Focused on Leasing

Midwestern community banks use lease
products to build a stronger business

By Matt Doffing

Early in his career, equipment lease financing was a conundrum for Don Burnett. “When I started in banking, I was at a bank in Arkansas,” said Burnett, now president and CEO of Focus Bank, Charleston, Mo. “I kid you not. When the local municipality would come to us wanting an equipment lease, we would take a promissory note and rubber stamp ‘lease’ on it,” he said with a laugh.

Burnett decided to end the conundrum in 1989 after he became president and CEO of Security State Bancshares, the holding company of Focus Bank. For years, at both his old employer and his new one, Burnett bought leases from a broker. Security State Bancshares had acquired $1 million in leases. He realized that 75 percent of them were originated from existing customers of the bank. “Then I asked myself why I was buying from this guy,” he said. “I came from a sales background; I wanted customers to be able to tell my bank apart from a competitor. Offer- ing leases gave me a competitive advantage. Plus, the yield on the portfolio I had was better and it had fewer delinquencies than any other portfolio. I decided to do it for myself.”

The realization spurred the bank to launch its own leasing product in 1990. Today, the bank has grown its lease portfolio to $20 million.

Operating vs. finance lease
Leasing is used to finance about 35 percent of U.S. equipment purchases. In 1992, Burnett hired Britt McConnell to find that 35 percent among Focus Bank’s customers and to grow the business to new ag, commercial and municipal clients.

McConnell was confident he could grow the business. Farm clients are interested in leasing equipment because of the tax advantages of an operating lease, he said.

In an operating lease, the bank wires funds to a dealer just as it would for a loan. The difference is that the dealer’s invoice lists the bank as the buyer rather than the customer. The customer then pays rent to the bank for use of the equipment. “Ag customers like these products because they can expense the lease payments,” McConnell said, noting that a five-year lease with a purchase option at term is popular among the bank’s farm customers. Often the purchase option states that the customer will buy the equipment at term for “a percentage of the original cost of the equipment or the fair market value, whichever is greater,” he said.

With the addition of leases, counties and municipalities became potential customers on the lending side of the bank. “These leases be- came big for us,” McConnell said. “If a municipality is going to take out a loan it needs to ask the voters for approval. Leased equipment allows them to finance equipment without becoming a borrower.”

Counties and municipalities, which are tax exempt, require a finance lease structure. “They want a lease that amortizes like a loan with a payoff schedule for each year and a $1 residual at the end of term,” McConnell said. “Municipalities vote annually; this structure allows them to buy out should they vote to no longer use the equipment.”

Farmers and municipalities finance equipment like tractors, combines, road graders and pavers. But Focus Bank also sees requests for financing on things that depreciate quickly like computer equipment and furniture. “A finance lease also is used for these types of equipment. We never have an ownership exposure to the value of that equipment,” McConnell said, noting that in a finance lease the customer is listed as the purchaser on the vendor’s invoice. The bank maintains a lien on the equipment as it would in a loan.

Branching out
Equipment leasing proved to be more than just another product on the bank’s menu. “We began to see demand for equipment lease financing from markets where we had no brick-and-mortar presence,” McConnell said.

This proved to be fortuitous for the bank. Since 1993, Focus Bank has opened seven locations. For nearly all of them, the bank had leasing customers in the area before it had offices there, McCon- nell said. “We wanted to branch to grow,” he said. “When you branch into a small farm town there tends to be limited business there. Many times, when we came to town, leas- ing already had created some of the first relationships we had there.”

A few years beforehand, Burnett had noticed 75 percent of the customers in his $1 million lease portfolio were bank customers. That also meant 25 percent of those lease customers had no other financial relationship with the bank. Leasing gave Focus Bank a chance to cross-sell its other services to this segment.

Burnett gave the example of a farm customer in Arkansas. The customer came in contact with Focus Bank because he needed a lease for a center-pivot irrigation system. “After that, we were able to get his $5 million production loan. Then we also helped him buy two more farms that amounted to another $11 million in financing. All that came from just getting in the door with the lease,” Burnett said. “We didn’t know this farmer existed until the dealer called us on a lease for him.”

