Journal of Equipment Lease Financing - Spring 2009

Copyright © 2009 by the Equipment Leasing & Finance Foundation • ISSN 0740-008X

VOLUME 27 • NUMBER 2 • SPRING 2009

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BUSINESS PROCESS IMPROVEMENT IN EQUIPMENT FINANCE By Charles R. Gowen III, PhD, and James M. Johnson, PhDCan process improvement methods be used in fi nancial services (leasing) fi rms? This article describes the experiences of fi ve companies that use process improvement methods successfully to increase performance and reduce costs, thereby gaining more effi ciency.

THE OPPORTUNITIES AND CHALLENGES OF EMERGING MARKETS

By Shawn D. Halladay, Jonathan L. Fales, and Rafael Castillo-Triana Equipment leasing in emerging markets potentially is a major business opportunity for international lessors. Although legal and regulatory frameworks continue to evolve in these markets and there is no single, successful business model, study and preparation will pay off for motivated lessors.

KNOCKING DOWN (GREAT) WALLS: AN UPDATE ON THE CHINESE EQUIPMENT FINANCING MARKET

By Jonathan L. Fales and Jason ZhouChinese large-ticket fi nancing and vendor programs both should continue to grow over the next two to three years, even with the current worldwide economic slowdown. This article updates the Great Walls study the Foundation published in 2005.

TRANSPORTATION EQUIPMENT FINANCING: TRACKING THE FORCES SHAPING THE MARKET

By Mark LauritanoA brighter day is coming for those who can adapt to the current environment and take the long view. Rail and marine should lead the way. But the fi rst signs of a turnaround in transportation fi nancing are not likely to appear until the end of 2009.

WINNER ANNOUNCED FOR 2008 ARTICLE OF THE YEAR

Business Process Improvement in

Equipment Finance By Charles R. Gowen III, PhD, and James M. Johnson, PhD

The well-known financial economist Fischer

Black (1975) wrote on the efficiency and

competitiveness of financial institutions over

30 years ago. His general observation was that

in an industry such as banking or equipment leasing,

facing perfect competition, the most ef-

ficient companies will earn competitive

rates of return and less efficient com-

panies will go out of business or be

acquired. Hence, this article discusses

some of the branded methodologies for

improving competitiveness and reports

on our qualitative survey of process

improvement practices of five equip-

ment leasing companies.

The competitive advantage of an

equipment leasing company can be

enhanced by the application of a busi-

ness process improvement (BPI) pro-

gram. Process improvement initiatives

have recently attracted the widespread

attention of transactional companies

due to their potential for enhanced

efficiency. More than 80% of the U.S.

gross domestic product relies on ser-

vice industries, and 30% to 80% of

service firm costs are estimated to be some form of waste

resulting from inefficiency (George, 2003).

In this paper, we discuss the nature of BPI programs,

our study of several leasing firms using BPI, and the find-

ings of our survey. The five equipment financing com-

panies we interviewed used a variety of BPI methods to

tackle various customer and process issues. None of the

firms used a pure branded method, although several of

the executives had been employed previously in finan-

cial services companies that used branded methods.

Our purpose here is not to be an advocate for any

particular business process improvement method but

to acquaint the reader with the core

concepts and deployment strategies of

these structured methods. Toward that

end, we begin by summarizing two of

the current branded methodologies,

that is, Six Sigma (SS) and lean man-

agement.

BUSINESS PROCESS IMPROVEMENT METHODOLOGIES

The purpose of BPI is the redesign of

processes to result in superior pro-

ductivity, speed, quality, and low cost,

which leads to greater cash flow, prof-

itability, customer satisfaction, and

competitive advantage (Womack and

Jones, 2005). Some BPI program driv-

ers and results appear in Table 1 (next

page). BPI can consist of a combination

of branded methods, such as Six Sigma

and lean management, which are mutually reinforcing

when they are implemented simultaneously. Lean im-

proves operations productivity and speed, whereas Six

Sigma ameliorates quality and low cost (Arthur, 2007).

Lean methods can be enhanced by Six Sigma’s fo-

cus on organizational culture, program infrastructure,

customer needs, and reduction of process variation. Six

Can process improvement

methods be used in

fi nancial services (leasing)

fi rms? This article

describes the experiences

of fi ve companies that

use process improvement

methods successfully to

increase performance

and reduce costs, thereby

gaining more effi ciency.

2

BUSINESS PROCESS IMPROVEMENT IN EQUIPMENT FINANCE JOURNAL OF EQUIPMENT LEASE FINANCING • Spring 2009 • VOL. 27/NO. 2

Sigma could benefit from lean’s pursuit of waste identifi-

cation, process speed (or cycle time improvement), and

quick, action-oriented events (George, 2003). Although

lean management and Six Sigma were originated by man-

ufacturing corporations (Schonberger, 2008), the recent

trend of financial service firms adopting BPI is driven by

the enhanced advantages resulting from combining lean

and Six Sigma practices (Hayler and Nichols, 2007).

Six Sigma Initiatives

Six Sigma is a process improvement methodology ex-

ploited by many leading financial service companies. It

is a systematic, data-driven approach

that finds and eliminates errors in

processes by focusing on the results

most critical to customers. The term

SS refers to the statistical measure of a

quality level equivalent to 3.4 or fewer

defects per million opportunities. The

SS infrastructure depends on teams of

employees who are highly trained in

statistically oriented practices for pro-

cess improvement projects (Summers,

2007).

Six Sigma projects are selected

based not only on customer require-

ments but also on their ability to achieve clear financial

returns for the organization. A recent survey reveals that

SS is used by more than 50 financial service firms (Hay-

ler and Nichols, 2007) because it enhances transaction

accuracy and speed while reducing costs such as search,

information technology, bargaining, decision, and moni-

toring costs (Arthur, 2007).

Six Sigma was developed as a quality improvement

program by many firms in the manufacturing sector.

Motorola pioneered SS and won the Malcolm Baldrige

National Quality Award in 1988, largely due to its SS

initiatives. Other companies such as General Electric and

Allied Sigma helped to provide a significant amount of

credibility and media attention to the SS concept. Since

then, SS has become a popular methodology for process

improvement across a range of manufacturing and ser-

vice industries.

The SS roadmap for process improvement of finan-

cial companies begins with examining a firm’s services

from the customers’ viewpoint. Marketing research dic-

tates what impact the “voice of the customer” (VOC)

technique would have for the company (George, 2003).

Then data-driven practices, such as quality function

deployment, demonstrate how the VOC affects the im-

provement of services. At Wachovia Corp., the applica-

tion of VOC within a SS program drove the customer

satisfaction rating up by 20%, customer loyalty up 26%,

and customer attrition rate down from 20% to 12%, with

16% annual earnings growth over five years (Hayler and

Nichols, 2007).

The SS team infrastructure depends on specially

trained participants. The key roles in SS teams typical-

ly include Champions, Master Black

Belts, Black Belts, and Green Belts. The

job of executive Champions involves

working with Black Belts to identify

possible projects. Champions also pro-

vide support and validate the results

at the end of the project. Master Black

Belts are experienced Black Belts who

serve as mentors and trainers for new

Black Belts. During a year of full-time

training, Black Belts are trained in ad-

vanced statistical techniques, team-

building, and project-selection skills

and are committed full time as the

leaders of a SS team.

Green Belts are trained in basic quality tools and are

assigned to SS teams on a part-time basis.

Typically, larger financial services companies, such

as American Express, start with a core group of employ-

ees and expand training programs over a few years to

include all employees (Hayler and Nichols, 2007). For

example, the main purpose of an extensive training pro-

gram at Capital One was a culture transformation, which

has provided dramatic results from 2005 to 2007, such

Table 1.

Key Drivers and Outcomes of BPI

Key drivers Key outcomes

Quality Cash fl ow

Low cost Corporate profi tability

Productivity Customer satisfaction

Speed Competitive advantage

Six Sigma projects are

selected based not only

on customer requirements

but also on their

ability to achieve clear

fi nancial returns for the

organization.

3


as a 39% reduction in the cost of a new account, 54%

lower servicing cost in existing accounts, and custom-

er satisfaction improvement of 10% (Immaneni et al.,

2007).

Problem-solving projects are another integral part of

the SS methodology. The objective for a SS team is to

analyze a problem and develop a permanent solution.

The problem-solving methodology used in SS is DMAIC,

which stands for Define, Measure, Ana-

lyze, Improve, and Control, and incor-

porates a wide variety of statistical tools

and process improvement techniques.

Started in 2001, Bank of America’s SS

program resulted in decreasing errors

by 24% in all customer channels and

by 88% in electronic channels, reduc-

ing transaction cycle times by more

than half, adding $2 billion in profit,

and increasing “customer delight” (de-

fined as a rating of 9 or 10 out of 10)

by 30% (Cox and Bossert, 2005; Hay-

ler and Nichols, 2007).

For the SS program initiated in

2001 at the retail services and consum-

er lending divisions of HSBC, N.A., customer complaint

projects saved $1.6 billion annually; training guideline

improvements reduced turnover by 10% and yielded

$1.9 billion annually; and sales leads priorities projects

produced $9.5 billion annual savings (Gordon, 2006).

Alternatively, many companies have developed varia-

tions of DMAIC, such as FASTER (Flow, Analyze, Solve,

Target, Execute, and Review) at Countrywide. These

methodologies have produced $244 million in produc-

tivity gains and $76 million in operating profits (Hayler

and Nichols, 2007).

Lean Management

Likewise, the importance of lean management has grown

considerably in recent years, and lean

programs have emerged as a major

source of competitiveness. The main

motivation for lean methods has been

relentlessly pursuing waste elimina-

tion, lowering costs, and increasing the

speed of delivery of products and ser-

vices to the customer (Arthur, 2007).

Although the Toyota Production Sys-

tem is credited as the origin (Liker,

2004), lean programs have also proven

highly effective for service companies.

Some differences among SS, lean, and

BPI (by combining SS and lean) initia-

tives are presented in Table 2.

Lean management consists of

three sets of principles: core tenets, waste sources, and

the 5S principle (defined below). The nine core tenets

of lean are:

1. Assess customer value.

2. Convert business processes to customer pull sys-

tems.

Table 2.

Characteristics of Three Process Improvement Methods

Six Sigma Lean BPI

Platform 1–4 month project 1–5 day event Project or event

Main motivation Reduce variation, innovation (DFSS), effectiveness

Variation, innovation, effectiveness

Customer value creation, corporate culture change

Competitive advantage Improve quality, productivity Improve speed, cost, productivity Sustainable competitive advantage

Metrics Defect rate Cycle time Customer value-added

Organization Six Sigma teams Kaizen teams BPI Teams

Techniques DMAIC, Design for Six Sigma Five Tenets, value stream mapping, future state map, 18 building blocks

Combination of methods, such as Six Sigma and lean

Human resource management Train selected employees as Black Belts

Train all employees in basic concepts

Train some employees in BPI concepts

The main motivation for

lean methods has been

relentlessly pursuing waste

elimination, lowering

costs, and increasing

the speed of delivery of

products and services to

the customer

4


3. Switch to one-transaction flow.

4. Level out the work load.

5. Stop and fix problems immediately.

6. Standardize processes.

7. Use visual controls.

8. Use proven technology.

9. Compete against perfection, not competitors.

(Arthur, 2007)

Lean management identifies and reduces seven sources

of waste: overprocessing that does not add customer val-

ue, transportation or unnecessary movement of services,

motion or excess time for employees, excess work-in-

process inventory, waiting time delays, defects or errors,

and overproduction of goods or services (George, 2003).

