Appeared in the October 2001 Monitor – Leasing and Financial ServicesIs your equipment leasing company having difficulty generating enough new business to meet your volume targets? Or, is your leasing company experiencing funding constraints that may require you to cut back on lease originations? Situations such as these are becoming increasingly common in the current leasing environment as we face an economic downturn, and a viable solution that warrants consideration is the active portfolio acquisition market. Our firm has recently seen great interest on the part of both buyers and sellers of lease portfolios, and we have arranged many portfolio sales. In this article, I will describe some of the things we have learned from our experiences, including profiles of typical portfolio sellers and buyers and tips on structuring a successful transaction. 

Who is selling portfolios?

Following are some of the types of leasing companies that are considering, or possibly
should consider, the sale of a portion of their lease portfolio:

• Leasing companies that are having problems obtaining funding sources or those that had planned to do a securitization but could not do so because of market conditions.
  

• Leasing companies that are near their credit limits with their funding sources.

• Lessors that are approaching debt to equity ratio limitations and are not able to raise additional equity.

• Leasing companies whose long range goal is to be acquired and who are delaying this move until the M&A market improves.
  
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• Lessors or their parent companies that need to show the income a portfolio sale can produce to keep their shareholders and/or lenders happy.

• Bank lessors that have customer or industry concentration issues.

• Companies experiencing a change in ownership or strategic direction.

• Leasing companies that are for sale but which have little or no going-concern value.

• Captive leasing companies that have a strategy of accumulating leases and then selling portfolios.

• Non-captives, including some of the largest lessors, that have a strategy of periodically selling a portion of their lease portfolio.

• Troubled companies, or secured lenders that have taken over the lease portfolios of troubled companies.

• Bank leasing companies that have regulatory or internal limitations on the amount they can invest in leases.

• Leasing companies that no longer have an appetite for the tax benefits of leasing.
  

 While many of the potential lease portfolio sellers are small to mid-sized independent leasing companies that have funding constraints, there are many very large leasing companies that are selling lease portfolios on a regular or occasional basis. At any given time, there are a wide variety of lessors that have a need to sell because of one or more of the special circumstances outlined above. Thus in today’s leasing marketplace, motivated buyers will have no difficulty finding motivated portfolio sellers.

Who is buying portfolios?

The continuing consolidation trend in the equipment leasing industry has reduced the number of potential portfolio buyers and greatly increased the concentration of equipment leasing assets held by a relatively few large lessors. Nevertheless, we have seen a large and diverse number of interested buyers of several small ticket and middle market lease portfolios we have recently represented for sale. Following are the types of buyers that are currently aggressive in purchasing portfolios:

• Bank leasing companies; banks that have a high degree of liquidity and do not have a strong demand for commercial loans often find portfolio acquisition opportunities to be attractive.

• Large diversified financial service companies.

• Smaller, well-capitalized leasing companies looking to expand.

• Leasing companies that are in the securitization market.

• Companies that specialize in buying troubled portfolios.
  

Many portfolio buyers are leasing companies that want to add assets and do not have the internal ability to fill all of their needs. They often look for portfolios that are complementary to their own business. We have also seen examples of companies buying portfolios to utilize more fully their servicing capability or, in the case of a young and rapidly growing leasing company with a relatively small portfolio, to justify creating an expanded collection and remarketing capability before they would otherwise have needed it. There are usually many potential buyers for any lease portfolio, and sellers are well advised to make their portfolio sale a competitive process in order to assure the best possible pricing. Sellers with good credit quality portfolios are currently experiencing quite favorable pricing on portfolio sales, often better than their traditional funding sources.

