Reprinted from World Leasing News – Oct.16, 2008
THE MISSING CREDIT COMPONENT IN ALL LEASING APPROVALS
The past few months shows what can happen when firms do not fully evaluate the risks in their marketplace. Lehman Brothers, Merrill Lynch, AIG, and Fannie Mae all fell victim to poor risk management. It was a classic case of ignoring or missing key credit components when evaluating credits and the result was a perfect financial storm that nearly destroyed Wall Street. What can we learn from this and what can we do to prevent similar nightmares from happening in the Leasing Industry? Inside this article I will divulge the single largest credit component that most leasing companies are missing when they evaluate their credit risk.
The major errors these Wall Street giants made were to rely on weak credit investigations based upon minimal information. Almost every Wall Street firm accepted the minimal standards because everyone else was doing it also. In the equipment leasing industry, we have had a similar mindset. We have grown quite comfortable in our present credit procedures and are content to maintain the status quo on how we investigate potential lessees as long as our static pools remain inside their guidelines.
The Missing Credit Component in Leasing
Imagine that someone wants you to buy millions in dollars of new leases. The yields are excellent, the lessees’ credit looks great, and the source of the paper has been dealing with some of the largest and most respected firms in the leasing industry. This sounds like a no-brainer right? Would you do the deal? If you said yes, you may have bought millions in worthless Norvergence telephone equipment paper.
Our industry has experienced many large credit blowups just like Norvergence and a large number of smaller yet equally devastating credit events that occurred when Lessors are hit in a credit “blind spot”. Just what is this “blind spot”? Most leasing companies ignore one party of every leasing transaction. Every Lessor spends a large amount of money investigating the Lessee, but little effort is done on the Vendor and Equipment. Most of our industry’s greatest errors have been the result of ignoring the Vendor/Equipment side of every deal. In fact, my 54 years in the credit industry have taught me that the vendor and equipment has a weighted importance of 40% for the success of every transaction. Just think about that ! Whenever you consider a lease applicant for approval, are you evaluating the Vendor/Equipment component in a manner similar to your review of the Lessee? My experience with many Lessors around the industry tells me that very few actually are evaluating this risk correctly.
My first recognition of this component occurred in the 1980’s. I owned a leasing company in the Dallas area, and we were dealing with two well respected vendors selling soft serve ice cream equipment. Both vendors sold the same equipment in the same regional market, but upon analyzing their performance, we noticed that their leases had remarkably different performances. One vendor’s leases performed like clockwork – losses were low. The other had a lost rate of over 20%! What was the difference? The lessees for both were extremely similar, so it was not the quality of the lessees. The equipment was the same, so that was not the issue. The only difference was the Vendor. What could possibly cause this?
In the example of the soft serve ice cream machines, the difference was how the vendor sold the equipment. The higher risk vendor was using a lot of cost justification sales tactics to their customers – promising them that the equipment would pay for the monthly lease payment. When the equipment failed to live up to lofty expectations, the lessees did not pay. In this case, the vendor in question was not fraudulent – just high risk. I began to notice the tell tale signs of this high risk vendor and recognized the missing component in our lease scoring models.
Signs of A High Risk Vendor
Most of us in the industry only recognize the famous fraudulent High Risk Vendors. These are the fake vendors who attempt to steal our precious capital outright – the Norvergence and Royal Links type vendors. High risk vendors can also be legitimate vendors who sell millions of dollars in equipment. They have legitimate operations, with large salesforces, but just like that bad soft serve Vendor, they also have very high loss rates. Because they spread their lease paper around the industry, very few people clue into the potential danger until it is to late. Below are some of my warning signs for these Vendors.
My High Risk Vendor Warning Signs
How to Incorporate the Missing Component In Your Credit Criteria
The above general characteristics of High Risk vendors can help, but there is no substitute for a review of actual vendor performance. Since many of these vendors move from one leasing company to another frequently, how does a Lessor spot them? LeasePolice.com is the only data source in the world that matches lease defaults with the vendors which produce the leases. Our database is growing exponentially and we expect to have data on over 50,000 vendors by sometime next year. Currently we have data on over 20,000 vendors.
At LeasePolice.com, we offer many great ways to pick up on these “High Risk” Vendors. First, our system aggregates lease performance histories for vendors and you can clearly see when a vendor is producing a number of non-performing leases. We also produce a Vendor Score for each vendor which gives you his relative risk. This score takes into account repossessions, inquiries, posted alerts, as well as proprietary data of Lease Police, Inc. to provide you with a score between 1 and 100 for each vendor (one being the safest vendor and 100 the highest risk vendor). With a large number of funders and lease professionals using the site, we have exposed more high risk and fraudulent vendors faster than ever before as we can now provide Lessors with a industry-wide view of a Vendor’s activity.
As our site matures, many of these Vendor trends and tendencies will become more evident. We have already noticed a large number of vendors who tend to produce a high incidence of early default leases. Lessors who ignore these vendors and put their sole faith into the credit-worthiness of the Lessee are exposing themselves to losing millions of dollars yearly. Are you one of the smart Lessors who sees the entire credit landscape? It goes without saying, if you are to protect your company completely you must address, recognize and evaluate the “Missing Component” of the Vendor and Equipment side of each deal. Otherwise,you run the risk of becoming a sad statistic like those firms mentioned above.
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