Finally, the 5S principle includes Sort for necessity, Sim-

plify the workplace, Shine for cleanliness, Standardize

processes, and Sustain standard processes (George et al.,

2005).

The implementation of lean management involves

several distinctive techniques, two of which are “value

stream mapping” and “lean work cell” design. Value

stream mapping visually displays the process flow, dis-

tinguishes between value-added and

non-value- added activities, assists

in pointing out root causes of waste,

identifies problems and opportunities

for improving workflow, and shows

how the future workflow would look

(George et al., 2005). Lean work cell

design assembles all of the necessary

work activities for a process into a cell

layout, such as an emergency room

with an X-ray machine, a CT scanner,

and lab testing equipment to reduce the

patient’s transportation time for faster diagnosis (Arthur,

2007). Lean projects are implemented by a lean team,

often an entire small department with process improve-

ment experts, as a lean or Kaizen event (Arthur).

The workflow process for an area is redesigned in a

five-day Kaizen as follows:

• First day to train team members and define the

problem(s)

• Second day to measure and analyze workflows, cy-

cle times, and value stream maps

• Third day to generate and test improvement alterna-

tives

• Fourth day to simulate and deploy the selected solu-

tion

• Fifth day to evaluate and report out to management

For example, Bank One’s National Enterprise Operation

(NEO) launched lean management based on the Kaizen

event approach in 2002 and fully implemented it by

2004, when it was acquired and became a division of

JPMorgan Chase. The NEO lean system is characterized

by a limited set of Lean techniques, voluntary employee

involvement, and collaborative use of lean experts who

coach Kaizen teams, while avoiding massive employee

training and teams of only experts (George, 2003). The

results include cycle time reductions of 30% to 70%,

improved revenue, and decreased costs of thousands of

dollars per event. The disadvantages concern time-con-

suming events, difficulty in effecting physical workplace

changes, and sustaining lean management as a priority

among other corporate initiatives.

BPI Scope: Organization-wide or Focused?

A fundamental choice for BPI deployment is whether

the scope of implementation should be organization-

wide or on a SWAT team-like basis.

The full Six Sigma model argues for

corporate-wide training of employees

and implementation of projects (Hay-

ler and Nichols, 2007). Alternatively,

other evidence supports a focused

approach—a SWAT team strategy—of

training only limited groups of em-

ployees for resolving the most urgent

problems (Arthur 2007, p. 230). The

contrast between the two approaches

is summarized in Table 3 (next page).

As in the Bank One example above, the lessons

learned from this successful program involve autono-

my for each business unit, tailoring the BPI model for

each organization, deploying at a pace that suits each

unit’s readiness, avoiding mandatory use of BPI, cross-

functional problem-solving, and preference for lean

methods as opposed to Six Sigma, which requires robust

metrics (George, 2003). Similarly at JPMorgan, a SWAT

team approach resulted in more than $1 billion in pre-

tax net benefits in 2002 and 2003. Then the program

was integrated with JPMorgan’s corporate efficiency pro-

grams in 2004 (Hayler and Nichols, 2007).

A fundamental choice

for BPI deployment is

whether the scope of

implementation should be

organization-wide or on a

SWAT team-like basis.

5


BPI methods are just as applicable to a small busi-

ness, as illustrated by Table 4. By deploying these meth-

ods for a small business, Mesa Products Inc. achieved

above industry and competitor business results, such as

customer and employee satisfaction, productivity, and

return on investment, as well as winning the prestigious

Baldrige Award in 2006 (Daniels, 2007).

STUDY OF LEASING FIRMS

We employed a telephone interview methodology to

collect information about five firms in the U.S. leas-

ing services industry. We contacted executives in an

independent equipment

financing company, two

captive firms, and two

bank-related firms. The

seven resulting interviews

were initiated in August

2008. All firms requested

to remain anonymous.

The structured tele-

phone interview method

was chosen to yield richness of information for certain

key issues, although there is limited quantification of

data. The interviews focused on several questions for

each of the four main issues: descriptive characteristics

of the BPI program, project success stories, program

drivers, and advice to firms considering the adoption of

a BPI program.

In terms of the characteristics of the program, there

were striking differences between the captive and in-

dependent corporations. The captive firms started BPI

initiatives several years before the independents began

theirs. Another disparity was the captive firm’s manda-

tory participation for all

departments, as opposed

to the bank-related and

independent companies’

policy of voluntary de-

partmental participation.

Generally, the captive

firms had implemented an

organization-wide model,

whereas the bank-related

and independent companies deployed the SWAT team

type of BPI program structure.

SURVEY FINDINGS

Our structured interviews revealed several insights about

successful deployment of a BPI program. The descrip-

tive characteristics suggested two distinctly different al-

ternatives for BPI implementation: the organization-wide

model and the SWAT structure, as discussed above. Sec-

ondly, there were a variety of program drivers that led

Table 4.

Deployment of BPI for a Small Business

Steps for designing BPI for a small business:

• Assess the potential readiness of managers and employees for organizational change.

• Build organization-wide commitment by CEO promotion of the BPI program.

• Train managers in BPI principles, then managers train subordinates in BPI tools through a cascading coaching process of knowledge transfer and a simple trial project.

• Be highly selective of initial projects so there are early wins.

• Develop a “pull” training system to provide BPI knowledge and skills as needed, widening the pool of managers and employees who are competent in BPI practices.

• Engage employees, in successively lower levels of the fi rm, as project team leaders by ownership of progressively complex and rewarding projects.

• Recognize employees and managers who adopt the most effective BPI practices.

• Build BPI successes into the corporate culture and reward system.

• Monitor program effectiveness periodically and become increasingly selective of new projects and BPI team leaders.

SOURCE: Arthur, Jay. Lean Six Sigma Demystifi ed. New York: McGraw-Hill Professional, 2007; Byrne, George. “Ensuring optimal success with Six Sigma implementations.” Journal of Organizational Excellence, 22, no. 2 (2003): 43–50; Daniels, Susan E. “From one-man show to Baldrige recipient.” Quality Progress, 40, no. 7 (2007): 50–55.

Table 3.

Implementation Characteristics of Two Approaches to BPI

Organization-wide approach

SWAT team approach

Purpose Culture change Problem-solving

Project choice Deterministic Situational

Participation Mandatory Voluntary

Financing High investment Limited risk

Strategy Maximizing return Optimizing return

Approach Full toolbox Selected tools

Structure Bureaucratic Opportunistic

We employed a telephone interview methodology

to collect information about fi ve fi rms in the U.S.

leasing services industry. We contacted executives

in an independent equipment fi nancing company,

two captive fi rms, and two bank-related fi rms.

6


to success stories for these BPI initiatives. The advice

our experts had for firms considering the adoption of

a BPI initiative will be discussed toward the end of this

article.

Program Drivers and Successful Projects

One of the equipment financing firms was looking at

ways to improve its cycle time (the response time with

customers that is required to close a transaction) and

employed its BPI methodology to do so in an organized

way. The company believed it could reduce cycle time

but needed to have the expectation that resources invest-

ed in doing so would reap a financial

return. The bank’s borrower and lessee

customers were saying that some of their

competitors “do it better.” The problem

and scope were defined, and then the

bank worked on the problem with a BPI

team. The result was a reduction in cy-

cle time and greater consistency in the

way transactions were processed. The

payoff was a higher conversion rate (the

proportion of business worked on that

resulted in booked business) and more

profitable volume.

A second financing firm was a mul-

tidivision company that was assessing

its varied financial services businesses,

which included small-ticket transactions, vendor pro-

grams, and direct financing business with customers.

For various reasons, individual business units were us-

ing their own process and showed little interest in coop-

erating with one another to streamline their processes.

Customers complained that they had to go to a different

contact person for each type of business they were doing

with the company.

Eventually, this became a mandated project to push

the various units onto one streamlined platform. The

company does not use a major branded process im-

provement methodology, but a number of executives had

previous experience with Six Sigma financial services

companies. Using an unbranded process improvement

tool borrowing some SS tools, the company was able to

map out existing processes to see how they might be in-

tegrated. The result was to combine business groups, one

at a time, and move them onto a new, common platform.

As a result, customers now have a consistent experience

and one point of contact, regardless of what financial ser-

vices mix they are buying from the company.

In contrast, another firm with a successful vendor

program was having difficulties in setting up new deal-

ers efficiently. For various reasons, the firm needed to

rework many dealer applicants to “get it right.” A project

was launched with the goal of greatly reducing rework

with dealers. Much energy went into examining the pro-

cesses to detect the causes of rework—not getting the

complete set of information from a dealer the first time,

not processing information consistently, and so forth.

The company now has implemented a

successful program in which its deal-

ers grade it each year against the best

service they received from the com-

pany’s competitors.

A fourth company suffered from

an inefficient process for collecting

interest on time. This became a proj-

ect for one of the leasing firms, with

the goal of reducing the time spent on

this function. The SS project team dis-

covered that, over time, the company

was using more and more methods to

perform the same function. Years ago,

the leasing firm would send out a re-

minder letter to customers that were

approaching a due date. When faxing technology be-

came prevalent, the company began to mail notifications

to customers and fax notices for the same issue. As email

came online, the company added that method of sending

their customers the same information.

The BPI team found that not only was the company

using redundant methods for collecting interest but also

that customers were becoming frustrated, being bom-

barded with multiple notifications. The team was able

to streamline the notification process, which resulted in

reducing the time spent by approximately 85%, while

realizing virtually the same on-time payment percentage

and improving customer relations.

In responding to customer feedback, the fifth leas-

ing company developed a project around “ease of doing

business.” From customer interviews, the project team

realized that the company received high ratings only

once the customer was on board. The typical complaint

The BPI team found that

not only was the company

using redundant methods

for collecting interest but

also that customers were

becoming frustrated, being

bombarded with multiple

notifi cations.

7


was how difficult the company’s processes were for a

prospect looking to become a customer. The team exam-

ined all aspects of how the leasing company originated

business and defined a series of projects to improve cus-

tomer responsiveness.

This leasing company was able

to reduce the number of documents

it required for a transaction and made

significant headway on instituting stan-

dardized templates. The net result was a

significant improvement in streamlining

the customer closing process. Now the

customer need talk with only one point

of contact rather than being referred to

five different people, depending on

what information the customer wanted

and for which product line.

Advice for Starting a BPI Initiative

The executives interviewed generally

agreed on the importance of establish-

ing BPI program goals and project ob-

jectives up front as well as specifying the

“end game.” Several executives emphasized that a key

goal should be to change the culture of the organization

by training and causing employees to think differently

regarding how they go about their work. One executive

indicated the value of viewing this process as a journey,

not a quick fix or an add-on function.

The five leasing firms indicated that getting outside

assistance is important and should take place at the out-

set of the initiative. Consultants and facilitators should

be engaged up front to help the organization get started

in parallel with training of the organization’s personnel.

Interestingly, the executives from organizations that used

brand-name process improvement methodologies did

not recommend that newcomers buy into an off-the-

shelf system but rather that they build to suit their com-

pany’s circumstances.