Tips for structuring a successful portfolio purchase or sale

My most important advice for portfolio buyers is to seek portfolios containing the types of leases with which you are familiar and comfortable, particularly with regard to credit quality, equipment type, residual risk and administrative requirements. You should probably not buy a microticket lease portfolio if you are a middle market lessor, and you may want to stay away from a portfolio of titled vehicles if you have no experience with leasing titled vehicles. Also, if all of your transactions are conditional sales you may not want to buy a portfolio containing principally fair market value residuals, unless you are prepared to develop a remarketing staff. Some lessors may choose to buy a small portfolio outside of their area of expertise in order to learn a new market prior to deciding whether to enter it.

Sellers of portfolios should remember that portfolio buyers are risk averse. Often sellers can increase the net sale proceeds by finding ways to minimize the risk to the buyer. A buyer’s greatest concerns are normally the amount of future collection losses and the ultimate realization of residual values. Collection losses can be mitigated by establishing specific or general loss reserves or holdbacks in the portfolio purchase; of course the seller must be comfortable with the buyer’s collection capabilities and motivation, and the seller may want to have the ability to pursue directly the collection of delinquent accounts. Buyers often prefer to exclude from a portfolio purchase seriously delinquent accounts or to acquire them for a steep discount, possibly sharing with the seller collections in excess of the purchase price. If the seller has a unique remarketing expertise that the buyer lacks, the buyer may want to enter into a remarketing agreement with the seller that contains incentive clauses wherein the buyer and the seller share in residual value profits.

Of course, the term “buyer beware” is pertinent to any portfolio purchase, and the buyer needs to protect its interests by performing a very thorough review of the portfolio prior to acquiring it. The buyer should review historical delinquency and bad debt charge off information, particularly on a static pool basis for small ticket leases. Determining where the seller has made their credit mistakes can be valuable in assessing future collection risks. Also, it is important for the portfolio buyer to look at the culture of the seller. Are they known in the industry for their integrity? Do they have thorough procedures for credit review and lease documentation? Most buyers will want to stay away from portfolios where the seller’s reputation is questionable or where lease documentation is deemed to be significantly deficient.

For middle market and large ticket lease portfolios, the buyer will likely want to get current financial statements and other credit information on each lessee and make an independent credit decision on each transaction. Any significant residual value interests should be evaluated. For small ticket lease portfolios where credit decisions are often made by credit scoring, financial statements may not be available. Credit files for small ticket leases are often reviewed on a statistical sampling basis. It is important for the buyer to review the seller’s credit decision process. Leases should be reviewed to determine adherence to the seller’s credit scoring parameters, and the buyer should determine if those parameters provide an acceptable risk profile. The buyer may also want to perform a current credit scoring of selected small ticket leases.

It is important for a portfolio buyer to have legal representation from a firm with equipment leasing expertise. Appropriate warranties and representations from the seller in the portfolio purchase agreement can greatly reduce the buyer’s risk, assuming that the buyer is comfortable with the seller’s financial capability to stand behind those warranties and representations. Warranties and representations that are particularly important in portfolio purchases include the enforceability of the lease documents, the perfecting of security interests and the complete disclosure of all pertinent information. Also, legal advice should be sought if vendor remarketing or repurchase agreements are to be assigned.

The portfolio purchase and sale market has become increasingly active, ensuring that most buyers and sellers will be able to locate opportunities that satisfy their parameters, providing that their pricing expectations are realistic in terms of the current market. As we enter a new economic environment, perhaps now is the right time for your leasing company to consider if a portfolio purchase or sale would help you satisfy your corporate objectives.

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Bruce Kropschot is President of Kropschot Financial Services in Vero Beach, FL. In the past 15 years, the firm has arranged the sale of over 130 equipment leasing and finance companies and numerous portfolios. Kropschot Financial Services also arranges lease funding, subordinated debt and equity for leasing companies and performs business valuations. Mr. Kropschot is a CPA and holds BBA and MBA degrees in accounting and finance from the University of Michigan. He has been in the equipment leasing industry since 1972 and was formerly President and an owner of Master Lease Corporation, which is now known as De Lage Landen Financial Services.