Burnett said he is not suggest- ing that opportunities this large come with every lease. “But we are trying to cross-sell with every lease contract we originate,” he said.

When Focus Bank expanded to Sikeston, Mo., in 1998, McConnell became president of that market. The bank already had about 100 leasing customers in the area. Today, the location brings $120 million in leases and loans to the bank’s total $540 million portfolio. It is the second-largest market in the bank’s footprint.

Helping other banks
In 1993, Focus Bank attracted media attention for its leasing business. It began to receive calls from other community banks around the Midwest about get- ting into leasing. The bank hired a software development firm to build a platform to price, document and audit leases. In 1994, the bank launched Banclease, a division that offers lease training and software to other community banks.

For the bank, the advantage in a lease is an asset that brings up to 1 percent more yield than a loan. Borrowers are attracted to leasing because it is 100 percent financing and requires no down payment. Leases also offer lower installments when there is a purchase option at the end of term.

But there are tricks to the trade. For instance, the bank needs to structure the lease so that the lessee pays a fair price if they purchase the equipment at term. And, if the lessee returns the equipment, the lease needs to be structured so that the bank can sell the equipment without losing money. Banclease offers training to help banks deal with these is- sues. Banclease also will prepare leases for other banks on a per- lease fee. The service has attracted more than 200 community banks from across the country.

Competing with FCS
F&M Bank, West Point, Neb., began to work with Banclease in 2002. “One motivation for offering the product is competition from Farm Credit Services,” said Lynn Stofferahn, vice president of the $260 million bank. “They have a heavy handed cross-sell when they get in the door with a customer on a product like a lease.”

F&M Bank tends to finance industrial equipment and farm equipment like combines, planters, tractors and some irrigation equipment, Stofferahn said. Since its customers are farmers, the bank’s sweet spot is an operating lease with a three- to five-year term, often with a 10 percent purchase option.

Customers tend to like to work with a local bank because they are more relationship oriented in enforcing the terms of a lease, Stofferahn said. Because of this, customers often see a dollar value in local service. “If we can get within 20 basis points of farm credit, we have a good chance of getting the deal,” he said.

Today, leases make up about 1 percent of F&M Bank’s $170 mil- lion portfolio. “These have been much like mortgages for us; we want to offer it if the customer needs it,” Stofferahn said. “But now we have made a decision to push the lease a little more than we have in the past. We want to expand the leasing program,” he said.

Before the end of 2013, farmers could rapidly depreciate equipment purchases as a tax shelter. This year, that tax incentive is gone. “Farmers will do almost anything to get out of paying Uncle Sam,” Stofferahn said. “We think [the tax changes] will make farmers more attracted to the tax advantages of an operating lease,” he said. F&M Bank is getting the word out to local tax accountants that it offers operating leases as part of its strategy to market leases.

NorthStar Bank, Estherville, Iowa, made its first lease in 2013. The bank reached out to Banclease after it received a request from a large commercial customer for lease financing on a building. “We wanted to be able to serve this large customer,” said Greg Deim, vice president of the $180 million bank. “We were able to offset the cost of the training and software from Banclease with that one deal.”

Competition with FCS also is a concern for NorthStar Bank. “Since a large portion of our business is in ag, we compete with FCS quite often,” Deim said. One direction the bank is looking at for leasing is farm machinery like planters, tractors and combines. For this, a primary competitor would be AgDirect, an FCS program that offers implement financing to farmers at the dealership.

NorthStar Bank plans to net- work with local dealers to originate leases. “We wanted to offer leases so we can compete with AgDirect; we don’t want them to get in the door with our farmers at the dealership and then take the land loans as well,” Deim said.

Depending on the age of the equipment, NorthStar Bank is offer- ing leases with a three- to five-year term and a purchase option. Often the purchase option is 10 percent of the original cost of the equipment. “We have a strong presence in Emmet County and we want to be able to offer the products needed to keep the business local,” he said.