Because we interviewed very different organizations,

using both customized and branded process improve-

ment methodologies, the advice we gathered for setting

initial expectations differed significantly. Some execu-

tives indicated that no savings should be expected for

more than a year due to the significant up-front invest-

ment in training and organizational change. One said,

“Do not underestimate the commitment front-end.” An-

other executive cautioned, “Be leery of a fast payoff” and

be mindful of third-party promoters telling tales of big

wins early in the process.

At the opposite end of the ex-

pectations spectrum, an executive

recommended starting with some

small projects, suggesting that sim-

pler events yield quick wins and keep

personnel focused. He indicated that

large, long-term projects have unin-

tended negative effects, such as per-

sonnel becoming bored, losing focus,

and struggling with the large project

pieces.

However, there was agreement

that a successful process improve-

ment program should be woven into

the fabric of the organization rather

than as a standalone entity. Three

comments summarize the advice we

received about BPI organizational

change:

1. It should not be viewed as an add-on, but a different

way of working.

2. Process improvement is a way of thinking.

3. It should be ingrained in the organization’s culture

to make it feel natural. Keep it simple. Take the best

of brand-name process improvement methodolo-

gies and develop a process that will feel natural to

the company.

Some of our interviewees came from organization-wide

SS environments and cautioned against allowing the pro-

cess to take over and become its own bureaucracy. The

seven executives with whom we talked recommended

proceeding with less formality than the original SS sys-

tem in which several of them were trained. They indi-

cated that, as their organizations transformed, it did not

appear necessary to be as rigid in implementing BPI. One

executive warned, “Don’t let the process take on a life of

its own. It’s a tool, it’s not the business.”

CONCLUSION: THE IMPORTANCE OF BPI

The literature for the financial service industry and our

study suggest that BPI may be a productive tool for

The seven executives

recommended proceeding

with less formality than

the original Six Sigma

system in which several of

them were trained. They

indicated that, as their

organizations transformed,

it did not appear

necessary to be as rigid in

implementing BPI.

8


achieving, increasing, or sustaining a competitive ad-

vantage. Several success stories of financial service com-

panies demonstrate the benefits of BPI methods, such

as voice of the customer and BPI projects for improving

quality and cost-effectiveness. BPI tools have also been

successfully deployed by financial service corporations

for improving productivity and speed, such as customer

delivery time.

Our study of five leasing firms reveals that each com-

pany found BPI to be beneficial in improving organiza-

tional performance as each defined it. The choice of the

type of program structure is critical. Our study suggests

that the larger captive leasing companies are effective in

adopting an organization-wide program, but the smaller

bank-related and independent firms are successful with

more of a SWAT team approach. BPI programs include

a variety of drivers and successful projects for improved

leasing transaction response cycle time, leasing plat-

forms, dealer application practices, interest collection,

and business origination processes. These projects re-

sulted in reduced customer response cost, greater leasing

transaction productivity, better transaction consistency,

lower application cost, higher collection rate, and in-

creased customer satisfaction.

Our study’s sources had the following advice on

starting a BPI program:

• Establish challenging BPI goals at the start—what

will be the end game?

• Seek initial consultant engagement, and set realistic

program expectations.

• Deploy BPI as an integral part of the organization’s

fabric versus making it an add-on.

• Design the program to be informal and a good fit

with existing organizational culture.

• Don’t expect instantaneous payoffs but plan for

gradually increasing wins.

In summary, our study reveals that a successful BPI pro-

gram can be deployed using some general guidelines,

but it will be most beneficial if it is tailored to the specific

needs of each equipment finance company.

References

*Arthur, Jay. Lean Six Sigma Demystifi ed. New York: McGraw-

Hill Professional, 2007.

Black, Fischer. “Bank funds management in an effi cient

market.” Journal of Financial Economics, 2, no. 4, (1975):

323–39.

Cox, Daniel, and James Bossert. “Driving organic growth

at Bank of America.” Quality Progress, 38, no. 2 (2005):

23–27.

*Daniels, Susan E. “From one-man show to Baldrige recipi-

ent.” Quality Progress, 40, no. 7 (2007): 50–55.

*George, Michael L. Lean Six Sigma for Service: How to Use Lean Speed and Six Sigma Quality to Improve Services and Transactions. New York: McGraw-Hill, 2003.

*George, Michael L., John Maxey, David T. Rowlands, and

Mark Price. The Lean Six Sigma Pocket Toolbook: A Quick Reference Guide to 100 Tools for Improving Quality and Speed. New York: McGraw-Hill, 2005.

Gordon, Jack. “Take that to the bank.” Training, 43, no. 6

(2006): 40–42.

*Hayler, Rowland, and Michael D. Nichols. Six Sigma for Financial Services. New York: McGraw-Hill, 2007.

Immaneni, Aravind, Allen McCombs, Gus Cheatham, and

Ron Andrews. “Capital One banks on Six Sigma for strategy

execution and culture transformation.” Global Business and Organizational Excellence, 26, no. 6 (2007): 43–54.

Liker, Jeffrey K. The Toyota Way. New York: McGraw-Hill,

2004.

Schonberger, Richard J. Best Practices in Lean Six Sigma Process Improvement. Hoboken, NJ: Wiley, 2008.

*Summers, Donna. Six Sigma: Basic Tools and Techniques. Upper Saddle River, NJ: Pearson Education Inc., 2007.

Womack, James P., and Daniel T. Jones. Lean Solutions: How Companies and Customers Can Create Value and Wealth Together. New York: Free Press, 2005.

*These references are most recommended for additional information.

9


Charles R. Gowen, PhD

[email protected]

Charles R. Gowen III is a professor of

management in the College of Busi-

ness at Northern Illinois University

in DeKalb, arriving there in 1987.

He has worked in operations management at Eastman

Kodak Co. and in commercial credit at Bank One (now

JPMorgan Chase) as well as consulted in quality man-

agement for several Fortune 100 companies. His cur-

rent research interests are in financial services, quality,

healthcare, and strategic management. Dr. Gowen has

published in several leading journals, such as recently in

the International Journal of Production Research, Journal of

Operations Management, Health Care Management Review,

Journal of High Technology Management Research, and Six

Sigma Forum Magazine, and presented papers at numer-

ous national and international conferences. He earned a

BS at The University of Rochester, N.Y., and an MBA and

PhD at The Ohio State University, Columbus.

James M. Johnson, PhD

[email protected]

James M. Johnson has been a pro-

fessor of finance at Northern Illinois

University, DeKalb, since 1987. He

has been a consultant, advisor, and

educator of lessors and lessees alike for more than 25

years. Dr. Johnson serves as an expert witness in leas-

ing disputes and has written extensively on lease finance.

His 2004 book, Power Tools for Small Ticket Leasing, was

coauthored with Richard Galtelli and Barry S. Marks and

was published by LeasingPress. Dr. Johnson’s previous

books, Power Tools for Successful Leasing and Technology

Leasing: Power Tools for Lessees, both co-authored with

Barry Marks, are also published by LeasingPress. He

serves on the board of trustees of the Equipment Leas-

ing and Finance Foundation and this journal’s editorial

advisory board. He received his PhD in finance from The

Ohio State University and a BBA cum laude and MBA

with honors from Western Michigan University, Kalama-

zoo.

Th e Opportunities and Challenges of Emerging

MarketsBy Shawn D. Halladay, Jonathan L. Fales, and Rafael Castillo-Triana

Editor’s note: In the past year, the Equipment Leasing and Finance Foundation added fi ve international studies to its library of research: Brazil: The Carnival of Equipment Financing (July 2008); Hispanic Latin America: Discovering and Conquering Equipment Financing (March 2009); India: How to Navigate the Equipment Finance Marketplace (February 2009); and Mexico: Factors for Success in the Mexican Equipment Finance Market (September 2008). All can be ordered at www.store.leasefoundation.org/department/research_studies_reports/.

It is clear that anyone seeking a lively debate over

whether or not the U.S. leasing and financing mar-

ket is mature is going to be disappointed. All one

has to do is listen in on conversa-

tions at any industry meeting or review

the Equipment Leasing and Finance

Association’s Survey of Industry Activ-

ity data. The competitive landscape is

tight, the product is a commodity, and

growth is slowing. Recent economic

events notwithstanding, the year-on-

year declines in spreads and the static

share of leasing as a percentage of total

financing opportunities serve to rein-

force the notion of a mature market.

Indeed, the only source of growth

in such an environment is increased

levels of equipment acquisition, unless

lessors choose to expand operations

outside the United States. Even then,

opportunities are limited and competi-

tion stiff in all but emerging markets.

Entering emerging leasing and finance

markets, which at first blush appears

a logical decision, comes with its own

unique set of challenges. This article

examines the initial decisions that must

be made in each environment when es-

tablishing operations outside the United States. The dif-

ferent challenges to be faced, particularly in emerging

markets, and how leasing and financing companies can

successfully overcome those challeng-

es, also are discussed.

ENVIRONMENTAL DIFFERENTIATION

A finance company faces constant

challenges even in its own country

—the task becomes even greater in an-

other jurisdiction, especially when it is

compounded by time, distance, and,

in many cases, the nascent legal and

regulatory frameworks of an emerging

market. As an example, the concept of

paying over time, with repeated pay-

ments, is a relatively new concept in

China. Other structural, accounting,

tax, and cultural differences add to the

mix of items that must be addressed

when entering an emerging leasing and

finance market.

Beyond these factors, a U.S. lessor

seeking to establish a presence in an

emerging market also must consider

the developmental stage of the leasing

industry it is entering. Many emerg-

Equipment leasing

in emerging markets

potentially is a major

business opportunity

for international lessors.

Although legal and

regulatory frameworks

continue to evolve in

these markets and there

is no single, successful

business model, study and

preparation will pay off for

motivated lessors.

2

THE OPPORTUNITIES AND CHALLENGES OF EMERGING MARKETS JOURNAL OF EQUIPMENT LEASE FINANCING • Spring 2009 • VOL. 27/NO. 2

ing leasing industries follow similar developmental pat-

terns, starting out small and then growing very rapidly

as multiple lessors enter the market. After a relatively

short period of growth and prosperity, however, there is

an economic adjustment, usually in the

form of a major contraction or even, in

some cases, a collapse.

A combination of government

regulation and more rational business

practices generally results in a subse-

quent period of slow growth, followed

by a stabilization of the industry. It is

at this point that the emerging leasing

industry, strengthened by its trials, is

poised to continue its development.

The Indian, Korean, and Indonesian

leasing industries all followed this pat-

tern. By understanding this pattern, a

U.S. investor can avoid losing hard-

earned traction in that industry.

On a more granular level, U.S. lessors must make

decisions such as whether to act on a cross-border basis,

establish a permanent presence in the emerging market,

or take on a partner. Special attention also must be paid

to languages, technological and physical environment,

social organization, geography, labor issues, country his-

tory, the concept of authority and political organization,

religion, and even the prevailing business and social ap-

proach toward time. The many things that are taken for

granted in the U.S. business environment now become

critical factors for success in an international environ-

ment.

In Latin America, for instance, the emphasis is on

relationships rather than formal contracts. Another dif-

ference from the United States is the inherent instability

of an emerging market’s economic cycle. This potential

instability requires lessors to look even more closely at

the social, cultural, and economic fundamentals of the

country, including the attitude of the government toward

the leasing and finance industry and the role it plays in

the economy.

