Original Equipment Manufacturers (OEMs) are extending their value chain by exploring ways to provide asset financing directly to their customers. With banks under relentless pressure to overhaul their lending practices and unable to keep up with customer demand, some OEMs have determined that it is more advantageous to conduct financing in-house rather than being dependent on financial institutions to support their lending programs.

This gives the OEM more control over the processes and a level of risk they are willing to tolerate. However, creating a captive financing center from scratch in an unfamiliar market can be a daunting task. For an OEM with funding in place to finance its products, there is another option that leverages the benefits of a captive center as part of a turnkey solution delivered by an experienced third party service provider.

Complexity and Competition in the Market

Setting up a non-core business in today’s dynamic, increasingly regulated lending market is a complex undertaking riddled with risks and challenges. However, as economies develop around the globe, manufacturers also find themselves going into new markets to build and maintain customer relationships -– be they in Europe, China, Latin America, Asia, or Australia –- and establishing lender relationships in new markets to finance their equipment can be time consuming. This is why many OEMs, particularly small and medium-sized firms, are motivated to set up their own captive business regardless of their level of lending expertise. But in order to successfully provide direct customer financing, an OEM must be able to secure a funding source, select and implement a technology platform, establish a credit methodology, and hire a capable operating team. In addition, it takes substantial experience in the lending industry to be able to successfully establish and manage a successful program and minimize non-performing assets and delinquencies.

In setting up a lending function, OEMs must also address the following challenges:

• In the short term, there is a challenge to keep up with client demands. ELFA estimates that a record $1.5 trillion in equipment is expected to be sold in 2014, of which 57% will be financed.
• Accounting rules and tax reform significantly impact the industry, and fear of complex regulatory changes may alter future business requirements.
• In order to meet hiring, infrastructure, and regulatory requirements, potential lenders will face huge capital outlays for people, software, hardware retrofits and core platform upgrades. The decision on capital outlays is compounded further by the loan volume volatility seen over the past decade and which is expected to continue into the foreseeable future. This leads to a major cost control challenge –- the ability to effectively balance resources across the spectrum of people, processes, and technology to optimize the overall operating model.
• OEMs entering the lending business must comply with a multiple regulations, many of them incomplete, vague and conflicting; these include the Dodd-Frank Act, the Equal Credit Opportunity Act, the Bank Secrecy Act and the Fair Credit Reporting Act. Non-compliance can result in severe penalties and, despite the uncertainty surrounding many of the regulations, any OEM program investments must be acceptable to auditors’ many years down the road.

In addition, from a customer’s standpoint, the relationship between the product purchase and lending experience must also be seamless. EFMA recently reported that 51 percent of customers are at risk due to a poor customer experience as a result of data issues such as: fragmented or incomplete data, data integrity (due to manual processes), lack of normalized data models, and the inability to leverage data across geographic or functional silos while still addressing data privacy concerns. The result? Erroneous notices, delayed disclosure notifications, and incorrect loan decisions. Each of these errors leaves a negative impression on the customer which can impact not only the asset financing function, but the OEMs’ core businesses as well.

Compounding the cost, regulatory, and customer experience issues, is the general uncertainty posed by an increasingly volatile business environment that requires wise investments that will generate returns over time. To remain profitable and achieve growth, OEMs seeking to establish a captive finance business must have the ability to develop an effective technology platform, a reliable credit methodology, and an operating team with the skill sets to deliver high quality back-office financing work. For those OEMs who have scale and expertise this will not be an issue, while for others it may be too daunting and risky and cause them to abandon direct financing altogether. But there is another option that forward thinking OEMs are now exploring -- building captive finance operations with the assistance and partnership of experienced third-party providers.

A More Contemporary Solution: Leveraged Partnerships

For OEMs that have made the decision to enter the asset financing business, a partnership can often provide a more efficient, effective, and scalable back-office operation. An outsourcing partner can leverage direct experience in this business and work across multiple clients to bring best practices and tested solutions to business challenges, leading to a quicker resolution at a lower cost. In addition, this allows firms to hedge profits through variable staffing models through scalable global workforces.

OEMs are therefore turning to companies that can provide a full turnkey captive system, putting them in a stronger position to drive profitability, address change, and remain flexible in a volatile market.

Companies that can provide value from the beginning of the captive set-up, writing the policies and procedures needed to run the business and then staffing it with a large and experienced team of risk managers will prove to be valuable partners. These partners must also have an understanding of the criteria for both originations and portfolio management to create risk scorecards to secure a high-quality portfolio. Moreover, a partner should have in place a proven technology platform, allowing OEMs to avoid the risk and cost that comes with developing something from scratch.

In total, the benefits to OEMs that result from choosing the right partner can be substantial:

• In-house expertise in credit policy, risk assessment, operations and technology without the need to invest in a captive from the ground up or to hire the people to run it.
• Lower operating costs by implementing a technology platform which can transact hundreds of thousands of deals a year, and through recruiting the right staff.
• Reduced start-up and time investments –- savings that can be transferred to the customer and drive business. The right partner can launch a lending business in three to four months and at almost half the cost of starting from scratch.
• Solutions that are customized to the requirements, priorities, size and customer sectors of the individual OEM finance business.
• By controlling financing, rather than lose control of the asset, OEM’s can control the profitable secondary market and maintain sole ownership of the customer.

It is important to note that financial services remain one of the most data-rich industries in the market, but individual firms continue to be the least effective in using this data. A partner with deep domain expertise in data analytics and industrialized lending operations can provide the operating model and support required to harness data to make better decisions for the business and the customer.

When it comes to customer financing, some OEMs may be well positioned to tackle the challenges outlined above, while others will need help along the way. The choice of starting a captive from scratch or partnering will depend on the OEM; its priorities, size, client sectors, and product segments. Starting a lending captive once required considerable time and resources, but now the entrance of third party providers enables OEMs to mitigate much of the risk associated with today’s volatile equipment finance sector. For OEMs with the funding in place to finance its products, the option to partner in the creation of a turnkey solution for its captive finance business can bring the benefits of direct customer lending in a quicker and more cost effective manner with less risk.