Paul Golden looks at the evolution of alternative finance and private equity-backed leasing providers in the UK, and considers how this trend has impacted acquirers, the firms they have acquired, and the wider market.
A growing understanding of the quality of the asset finance sector and demand for alternatives to bank debt funding from the SME sector have led to growth in the market and a sustained, perceived superior yield and broadly low-risk character.
That is the view of IAA Advisory chief executive officer Lindsay Town, who says the other issue is distribution. “This is why we see the acquisition of brokers with a book – the ability to get money out the door, but with a platform to hold and build a portfolio, something most of the new market entrants do not have.”
The low-interest-rate environment has prompted those with capital to invest and look for a steady return to invest in what has in the past been seen as a rather boring sub-set of the finance sector as a means of achieving mid-to-high-single-digit returns for asset-backed income streams adds Roy Royer, head of business development at Somerset Capital Finance.
The level of investment in the UK lease sector via new market entrants and acquisitions in recent years can be at least partly attributed to greater awareness of leasing as an alternative to bank funding, suggests Simply Finance chief executive officer Mike Randall.
The private equity houses see opportunity in this industry with its heavy reliance on brokers, he explains. “Acquisitions will lead to less choice for customers and as each firm works differently, integration will have to address cultural differences. Product alignment is also a challenge when acquiring multiple brokers.”
Tarun Mistry, director of T Mistry & Associates and former partner with the financial services corporate finance and automotive advisory team at Grant Thornton, notes that some private equity houses are getting to the end of their investment horizon and are therefore looking to exit.
At the same time, fund managers have looked at – and invested in – peer-to-peer-type platforms and are now looking at equipment leasing and other forms of lending platform.
“What we may see is some of the larger private equity companies continuing to show an interest in this space and looking to consolidate in the next stage, with smaller houses being bought out by larger competitors with more capital to deploy and better access to cheaper funding,” Mistry explains.
Higher margins following the credit crunch have proved very attractive to non-traditional investors such as challenger banks, pension funds and hedge funds, which have seen the leasing sector as offering exceptional margins with a broad spread of risk. However, Shire Leasing managing director Mark Picken warns that it remains to be seen how long these new entrants will survive as returns inevitably fall and risk costs turn upwards.
Fragmentation in the small-ticket asset finance space has presented consolidation opportunities and private equity firms see the benefit of taking on that consolidation challenge, gaining economies of scale and selling on the bigger, leaner business to an acquirer.
Leasing distribution should benefit from these acquisitions, assuming private equity continues to fund the growth and development of the businesses they have acquired, Picken believes. “However, many of the brokers that have been acquired were owner-managed businesses where the owner has become used to being out of the corporate environment; potentially being ‘reined in’ by their new environment will be a challenge to some. Having their business manipulated and integrated into a bigger structure where they no longer hold full control will challenge the speed of the strategic intent.”
Town describes the effect of acquisitions on leasing finance distribution and origination for the banks as relatively modest, at least in the short term. “However, those banks that have historically depended on the intermediary world may face new volume and return challenges as more broker volume is absorbed by new owners and competition intensifies for the remaining pool of acceptable transactions.”
He anticipates new origination models being developed to counter the threat of reduced volume. “Competition for volume – exacerbated by the entrance of fresh capital – will, and to a point already has, translated into compressed yields. It may also be translating into increased risk acceptance, but the proof of that will take time.
“A material slowdown in capital expenditure in the economy or an increase in insolvency levels will highlight some of the possible trends quite rapidly.”
Bluestone Leasing managing director Vineesh Madaan reckons that acquisitions will not only reduce the level of business coming the way of the banks, but will also change the credit mix. “The individuals who created these businesses may find it challenging having someone to report to, as well as having to provide more information and hit certain milestones to achieve any future payouts. All of this will end up changing the business, applying pressures that were not there before, so in reality it will probably not be the same business as it was previously.”
Private equity firms have the advantage of being able to use highly leveraged buyouts, where the cost of debt has potentially provided a significant advantage compared to institutional investors, observes Roger Skinner, chief executive officer at Maxxia Group.
“This situation has changed significantly with the 2015 and 2016 Finance Acts, with substantial changes to the taxation of private equity returns,” he adds. “Nevertheless, there are offshore structures that mean they remain very effective and attractive.”
Just as the impact on banks will vary significantly depending on the corporate strategy, capital allocation, customer-management strategy and distribution model employed, so the impact of being acquired by a private equity firm will differ. “In the end, the business will – in all probability – be sold again, perhaps to an institution or another private equity house,” adds Skinner.
“This may not be an issue for the original shareholder, who may be able to exit on attractive terms, but this might not be the situation for other stakeholders who may find that they are not culturally and strategically aligned to the new owners.”
These acquisitions could disrupt the banks’ model of using brokers as their route to market rather than employing their own direct sales staff, but few of the acquired brokers completely close themselves off from funders and, on experience to date, continue to place business, according to Scott Maybury, chief executive at PCF Bank.
With this and increasing use of the internet to source business, distribution channels in the asset finance sectors are changing significantly, he notes.
“These acquirers are focused on scale in a defined time frame, so aggressive growth strategies and good technology infrastructure are key.”
In discussing the rise of non-bank lenders, it is also important to mention captives, suggests Invigors partner Richard Ryan. “This is another area where we have seen significant growth, particularly in the technology and office sector with Dell Financial Services moving from a vendor programme relationship with CIT to an in-house captive, while Cisco has become more captive-based, and Microsoft – in the US initially – is looking to do more business ‘on-book’.”
In the office equipment space, Invigors has been involved in helping Ricoh to set up its in-house captive in Europe, and is aware of another office equipment vendor looking to do the same.
“We are also working with two other second-tier technology vendors to establish the business case and practicality of setting up captive finance operations,” adds Ryan. “These have been set up in response to limitations from their vendor partners, primarily banks, which have decreased their appetite for asset finance.”
Royer believes direct lending funds have the capacity to present a serious challenge to traditional lessors. “They can be very light on their feet and chip away at niche areas which in isolation looks harmless, but the cumulative effect can be significant.”
Maybury suggests that the acquisition of Aldermore by First Rand Bank could have wider significance, observing that since the global financial crisis, the PRA has actively sought to increase the number of banks in the UK, giving rise to the emergence of numerous ‘challenger’ and ‘specialist’ banks.
“These new banks enjoyed significant growth in their early years, but it is becoming increasingly hard for many of them to sustain that level of growth,” he says.
“It could well be, therefore, that the wheel is coming full circle and those banks will have to look at an acquisition strategy to maintain their growth, shareholder returns and franchise value, leading to the type of consolidation in the banking sector we have seen in the past. The acquisition in question may be driven by some geopolitical influences as well.”
Randall agrees that direct lending funds present a serious challenge to traditional lessors, but is unconvinced that the Aldermore-FirstRand deal signals the start of the acquisition of smaller niche lenders in the UK market.
“First Rand has a presence in the UK motor market, so acquiring Aldermore would appear to be simply a logical decision,” he says.
Town also refers to the possibility of some acceleration of ownership changes as new rules take effect. The impact of IFRS 16 has been widely discussed, but could, at least to a degree, shift the risk profile for some areas and make current owners question the economics and strategic rationale of having an asset finance activity, he concludes.
“Additionally, IFRS 9 arrives with its impact on provisioning, which could lead to some banks having to bite the bullet on disposals and realignment of direction.”