The number and nature of the regulations and rules

are another dissimilarity between leasing in the United

States and in other countries. Most emerging markets

consider equipment leasing and financing as financial

activities, so they regulate them with the aim of ensur-

ing transparency, professional reliability, and minimum

damage to the public interest. Consequently, regulatory

agencies such as the central bank or ministry of finance,

have oversight of leasing companies. Some markets also

may consider leasing to be a commer-

cial activity subject to regulation by

other government bodies, such as the

Ministry of Commerce in China.

Lastly, the U.S. leasing and finance

company must consider the size of

the emerging market it is consider-

ing entering. The total leased assets

by leasing companies in China as of

December 2003, for example, was ap-

proximately US$2.6 billion. This figure

indicates a leasing penetration rate of

0.44% of capital formation,1 indicating

the tremendous growth potential of

the Chinese leasing industry. Other

leasing markets, by comparison, in-

clude Mexico (with a total portfolio of roughly $5.6 bil-

lion) and India (with a total portfolio of roughly $364

million), all the way down to El Salvador’s portfolio of

$23 million.

ESTABLISHING OPERATIONS

The number of rules and regulations with which finan-

cial companies must comply in emerging markets is, as

a general rule, much higher than in the United States,

including those necessary to establish operations in the

country. In spite of this general rule, however, some

countries, like Argentina, do not have formal barriers to

organizing a leasing company.

Regulation

The regulatory agencies in the vast majority of emerging

market countries allow lessors to establish either of two

types of leasing companies. These are financial leasing

companies (subject to financial company/banking rules)

and operating lease companies (generally not subject

to financial company/banking rules). Financial leasing

companies require a license granted by the authorities,

usually the ministry of finance or central bank. Operat-

ing leasing companies, on the other hand, do not. This

distinction makes it much less burdensome to establish

and run an operating leasing company.

On a more granular

level, U.S. lessors must

make decisions such as

whether to act on a cross-

border basis, establish a

permanent presence in the

emerging market, or take

on a partner.

3


Obtaining a license to conduct financial leasing re-

quires a vetting process that includes proving financial

capacity plus a minimum amount of capital. China re-

quires $10 million of capital to establish a leasing com-

pany, while the number is closer to $4 million in Brazil.

There are no minimum capital requirements in Mexico,

although the tax rules regarding thin

capitalization and the consequences

under Basel II of undue leverage must

be taken into account.

There also are differences in the

types of companies foreign lessors may

be allowed, or required, to form. Au-

thorization to establish a foreign leas-

ing company in China, for example,

must be obtained from the ministry of

commerce. The ability to operate as a

branch, representative office, or a per-

manent establishment may be available

only to certain types of companies or

require various levels of authorization.

Brazil prefers that foreign lessors act

as subsidiaries, rather than branches,

since a subsidiary is subject to the

domestic and regulatory framework,

which reduces the number of cross-

border regulatory problems more likely to appear in a

branch scenario.

Partners

Even though the foreign government may give owner-

ship and/or control over the leasing company to the U.S.

investor, the need for local alliances and know-how is

critical for success in any emerging market. Local part-

ners offer the following advantages:

• local market knowledge

• existing business relationships

• staffing

• familiarity with the local legal system

• speed to market

• language

• hierarchical interactions

Most international lessors with operations in China to-

day have Chinese partners, due in part to the fact that a

local partner was required to obtain a leasing license.

FundingFunding options available to lessors in emerging markets

may be tied both to the lessor’s type of leasing license

and the terms of the license itself. Lessors with licenses

to lease only in foreign currency in China, for example,

generally fund offshore. Leasing in China’s local cur-

rency creates regulatory barriers (gen-

erally exchange barriers) along with an

exchange risk factor.

According to the U.S. Embassy’s

China Country Commercial Guide,Foreign-invested firms, like domestic

firms, must register all foreign loans

with the State Administration for For-

eign Exchange (SAFE). Along with the

People’s Bank of China, SAFE regulates

the flow of foreign exchange into and

out of China.2

Because of these factors and other

regulatory barriers most multination-

als tend to self-fund their operations in

China.

Onshore funding options are lim-

ited in some countries, so bank loans

represent the only real funding oppor-

tunity. This is particularly true for op-

erating lease/independent companies

that, although less regulated, also have fewer funding

options as a result of less regulation. It is not unusual

for the commercial paper market to be underdeveloped

in emerging markets as there is little available credit in-

formation on most companies. Some emerging markets

such as Chile have sophisticated funding options, how-

ever.

Funding options in some emerging markets include

domestic bank loans, cross-border loans (subject to for-

eign exchange restrictions), commercial paper, deben-

tures, and securitizations placed in the domestic capital

markets. There are, however, potential obstacles of which

lessors need to be aware. Argentina3 and Colombia,4 for

example, require that a cash reserve be deposited at the

Central Bank together with the filing of cross-border

loans.

Although these requirements make the effective cost

of cross-border loans more expensive than their original

terms, these countries have good domestic capital mar-

ket conditions for funding leasing companies. In Argen-

Funding options in some

emerging markets include

domestic bank loans,

cross-border loans (subject

to foreign exchange

restrictions), commercial

paper, debentures, and

securitizations placed

in the domestic capital

markets.

4


tina, securitization is the preferred vehicle for funding

leases. Argentine lessors tend to establish equipment

leasing trusts and issue securities or paper out of such

trusts. Colombian companies use the commercial paper,

medium term notes, and bond markets extensively. Chil-

ean pension funds are very important investors and have

enormous potential to funnel funding into leasing and

equipment financing companies.5

Independent leasing companies, however, are not

allowed to raise funds from the public, so they must

obtain funding elsewhere. According to a recent survey

made by the Chilean Leasing Association, 53% of leas-

ing company funding comes from banks and 17% from

the placement of bonds. Since the average equity of the

leasing companies is 15%, the remaining 15% of funding

comes from vendors and other sources.

Staffing

Human resources are critical to the success of the leas-

ing and finance company no matter the locale. The chal-

lenges in this area, however, vary based on the market.

Mexico, for example, has an adult literacy rate of 92%,

whereas other Latin American countries have rates as

low as 70%. Although a U.S. company

may use expatriates to a certain extent,

U.S. financiers ultimately will have to

depend primarily on local talent. This

necessity has a cost benefit associated

with it, though, since local employees

work at a lower cost (around 20% of

expatriate wages in China, for exam-

ple).

Attitudes toward the workplace also are important.

Brazil has a literate and generally well-educated work-

force, but most leasing staff have been raised in an en-

vironment in which innovation is not encouraged. This

tendency is exacerbated by the inherent bureaucracy as-

sociated with prevailing business practices in Brazil.

The employment systems in many emerging mar-

kets can be very complex, highly protected, and rigid.

Some employment contracts are subject to minimum

statutory benefits and conditions stipulated by collective

bargaining agreements with employment unions, even at

the professional employee level. Other employment reg-

ulations create additional costs. In Mexico, for instance,

nonmanagement employees must have the right to share

up to 10% of their employer’s profits before taxes. Mexi-

can lessors address this burdensome requirement by cre-

ating special-purpose, service provider companies.

RISK CONSIDERATIONS

As previously mentioned, being a successful lessor is a

challenge even in one’s own market; thus it is even more

so in an emerging market. An international expansion

strategy, therefore, also must be supported by a very sol-

id risk management culture and organization. The strat-

egy must assess unique market risks, including country,

operating, currency, and funding risks. Lastly, a prudent

lessor will analyze and define a sound exit strategy.

Sovereign Risk

Sovereign risk is a prime example of the type of unique

risks that U.S. lessors may face internationally but do

not have to contend with at home. One aspect of sov-

ereign risk is political risk, which encompasses political

violence and revolution, expropriation, and other factors

such as government breach of contracts.

The likelihood of arbitrary nationalization of for-

eign companies is fairly low in many emerging markets

while very high in certain others such

as Venezuela, Nicaragua, Ecuador, and

Bolivia. Although the size of the leasing

portfolios at risk in these countries is

not that large, the risk still exists, as ev-

idenced by Venezuela’s nationalization

of Venezuela’s largest lessor, the Banco

de Venezuela (from the Spanish Grupo

Santander). As a result, a careful study

of the risk of expropriation should be undertaken before

investing in an emerging market.

It should be noted that there are protections against

expropriation. For example, Mexico, under the North

American Free Trade Agreement (NAFTA), may not ex-

propriate property, except for a public purpose and only

on a nondiscriminatory basis. In China, there have been

no cases of outright expropriation of foreign investment

since China opened to the outside world in 1979, al-

though the U.S. State Department believes that there are

several cases that may qualify. U.S. lessors may obtain

protection against political risks through the Overseas

Private Investment Corporation or the Multilateral In-

vestment Guaranty Agency, a World Bank Agency that

The employment systems

in many emerging markets

can be very complex,

highly protected, and rigid.

5


provides political risk insurance to international inves-

tors.

Market Size

Another market entry risk to be considered is the size of

the market itself, as it does not make sense to incur the

costs of entering a market in which there is little incre-

mental business to be gained. This de-

cision is easy for some markets, such as

China, in which the potential is great,

although market size can be deceiv-

ing. India, for example, has as much

potential as China in terms of popula-

tion and growth. The leasing market in

India, however, is still plagued by un-

certainty and regulatory hurdles that

should be considered in the market

entry decision.

Other factors to be considered

include the level of competition in

the market and the types of products

offered. There are over 10,000 do-

mestic leasing companies in China,

for instance, although most of these

companies offer relatively unsophisti-

cated leasing services and concentrate

on financing simple, commodity-type

equipment such as automobiles. Such

companies lack any funding strength and are, in general,

relatively unstable.

The primary leasing product offered in emerging

economies is the finance lease, in which there is little

if any residual position taken. Residual management is

very poor, such that residuals are not even on the hori-

zon in some markets. On the surface, this would appear

to present a great opportunity for U.S. lessors to offer

operating leases. Unless the U.S. lessor has global—or at

least regional—asset management capabilities; however,

this is not an advantage as the secondary equipment

markets in developing economies do not exist.

Credit Risk

Credit risk always is of primary concern whenever a les-

sor enters a new market. Listed companies typically pro-

vide the best source of information through the firm’s

filings with the stock exchange. Credit reporting agen-

cies, though, are not well developed, if they exist at all,

in many emerging leasing markets. As a result, most leas-

ing and finance companies rely on informal sources of

information and local partner knowledge.

This being said, Mexico has an increasingly effec-

tive credit information system through Buro de Crédito,

a privately owned company. In addition, a legal bureau

tracks lawsuits against credit appli-

cants, which is a valuable tool for credit

evaluations. Credit reporting agencies

such as Veraz in Argentina, Datacredito

in Colombia, and Serasa in Brazil have

existed for many years. The informa-

tion provided by these agencies is not

yet comparable with what is available

in the United States, as the coverage is

not very comprehensive, both in terms

of quantity as well as in quality.

Exit Risk

Finally, exit risks should be an impor-

tant element of the analysis to conduct

business in emerging countries. Joint

ventures, while allowing foreign les-

sors to shorten the learning curve, also

are more difficult to terminate, as they

require the parties to work out satisfac-

tory terms if the structure is unwound.

