R&R leases while Type B will be treated as operating leases. Under the R&R method assets are the PV of the receivable and a plugged residual with earnings recognized using the implicit rate in the lease. Certain residual guarantees where guarantor gets the residual upside are considered minimum lease payments. Sales-type gross prots are limited with residual portion of gain be deferred until resolved through a sale or release. Leveraged lease accounting is eliminated with no grandfathering and tax credits will not be reported as lease revenue. This is a FASB only issue. 38
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