Repatriation of capital also is of primary concern. Mexico

and China do not have any restrictions on repatriating

capital, but other countries do. U.S. financiers should be

aware of any withholding taxes on repatriated profits, or

any other government restrictions.

OTHER CHALLENGES

It is fairly obvious that a lessor operating internation-

ally will face differing tax, accounting, and legal rules

and regulations. These differences can be reduced to a

set of common differences, however. As an example, al-

though legal systems differ between countries, they gen-

erally may be classified as either common law or civil law

systems. Common law systems are present in all former

British colonies and protectorates such as India. Civil law

systems, on the other hand, are present in countries col-

onized or influenced by continental European cultures,

such as Spain, Portugal, France, and Germany.

The primary leasing

product offered in

emerging economies

is the fi nance lease, in

which there is little if any

residual position taken.

Residual management

is very poor, such that

residuals are not even

on the horizon in some

markets.

6


Legal Challenges

The legal ownership of equipment subject to a lease in

the emerging economies is determined on either a form

or a substance basis. Legal ownership in Mexico, for

example, is based on the form of the transaction rather

than its economic substance, as is the

case in Brazil and most other Latin

countries. In a form country, the lessor

always is the owner of the equipment

for legal purposes. As a result, the le-

gal definition of a lease may not exactly

match the accounting or tax definition

of ownership.

Once legal ownership of the asset

is established it also is important to be

able to enforce the lessor’s ownership

rights in the event of disagreement.

The components necessary to enforce

leasing transactions in any economy

include (1) the rule of law, (2) a cor-

ruption-free environment, and (3) an

efficient legal system. U.S. financiers entering emerging

markets should, therefore, be fully aware of the time and

cost to resolve legal disputes. Commenting on this con-

cern, Karel van Laack, of Atradius Seguros de Credito in

Mexico, has stated, “Mexico’s sluggish legal system is a

known problem; trying to execute security like personal

guarantees and mortgages can take years.”6

The time and cost to resolve legal disputes in se-

lected emerging economies is shown in Table 1, which

also includes the United States as a benchmark.

Table 1.

Resolving Legal Disputes Cost to resolveCountry Days to resolve (% of claim)

United States 300 9%

Brazil 616 17%

Russia 281 13%

India 1,420 40%

Venezuela 510 44%

China 406 11%

Mexico 415 32%

SOURCE: Doing Business in 2008. Washington, D.C.: World Bank, Sept. 2007.

Taxation

The tax systems of the various countries of the world

also share common threads. The particulars will differ,

but each country has a tax on income, some form of cost

recovery, and a tax on consumption. U.S. lessors none-

theless must be cognizant of the dif-

ferences in application of the tax laws.

Top managers of enterprises in China,

for example, may be held criminally

liable if the company’s tax returns are

deemed as concealing or evasive.7

There are a range of taxes that must

be considered in other jurisdictions,

many of which are a mix of federal,

state, and local taxes. Although every

country has a tax on income and con-

sumption (value-added tax, or VAT)

additional types of taxes not found in

the United States are imposed. In ad-

dition to these basic taxes, the U.S.

financier may encounter the following

taxes, depending on the country:

• stamp duty

• central sales tax

• lease rental tax

• service tax

• cross-border lease tax

• lease development tax

• alternative minimum tax

• vehicle tax

• business tax

Like the variety of taxes, corporate tax rates between

countries. Most income tax rates fall somewhere between

30% and 35%, although they may range from a low of

10% in Paraguay to upward of 40% in Brazil. As a gen-

eral rule, however, U.S. lessors can expect a tax burden

similar to the United States’s as it relates to income taxes.

The rates for VAT, withholding, and other taxes must

be determined on an individual country basis. How the

taxes are applied also will vary as, for instance, the VAT

paid on transactions between states in India may not be

reclaimed. Suffice it to say that U.S. financiers will en-

counter a wider variety of taxes in emerging countries

than in the United States.

In a form country, the

lessor always is the owner

of the equipment for legal

purposes. As a result, the

legal defi nition of a lease

may not exactly match

the accounting or tax

defi nition of ownership.

7


U.S. lessors establishing operations in emerging mar-

kets will find that tax ownership of leased assets is deter-

mined based on one of two systems. In form countries,

such as Brazil, the lessor always is considered the tax

owner. In other countries, such as India, tax ownership

is based on the economic substance of the transaction,

which is similar to the methodology used in the United

States. Lessors in emerging markets also are allowed to

depreciate their assets, typically on a straight-line, rather

than accelerated, basis.

Accounting

Accounting regulations are always an

issue in any international expansion,

but there is not much divergence in the

accounting for leases between coun-

tries. At the present time, all countries

make a distinction between finance

leases and operating leases, whether

that distinction is based on either a

form or substance concept.

Many emerging markets now fol-

low International Accounting Standard

No. 17 (IAS 17) or a local lease ac-

counting standard based on IAS 17 or

FASB 13. Interestingly enough, several

countries, such as Colombia, Argentina, and Uruguay,

prohibit application of international accounting stan-

dards. Even so, and although accounting requirements

still may be different in line with the local legal systems

and business cultures, there is a continuing trend toward

international harmonization of these rules.

This unification may create localized operational

issues. U.S. lessors in Brazil, for instance, will need to

have the systems capability to adjust leases classified as

finance leases for accounting purposes to reflect the le-

gal ownership required for fiscal and tax-reporting pur-

poses. This also will require an integration process with

the U.S. lessor’s legacy lease management system. In this

regard, there are few to no local lease management and

reporting systems available in emerging leasing markets.

CONCLUSION

Equipment leasing in emerging markets can become a

major business opportunity for international lessors in

the coming years. To be sure, these economies pose a

number of significant risks that must be managed to be

successful. Furthermore, there still is much market de-

velopment activity to be done before leasing is accepted

as a mainstream financial product in some of the devel-

oping countries. U.S. financiers can compete successful-

ly, however, if they enter the target market with sufficient

study, preparation, and rigorous execution.

As U.S. lessors consider entering these emerging

markets, they should be aware of these significant fac-

tors:

• There is no single, successful busi-

ness model.

• Identifying and managing the risks

of doing business is the critical factor

to success, but the task should not be

overwhelming.

• The lack of trained local personnel

should be factored into the business

plans.

• Leasing may be a new concept for

many businesspeople in these mar-

kets.

• The used equipment market is largely

undeveloped, but it could be a huge

opportunity for certain assets.

As a final note, successfully entering a new market does

not happen overnight, so lessors should plan on every-

thing taking longer than anticipated. The opportunities,

however, are there for the prepared.

Endnotes

1. This number does not include hire-purchase agreements.

Including hire-purchase transactions pushes the rate closer to

40%. Source: Knocking Down (Great) Walls: Identifying Factors for Success in the Chinese Equipment Leasing Market, by The Alta

Group. Washington, D.C.: Equipment Leasing and Finance

Foundation. www.store.leasefoundation.org/product/chinarpt/

2. “China Country Commercial Guide FY 2004. A Guide to

Doing Business in China & Information on Current Economic

Conditions,” prepared by the U.S. Embassy, Beijing.

3. The amount of the deposit is 30%, pursuant to Comuni-

cación A 435 of the Central Bank of the Argentine Republic,

effective Oct. 6, 2005.

4. The amount of the deposit in Colombia is 40%, pursuant

to Resolution 8/2000 of the Board of Directors of the Banco de

la Republica, as amended in 2007.

At the present time,

all countries make a

distinction between

fi nance leases and

operating leases, whether

that distinction is based

on either a form or

substance concept.

8


5. Further details about the capital markets in Chile can be

found in the study “Capital markets in Chile: from fi nancial

repression to fi nancial deepening,” available at www.bis.org/

publ/bppdf/bispap11g.pdf, and in the Capital Markets Reform

paper posted www.buyusa.gov/chile/en/capital_market_re-

forms.pdf

6. InsideARM: Report: Mexican Legal Collection System

Provides Poor Protection to Creditors, March 12, 2008. www.

insidearm.com

7. Article 201 of the Peoples Republic of China Criminal Law,

as amended in March 1997.

Shawn D. Halladay

[email protected]

Shawn D. Halladay, based in Salt

Lake City, Utah, is a principal of

The Alta Group and is the managing

principal of its professional develop-

ment division. He began his career in the audit division

of Arthur Andersen & Co., and over the past 25 years,

he has developed significant expertise in all areas of leas-

ing, including accounting, pricing, taxation, funding,

and operations. Mr. Halladay has international teaching

and consulting experience on leasing practices and poli-

cies, having conducted consulting assignments or taught

classes in more than 25 different countries. He has writ-

ten eight books on various aspects of equipment leasing,

served as managing editor and co-author of the Handbook

of Equipment Leasing, and regularly contributes to various

industry trade journals. He is a member of ELFA’s Finan-

cial Accounting Committee and serves on this journal’s

editorial review board. A certified public accountant, he

received his BS in accounting and MBA in finance from

the University of Utah, Salt Lake City.

Jonathan L. Fales

[email protected]

Jonathan L. Fales, based in King-

sport, Tenn., is a principal in The

Alta Group. For more than 31

years, he has worked in the IT and

equipment leasing fields. Prior to joining Alta, he held

numerous positions around the world with IBM Global Fi-

nancing, including general manager of Asia Pacific South

Global Financing and a member of IBM Credit General

Business Customer Financing Group, which focused on

marketing leases through indirect dealer channels. Mr.

Fales has helped Alta clients launch and manage vendor

finance programs in Latin America, Europe, and Asia as

well as the United States. He also works in benchmark-

ing operations, litigation support and strategic consult-

ing, including market-entry analysis and business case

development. A former member of the ELFA board of

directors and executive committee, he frequently pres-

ents at global leasing conferences, writes articles for lead-

ing industry magazines, and is considered an expert in

vendor finance. Mr. Fales received a BA in mathematics

from Vanderbilt University in Nashville, Tenn.

Rafael Castillo-Triana

[email protected]

Rafael Castillo-Triana, based in

Weston, Fla., is a principal in The

Alta Group and its managing prin-

cipal for Latin America. Previously, he was executive

vice president of Leasing Grancolombiana, S.A., lead-

ing a successful turnaround of the company; the first

CEO of Megaleasing S.A., for big-ticket leases in the

energy leasing business in Latin America; the first CEO

of Equileasing S.A., captive for Canon in Latin America;

and eventually advisor and counsel to Siemens, Mitsui,

Corporacion Financiera Union, AT&T Capital, New-

court, CIT Group Inc., and the International Finance

Corp. (the private arm of the World Bank). Mr. Castillo-

Triana was instrumental in drafting the leasing laws of El

Salvador and Tanzania. He has represented Colombia on

the advisory board of UNIDROIT for the Model Law on

Leasing, including the third draft adopted in 2008. Mr.

Castillo-Triana received both his master’s in economics

and JD from Javeriana University in Bogota, Colombia.

Knocking Down (Great) Walls: Identifying Fac-

tors for Success in the Chinese Equipment

Leasing Market was first published by the

Equipment Leasing and Finance Founda-

tion in October 2005. Recognizing the need for better in-

formation about equipment leasing in China, Great Walls

provided data regarding the environment and described

the unique risks as well as how others have entered the

market or could enter the market. We hoped lessors

would use this data to make informed

decisions as to how, or if, they should

pursue the opportunity.”1

More than three years have elapsed

since Great Walls was published, and

much has changed, both in China gen-

erally and in the Chinese equipment

financing market in particular. This

article examines the most important

changes as they pertain to equipment

financing and leasing companies and

is designed to provide up-to-date in-

formation on several important issues

in the equipment financing industry in

China.

SUMMARY OF KEY POINTS IN GREAT WALLS

The Great Walls study included core

research on the Chinese equipment

financing market, a primer on how to

establish a leasing/financing company

in China, an analysis of risk considerations, and five case

studies. Among the key research and information items

from Great Walls were:

Knocking Down (Great) Walls: An Update on the Chinese

Equipment Financing MarketBy Jonathan L. Fales and Jason Zhou

• The domestic Chinese equipment leasing market had

existed since the first leasing company was estab-

lished there in 1981. By 2005, over 10,000 leasing

companies existed in China, though the vast major-

ity of these were small vehicle leasing companies.

• Leasing companies were required to obtain a license

from the Ministry of Foreign Trade and Economic

Cooperation, or MOFCOM. Paid-up capital re-

quirements varied by ownership structure. Wholly

foreign-owned enterprise leasing com-

panies (WFOEs) were permitted for

the first time in March 2005, and a

small number of Western lessors had

obtained WFOE licenses by October of

that year. The People’s Bank of China

(PBOC), which approved the creation

of bank-owned lessors, had placed

a moratorium on new licenses, and

PBOC-approved licenses were frozen

at 12.

Key challenges for lessors included

poor availability of credit information,

unclear lessor ownership and reposses-

sion rights (although legislation had

been proposed in 2005 to address these

issues), lack of skilled and experienced

resources, and an undeveloped used

equipment and operating lease market.

In addition, the concept of leasing was

not well understood by many businesspeople and pro-

spective employees, making lease sales and recruitment

difficult.

Chinese large-ticket

fi nancing and vendor

programs both should

continue to grow over the

next two to three years,

even with the current

worldwide economic

slowdown. This article

updates the Great Walls

study the Foundation

published in 2005.

2

KNOCKING DOWN (GREAT) WALLS JOURNAL OF EQUIPMENT LEASE FINANCING • Spring 2009 • VOL. 27/NO. 2

• Vendor programs have become much more popular

among multinational manufacturers, particularly

since the establishment of MOFCOM WFOE licens-

es in 2005. As of year-end 2008, over 100 MOF-

COM financing licenses had been granted. Some of

the larger manufacturers that have obtained WFOE

licenses include Caterpillar, Cisco, GE, Hitachi, and

Doosan.

• Large-ticket financing transactions have grown rapid-

ly as China’s economy expands. Both multinational

and Chinese lessors have financed equipment used

in China’s large infrastructure and transportation

expansion projects over the last three

years. Aircraft in particular has re-

ceived focus from lessors. According to

the World Leasing Yearbook 2008, “Major

foreign aircraft manufacturers have es-

timated that China may acquire more

than 2,800 aircraft in the next 20 years.

It is generally believed that demand for

leasing of equipment will assume expo-

nential growth in the near future.”6

Another important factor—and one

with significant implications for the

future—has been the reemergence of

banks in the Chinese leasing industry.

“Measures for the Administration of

Financial Leasing Companies,” written

and administered by the China Bank

Regulatory Commission (CBRC), was

issued in early 2007 to serve as the reg-

ulatory framework for bank-affiliated

leasing companies, and was put into

force on March 1, 2007.

Since that time, five large Chinese banks have ob-

tained CBRC leasing licenses; their collective paid-in

capital totals more than RMB 14 billion (approximately

US$2 billion), and a sixth bank acquired an existing,

independent Chinese lessor and injected approximately

RMB 8 billion (US$1.2 billion) in fresh capital. These

six bank lessors, in little more than 18 months, together

have amassed equipment financing portfolios in excess

of 46 billion RMB.7 It should be noted that, at the time

of this writing, the CBRC appears to have slowed down

the pace of issuance of new licenses in 2009, to ensure

CHANGES IN CHINA SINCE 2005China has undergone a number of changes since 2005

that are reflective of its tremendous growth. China’s gross

domestic product (GDP) surged to over RMB 30 trillion

by the end of 2008 (the renminbi, or RMB, is China’s

currency; this amount represents approximately US$4.4

trillion)—up from less than RMB 20 trillion in 2005

(about US$2.9 trillion)—while its population increased

2.3%, to 1.33 billion.2 Its foreign currency reserves have

grown to US$1.9 trillion,3 and it is by far the largest

holder of U.S. government debt securities.

Although the 2009 outlook for Chinese GDP growth

has been reduced to 8%—still robust

by Western standards—China’s govern-

ment enacted a large domestic stimulus

package in late 2008 worth $586 bil-

lion in response to the world credit cri-

sis.4 Most of these funds are to be used

for infrastructure projects, which will

create large funding opportunities for

equipment financing companies.

China’s currency was floated with-

in a managed bandwidth beginning in

July 2005, and the RMB has strength-

ened 21% since then, to approximately

6.8 RMB/dollar at the time of this writ-

ing. This has had the important effect

of making the large cash position of

China’s major banks (discussed in more

detail below) of even more relevance

with respect to prospective future in-

vestments in the equipment financing

industry.

CHINA’S EQUIPMENT FINANCING INDUSTRY IN 2009

The Industry Today

China’s equipment financing industry has grown from

RMB 21.36 billion in annual lease originations in 2005

(approximately US$2.6 billion at the then-current rate of

exchange) to RMB 100 billion, or US$14.7 billion at the

December 2008 exchange rate, by the end of 2008.5

Much of this growth has been fueled by the expan-

sion of vendor programs and large-ticket financing in

China:

Although the 2009

outlook for Chinese GDP

growth has been reduced

to 8%—still robust by

Western standards—

China’s government

enacted a large domestic

stimulus package in late

2008 worth $586 billion

in response to the world

credit crisis.

3


that capital enters the Chinese market on a carefully con-

trolled basis.

The small and medium business sector (SMB) re-

mains largely unpenetrated by lessors. As it was in 2005,

reliable Western-style credit information is difficult to

obtain, and credit decisions involv-

ing SMB companies must be made

by manual research. This makes the

SMB market uncompetitive from an

expense standpoint for most Western

lessors. This may change in coming

years, however. Large Chinese banks

have significant amounts of data on

SMB companies as well as experience

in extending credit to many of them.

In addition, the government has identi-

fied SMB growth as a priority for the

country, which creates an incentive for

banks with CBRC leasing licenses to

enter the market. This has not yet hap-

pened but is a distinct possibility over

the next two years.8

A new development in the Chinese equipment fi-

nancing market is the emergence of captive vendor fi-

nancing programs owned and operated by Chinese

manufacturers. Manufacturers in the construction,

power generation, and transportation industries, among

others, have created their own captive subsidiaries over

the last three years, and in 2008 three of them exceeded

US$100 million in financing originations.9

Although most of the financing activities of the

captives are within China, several captives have plans

in the next two to three years to support their parent

companies in international markets. This will provide

both opportunity and risk for other captives and ven-

dor program providers in these countries. There is also

a distinct possibility that Chinese banks could enter the

vendor program business, which, with their ample cash

reserves, could provide formidable competition to West-

ern lessors.10

Status of Leasing Legislation

The Great Walls study referenced new legislation, slated

for approval by the National People’s Congress (NPC) in

2006, which would “eliminate the duplication of effort

[regarding leasing regulation] between CBRC and MOF-

COM. The new leasing law will authorize, regulate, and

govern leasing operations.”11

This legislation has not yet been passed into law.

The proposal was tabled, as the NPC considered and

passed large amounts of legislation on issues pertinent

to the Olympic Games during its 2006

and 2007 plenary sessions. Unfortu-

nately, the proposal was not included

in the new NPC legislative agenda in

March 2008 and now does not appear

likely to pass into law within the next

few years. The key issue appears to be

that the NPC does not understand the

necessity of the new law, as there are

an existing property law and a contract

law that cover some of the same issues

as the proposed leasing law.

The ramifications in the interim

for most Western lessors are that tax

incentives for manufacturers may not

pass automatically to lessors. Also, cer-

tain funding options for nonbank lessors, such as the

issuance of corporate bonds or public equity offerings,

will not be available until the legislation passes.

Other Notable Developments

• The market for operating leases, other than for

large-ticket equipment, has not yet developed in

China, in large part because of the perception that

a business tax of 5% applies to the entire amount

of an operating lease payment. By contrast, the tax

applies only to the interest portion of capital lease

payments. This perception is being challenged by

many in the industry, notably the Leasing Business

Committee (LBC) of the China Association of Enter-

prises with Foreign Investment (CAEFI). Although

the State Authority on Taxation (SAT) has not yet

issued a position on this interpretation, the CAEFI,

LBC, and others continue to pursue a favorable rul-

ing from SAT.

• A part of the economic stimulus issued by the

Chinese government in November 2008 has inad-

vertently placed some lessors at a significant disad-

vantage. The stimulus allows manufacturers to claim

value-added tax (VAT) offsets for equipment pur-

chased for use in the manufacture of its products;

Although most of the

fi nancing activities of the

captives are within China,

several captives have

plans in the next two to

three years to support

their parent companies in

international markets.

4


however, the offset is not available if the equipment

is leased. Several leasing industry trade associations,

as well as some captive lessors, are working with

SAT to remedy the situation at the time of this writ-

ing.

• The service provider industry for the leasing indus-

try in China is growing, albeit slowly. Mandarin-

language leasing software is now available from one

major provider, and a new Man-

darin-language e-trading platform

for construction equipment began

operation in 2008. This latter de-

velopment is an important step in

the creation of a viable used equip-

ment market in China.

• China implemented a new lease

accounting standard on January 1,

2007, which aligns Chinese stan-

dards closely with International

Accounting Standards (IAS).

• An important new property law

was enacted on October 1, 2007;

it is a milestone law that provides for the protec-

tion of property ownership in China. The property

law makes clear that government- and state-owned

entities cannot usurp the ownership rights of pri-

vate entities. Unfortunately, two issues important to

equipment financing companies—asset registration

and the enforcement of hell-or-high-water clauses—

were not included in the law.

• A new income tax law, implemented on January 1,

2008, equalizes the general income tax rate at 25%

among both foreign investors and domestic inves-

tors. The law it superseded, which had been in ef-

fect since 1993, provided significant tax incentives

to foreign investors to invest in China. Thus these

incentives no longer exist.

FINAL THOUGHTS

The original Great Walls study predicted that the equip-

ment financing market in China would continue to

evolve steadily in coming years and that Western lessors

would need to exercise caution before establishing op-

erations in China.

Although the admonitions for vigilance still exist,

“steady growth” proved to be an understatement. Fi-

nancing origination volumes have grown an estimated

368% since 2005 and are on pace to continue expanding

rapidly in 2009. The biggest surprise has been that much

of the growth has come from Chinese equipment financ-

ing companies, in particular from Chinese banks.

Many of the risks analyzed in Great Walls still exist,

to be sure. Notably, there is still a lack of available West-

ern-style credit information (particularly for small and

medium business sector companies),

there is no leasing-specific legislation

that protects the ownership rights of

lessors, and nonbank lessors have lim-

ited funding options available to them.

But it is noteworthy that both Chinese

and Western lessors have found ways

to deal with these issues, and they have

expanded their equipment financing

business remarkably over the last three

years.

Chinese large-ticket financing and

vendor programs both should contin-

ue to grow over the next two to three

years, even with the current worldwide economic slow-

down. If the Chinese banks choose to enter the small and

medium business sector, this growth could accelerate

dramatically. Western equipment financing companies

would do well reexamine the Chinese market, if they

have not done so recently, as a rich source of potential

growth.

Endnotes

1. Knocking Down Great Walls: Identifying Factors for Success in the Chinese Equipment Leasing Market, Washington, D.C.:

Equipment Leasing and Finance Foundation, October 2005;

p. 5 (Preface).

2. https://www.cia.gov/library/publications/the-world-fact-

book/print/ch.html

3. www.bloomberg.com, Jan. 23, 2009.

4. www.forbes.com, Nov. 11, 2008.

5. The Alta Group estimate, based on analysis of public and

proprietary information from CBRC- and MOFCOM-licensed

lessors in China.

6. World Leasing Yearbook 2008, Euromoney Yearbooks, p.

176. www.euromoney-yearbooks.com

China implemented a new

lease accounting standard

on January 1, 2007,

which aligns Chinese

standards closely with

International Accounting

Standards (IAS).

5


Jonathan L. Fales

[email protected]

Jonathan L. Fales, based in King-

sport, Tenn., is a principal in The

Alta Group. For more than 31

years, he has worked in the IT and

equipment leasing fields. Prior to joining Alta, he held

numerous positions around the world with IBM Global Fi-

nancing, including general manager of Asia Pacific South

Global Financing and a member of IBM Credit General

Business Customer Financing Group, which focused on

marketing leases through indirect dealer channels. Mr.

Fales has helped Alta clients launch and manage vendor

finance programs in Latin America, Europe, and Asia as

well as the United States. He also works in benchmark-

ing operations, litigation support and strategic consult-

ing, including market-entry analysis and business case

development. A former member of the ELFA board of

directors and executive committee, he frequently pres-

ents at global leasing conferences, writes articles for lead-

ing industry magazines, and is considered an expert in

vendor finance. Mr. Fales received a BA in mathematics

from Vanderbilt University in Nashville, Tenn.

7 .The Alta Group research. Sources included Chinese regula-

tory agencies, bank lessors, and industry trade groups in

China.

8. Based on The Alta Group research among Chinese bank

lessors.

9. The Alta Group research. Sources included Chinese captive

lessors and industry trade groups in China.

10. Ibid.

11. Great Walls, p. 22.

Jason Zhou

[email protected]

Jason Zhou is the managing princi-

pal of The Alta Group in the Great

China region. He oversees the firm’s

practices of consulting, financial ad-

visory, and professional development in the region. He

has over 15 years of experience in multinational firms

and China state-owned enterprises. From 2004 to 2007,

he was one of the founding executives of Caterpillar Fi-

nancial’s business in China. Mr. Zhou received his mas-

ter’s degree from Foster College of Business, Bradley

University, Peoria, Ill., and a BS from Zhejiang University

of Science and Technology in China.

Transportation Equipment Financing: Tracking the

Forces Shaping the MarketBy Mark Lauritano

People often say, “The darkest hour is just before

the dawn.” Financing opportunities within the

transportation equipment sector have steadily

declined since the middle of 2008. Has the in-

dustry reached the darkest hour? Can the dawn of re-

covery be far off? What are the early

signals that a rebound is about to

commence, and what type of recovery

should industry participants expect?

The answers to these questions depend

a great deal on which segment or mar-

ket niche of this highly specialized sec-

tor one’s business supports.

This article highlights the findings

from a four-part study commissioned

by the Equipment Leasing and Finance

Foundation on the equipment finance

outlook within the transportation sec-

tor. IHS Global Insight was selected

to conduct the research and prepare

reports on four equipment financing

market segments: truck and trailer, rail

and locomotive, aircraft, and marine.

The studies published between Sep-

tember 2008 and February 2009 offer

a review of the current situation and analysis of future

trends, providing insights on the underlying factors driv-

ing the market.

As a general rule, transportation equipment financ-

ing should not be viewed as a single asset class, because

each type of equipment is designed to serve a unique set

of shipping requirements and has distinctive operating

constraints. Despite the unique characteristics of the var-

ious segments within transportation equipment finance,

a common set of factors shapes the market. These factors

center on two forces: (1) the general state of the econo-

my, which drives the demand for the underlying ship-

ment of goods (or people, in the case of aircraft) from

point A to point B and (2) the liquidity

of financial markets, which influences

the ability to raise capital and in turn

has a direct impact on asset values.

Unfortunately the news on both of

these fronts, the economy and capital

markets, is currently very dark indeed,

and even the healthiest segments of the

transportation equipment sector can-

not escape these forces. As the worst

recession in the post-World War II

era, the present downturn is now se-

vere enough to warrant the descrip-

tion “great” (see Fig. 1, next page). IHS

Global Insight now pegs the 2007 to

2009 peak-to-trough drop in real gross

domestic product (GDP) at 4.8%. Giv-

en the extent of the current downward

momentum, real GDP is expected to

fall 3.7% in 2009, and the unemploy-

ment rate is expected to peak at 10.3% in the first half

of 2010.

The government’s efforts to inject demand through

the fiscal-stimulus package, shore up the financial sector,

and revive lending to consumers and businesses will take

time to become effective and will need to be expanded.

Making matters worse, a key dimension of this stimulus,

the banking sector fix, is not yet in place and will require

A brighter day is coming

for those who can adapt

to the current environment

and take the long view.

Rail and marine should

lead the way. But the fi rst

signs of a turnaround in

transportation fi nancing

are not likely to appear

until the end of 2009.

2

TRANSPORTATION EQUIPMENT FINANCING JOURNAL OF EQUIPMENT LEASE FINANCING • Spring 2009 • VOL. 27/NO. 2

spending as yet unauthorized. IHS Global Insight’s anal-

ysis suggests the various stimulus efforts will gradually

ease the rate of GDP decline as 2009 progresses and pro-

duce a modest positive growth rate in the fourth quarter

(see Fig. 2).

When an economy is in the midst of a severe glob-

al recession, virtually all sectors are in alignment and

pointing downward. Yet several indi-

cators have a particularly strong bear-

ing on the outlook for transportation

equipment. For example, the manu-

facturing production process places

great demands on transportation ser-

vices for the movement of raw materi-

als, components, intermediate goods,

and finished goods. Recent indicators

suggest that inventories are still far too

high relative to sales and must contract

sharply. The demand for manufactured

goods is currently driven by weak do-

mestic demand, as well as a collapse in

exports. In 2008 real exports expanded

by 6.5%, but IHS Global Insight ex-

pects U.S. export volumes to fall 14.7%

this year as world trade contracts.

Another bellwether for the transportation sector

is the state of the construction sector. With greater in-

security among potential purchasers, housing starts

are plumbing new depths. IHS Global Insight expects

housing starts to hit bottom only in the second quar-

ter of 2009, at just 502,000 units (annual rate), and to

improve only very gradually thereafter. Unlike housing,

nonresidential structures spending is just now beginning

to turn down with a vengeance, as overcapacity in retail

and office space mounts and financing for commercial

real estate tightens sharply.

The stabilization of the housing market is a neces-

sary precursor to a turnaround in the financial crisis.

The recovery of the capital markets will

require a more comprehensive plan

from the U.S. Treasury than has been

announced so far, but there is some

short-term relief in sight as the Federal

Reserve Board launches its new Term

Asset-Backed Securities Loan Facility

(TALF) program to provide financing

directly into securitized consumer and

business credit markets. This should

help to unclog a portion of the second-

ary market capital channel, which has

been generally frozen since the col-

lapse of the mortgage-backed security

market.

With these financial and eco-

nomic indicators as a backdrop, how

will the transportation equipment fi-

nance market fare? As might be expected, the short-term

outlook for purchases of transportation equipment is

down sharply. In fact, IHS Global Insight is forecasting

real transportation equipment investment to drop 12%

in 2009, a third consecutive annual decline in spending.

This drop-off in spending is marginally better than the

The short-term outlook

for purchases of

transportation equipment

is down sharply. In

fact, IHS Global Insight

is forecasting real

transportation equipment

investment to drop 12%

in 2009.

-5%

-4%

-3%

-2%

-1%

0%

0801908180737060575348

Figure 1

GDP Declines During Postwar Recessions(Peak-to-trough percent change, date is year of peak quarter)

SOURCE: U.S. Dept. of Commerce, IHS Global Insight.-8%

-6%

-4%

-2%

0%

2%

4%

6%

11Q311Q110Q310Q109Q309Q108Q308Q1

Figure 2

2009 Begins About the Same As 2008 Ended

(Real GDP, annualized percent change)

SOURCE: U.S. Dept. of Commerce, IHS Global Insight.

3


17% drop expected in overall equipment and software

investment, because the transportation equipment in-

vestment was already down sharply in 2008.

TRUCK AND TRAILER EQUIPMENT FINANCE

Among the four major transportation segments, the situ-

ation in the truck and trailer leasing and financing market

looks especially grim, and the verdict is that things will

get worse before they get better. The markets on which

the truck and trailer segment is dependent (manufactur-

ing production, construction, and con-

sumer spending) are weak, tonnage is

down, and companies are going under.

The situation has been exacerbated by

the environmental regulations, which

caused overcapacity and reduced the

desire to acquire new vehicles while

increasing running costs.

The credit crunch has been espe-

cially harmful to finance companies

serving the needs of smaller operators,

which comprise a significant propor-

tion of the demand for trucks and

trailers. Fleets are being shrunk, and

full-service leases are being used by

lessees to manage their risk.

On the bright side, when demand

picks up in 2010, things will improve

rapidly and significantly. With nearly 2,000 trucking

companies failing in the just the first half of 2008, many

of the weaker players will have exited the market. In

addition, up until this year the export market for used

trucks was quite strong, helping to move older equip-

ment overseas. With higher demand for capacity kicking

into gear in 2011 and 2012, those old trucks will not be

available, and demand for new vehicles will soar.

Furthermore, with companies being forced out of

the market during the period of low demand, overcapac-

ity will not be a problem, shipping prices will rise, and

carriers should be flush with money and searching for

vehicles. The timing of the slowdown in freight is likely

to reduce the pre-buy before the 2010 Environmental

Protection Agency rules come into effect, but this will

smooth things out in the medium to long run and benefit

the survivors of the current inhospitable market.

RAIL AND LOCOMOTIVE EQUIPMENT FINANCE

Although the near-term economic outlook leaves much

to be desired, the railroad industry is well positioned as a

long-term, stable source of equipment finance demand.

Existing order backlogs helped prop up deliveries of rail-

cars at the outset of 2009. Nevertheless, with rail traffic

in retreat and the credit crunch still in play, new orders

for equipment will weaken appreciably in the short term.

IHS Global Insight is not anticipating any meaningful

snapback in new equipment demand

until well into 2010. As we look fur-

ther out, the prospects for freight-car

financing will brighten as traffic builds

up a head of steam and the pressures

resurface to expand or upgrade carry-

ing capacity.

Railcar demand and supply can-

not be effectively viewed as a single

market. Instead, one must realize that

different cars serve different purposes

and that the fortunes of those cars rise

and fall in tandem with the markets

and commodities they serve. For ex-

ample, conventional flatcar shipments

have been weak for some time now as

they are particularly sensitive to the

housing and auto industry downturn

and the subsequent drop-off in lumber, light vehicles,

and steel-mill product cargoes.

Coal production was a rare bright spot for open-top

hoppers in 2008, because of its competitive advantage

in a year of high fuel costs and a weak dollar driving

exports. That has abated, however, and production is

expected to decline in 2009. Steel production, which af-

fects open-top hopper traffic for coke and ore, also re-

mains weak. The covered hopper market largely reflects

the mixed outlook for agricultural output, which is gen-

erally lower than output growth in recent years because

of high crop prices and ethanol.

The fuel price crisis that hit the logistics industry

hard in 2008 has provided some lingering benefits to the

rail industry, however. Rail is a comparatively energy-

efficient mode of transportation, and green, fuel-efficient

logistics plans are often still intact despite the subse-

With companies being

forced out of the market

during the period of low

demand, overcapacity

will not be a problem,

shipping prices will rise,

and carriers should be

fl ush with money and

searching for vehicles.

4


quent decline in fuel prices. Consequently, rail is looking

at modal share gains over the long term.

AIRCRAFT EQUIPMENT FINANCE

With more than 5,000 aircraft leased worldwide, rough-

ly one-third of the global freight and passenger fleet is

under lease. This is up from 25% in 2001, and analysts

predict that the proportion under lease will reach 50%

by 2010. The aircraft leasing industry usually runs coun-

tercyclically, because airlines seek more

financing during downturns.

The year 2008 was a rough one

for airlines. First, they had to deal with

volatile and sky-high fuel costs. Now

economic conditions continue to dete-

riorate, and air-travel demand is crum-

bling. The collapse in fuel prices is a

major relief, but weak demand means

airlines are looking to cut capacity, not

add it in the form of new aircraft. While

at this point 2009 production for new

aircraft is mostly set, deferments and

cancellations could occur for deliveries

scheduled for 2010 and beyond. The

severity and length of the economic

downturn will determine how long airlines will wait be-

fore looking to expand again.

Production delays at major manufacturers and the

machinists’ strike at Boeing in 2008 have been a godsend

to the aircraft financing industry. The deferred introduc-

tion of new aircraft models into the present well-sup-

plied market has been beneficial to the values of newer

narrow-bodied and wide-bodied aircraft. Meanwhile,

values for older narrow-bodied aircraft are crumbling

as airlines remove them from service in favor of their

newer generation counterparts. Values for wide-bodied

aircraft, which are used primarily for long-haul flights,

have held up better in comparison to narrow-bodies, but

their values are under increasing downward pressure in

the weakened global economy.

While the short-term obstacles are significant, long-

term fundamentals remain solid for aircraft financing.

New models will find niches that airlines and cargo car-

riers are eager to fill. International markets will show

strength in the coming years, and large established air-

lines tend to have benefited from the rough first half of

the decade to emerge leaner and more flexible. Rising

wealth in emerging markets is creating a new class of

citizens eager to travel.

MARINE EQUIPMENT FINANCE

The marine shipping industry is being squeezed by a

combination of forces. Most significantly, international

freight, which represents nearly 60% of total waterborne

tonnage, has deeply suffered. The U.S. economic slow-

down reduced domestic demand and

cut down import traffic, and as the

recession spread globally, exports—

the lone bright spot in the U.S. econ-

omy—began to drop off as well. In

the face of uncertainty, banks are re-

luctant to offer financing or to issue

letters of credit, which facilitate the

transport of goods. Cargo and ships

both are sitting idle at ports, resulting

in lack of freight revenue and creating

an overcapacity situation in the ma-

rine market.

Though weaker than last year,

coastal and inland waterborne com-

merce have not fully collapsed. For

the year ending in November 2008, internal waterway

tonnage was down 7.1%. Petrol and chemicals were

down 13.6%, food and farm products dropped 29%,

and manufactured goods and industrial commodities

rose 3.7%. Coal has been a bit stronger in recent months

and traffic was up 3.8%. Buoyed by high water levels,

iron ore traffic on the Great Lakes was up 11.5%. Stone

shipments were flat. The drop in demand has allowed

shipping companies to lay up aging equipment, which

comprise a higher percentage of the U.S. Jones Act fleet

than of the total fleet sailing under the U.S. flag.

Declining vessel values were also detrimental to all

ship owners and lessors. The price of scrap fell precipi-

tously during the final quarter of 2008, and ship own-

ers held on to their retirement-aged vessels. Much lower

iron and steel prices meant that owners would not easily

recoup the value of the vessel. Further, a large number of

vessels were scrapped when prices were near their highs,

and ship breakers currently have a full inventory. While

demand remains low and ship breakers’ inventories re-

main full, ship owners will have to adjust by laying up

While the short-term

obstacles are signifi cant,

long-term fundamentals

remain solid for aircraft

fi nancing. New models

will fi nd niches that

airlines and cargo carriers

are eager to fi ll.

5


extra vessels now and concentrate on rightsizing and op-

timizing their fleets for future operation.

LOOKING FOR SIGNS OF RECOVERY

In the current climate it is premature to start looking

for signs of recovery in the transportation equipment

finance industry. Chances are high that things will get

worse—possibly a lot worse—before they get better.

That being said, it is only prudent to think about the in-

dicators that should be monitored for

signs of recovery.

Before shippers are willing to

make a significant commitment to fi-

nancing new equipment, they need ev-

idence that demand for the services of

their existing equipment is on the rise.

Among all products dependent on the

transportation services industry—raw

materials, components, intermediate

goods, finished goods, and in the case

of aircraft, business and leisure travel-

ers—the first category likely to see a

rebound in demand will be raw mate-

rials. When inventories hit bottom, the

first thing needed to replenish produc-

tion will be raw materials. As produc-

tion ramps back up, the other markets

for transportation services will follow.

One of the best measures to gauge the global sup-

ply and demand of commodities is the Baltic Ocean Dry

Bulk Freight Index (BDI). The BDI is a daily index of

overseas shipping rates for dry bulk commodities such as

grains, coal, and iron ore. Due to the high cost of taking

oceangoing ships out of circulation, the supply of vessels

is relatively fixed in the short term. As a result, the BDI

responds sharply to changes in demand. For example,

the dramatic ride of the freight market was apparent in

2008, with the BDI reaching 11,793 on May 20 and fall-

ing to 663 on December 5: a 95% drop. The BDI did

experience a move upward in February 2009, but this is

considered to be just a temporary shift caused by an inef-

ficient positioning of ships and a short-term movement

in demand. As that short-term demand is covered, the

BDI is expected to drift back down (see Fig. 3).

Of course, it always helps to have confirmation of an

economic recovery in more than one indicator so as not to

interpret a false-positive signal. Other early indicators for

a rebound in production include average weekly hours

and temporary employment. Typically, weekly hours in-

crease before manufacturing firms make the leap to hire

new workers. Along the same lines, temporary workers

are usually the first to be hired when demand improves

and the first to be let go when demand softens.

In summary, the players in the transportation equip-

ment finance industry that are able to adapt to the cur-

rent environment and take a long view

of their market opportunities will see a

brighter day. Among the four segments

of the industry addressed in this arti-

cle, the first to see an improvement will

be the services that primarily transport

commodities, namely rail and marine.

Based on IHS Global Insight’s perspec-

tive on economic and capital markets,

the first signs of a turnaround in trans-

portation financing are not likely to ap-

pear until the end of 2009.

In addition, it is a pretty safe bet

that lenders will be fairly cautious com-

ing out of the great recession of 2008–

2009, based on recent losses. Deals

will be limited to customers carrying

low debt levels and generally solid bal-

ance sheets. As the overall demand for

transportation services improves and liquidity returns to

the capital markets, there will be significant opportunity

to finance new equipment in the second half of 2010

and beyond.

Among all products

dependent on the

transportation services

industry, the fi rst category

likely to see a rebound

in demand will be raw

materials. As production

ramps back up, the other

markets for transportation

services will follow.

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

2007 2008 2009

Figure 3

Shipping Rates(Baltic Ocean Dry Bulk Freight Index, Jan. 1985 = 1000)

SOURCE: The Baltic Exchange.

6


Mark Lauritano

[email protected]

Mark Lauritano is executive manag-

ing director of IHS Global Insight in

Lexington, Mass., the world’s largest

economic forecasting and consulting firm. He directs the

business planning and strategy practice, a team of econo-

mists and business analysts that works with companies

to enhance their planning processes by implementing

state-of-the-art market sizing, product-line forecasts,

and market segmentation analysis tied to external eco-

nomic business drivers. The group provides advisory

services to a broad spectrum of industries including fi-

nancial institutions, consumer packaged goods, retail-

ers, heavy equipment manufacturers, and information

technology. Mr. Lauritano has more than 16 years’ ex-

perience at IHS Global Insight assessing global business

markets and their exposure to economic risks. Recent

studies completed for the Equipment Leasing & Finance

Foundation include 2009–2011 Transportation Outlook

Series, U.S. Equipment Finance Market Study, and Propen-

sity to Finance Equipment—Characteristics of the Finance

Decision. Prior to joining IHS Global Insight, he served as

the director of research for Hancock Realty Investors, an

investment subsidiary of John Hancock. Mr. Lauritano

received his MBA with a concentration in finance from

Boston University, Boston, Mass., and a BA in economics

and environmental studies from Colby College, Water-

ville, Maine.

2008 Article of the YearTh e Impact of Bundling on

Equipment Lease Syndications from the Purchaser’s Perspective

By Philip R. Rosenblatt, Stephen J. Patterson, and Richard S. Rosenstein

Philip R. Rosenblatt, Stephen J. Patterson, and

Richard S. Rosenstein are co-authors of the

winning 2008 Article of the Year from the

Journal of Equipment Lease Financing. Their

article, which appeared in the Fall 2008 issue, is titled,

“The Impact of Bundling on Equipment Lease Syndica-

tions From the Purchaser’s Perspective.” This article dis-

cusses the practice of bundling equipment acquisition

financing with services and supply contracts. It explains

that the incremental risks that come with purchasing a

bundled transaction must be properly understood and

appropriately allocated.

The three authors are with the Boston-based law

firm of Nutter, McClennen & Fish, LLP. Philip R. Rosen-

blatt is a partner in the business department, where he

co-chairs the firm’s commercial finance group. Stephen

Patterson is a partner, whose practice focuses on com-

mercial finance. Richard S. Rosenstein is senior of coun-

sel practicing in the business department.

The Article of the Year award is based on secret bal-

lots of members of the journal’s editorial review board,

voting on the three online issues published in the award

year. Excluded from voting are articles based on research

generated or commissioned by the Equipment Leasing

and Finance Foundation (the journal’s publisher) or the

Equipment Leasing and Finance Association.

The revised version of the article is available at

http://www.store.leasefoundation.org/product/fall08_

impact_bundling/.

.

Philip R. Rosenblatt

[email protected]

Stephen J. Patterson

[email protected]

Richard S. Rosenstein

[email protected]

Journal of Equipment Lease Financing - Spring 2009

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