THE EVOLUTION OF AN INDEPENDENT
BY DALE KLUGA
There has been a flurry of M&A activity recently as large banks and captives have snapped up successful independents. Dale Kluga, President, Providence Equipment Finance, (formerly of Cobra Capital) looks at his own journey from independent to bank-owned and asks other executives from independents and former independents about their own evolutionary experience.
As I glanced through the recent Monitor 100, I noticed that one third were independents with more than $11 billion in collective volume, or 6% of the entire group, (up from 4.8% in 2018). That $11 billion market share is significant whether you’re a bank or an international global company looking to expand its U.S. presence through acquisitions. The additional upside benefits from this volume segment are the impressive, above market capital returns from the companies’ entrepreneurial focus on earnings and a “skin in the game” philosophy toward risk management.
In the following pages of this article, several executives from former independents discuss their evolutionary experience.
While Cobra Capital was a small independent, we shared the same approach to profitability and risk management as Monitor 100 companies. We started Cobra with $250,000 in cash and a $10 million warehouse line from Cole Taylor Bank (MB NKA Fifth Third). After paying off all of our direct and indirect non-recourse debt, we returned $7 million in cash by the end of our 12th year when my partner retired, an enviable pre-tax, average annual ROE of 225%. That return also included $100,000 of nominal cumulative losses on $100 million of volume over that same time period. Not big volume numbers, but very sound return and portfolio performance metrics for a small firm.
After surviving the small ticket leasing crisis in 1999 and multiple recessions, not to mention prevailing in earth scorched IP litigation with a global bank, and upon the retirement of my partner, I decided it was time to look for a capital partner who could help scale up Cobra’s approach to financing the equipment needs of emerging small businesses. I initially explored partnering with a private equity firm or family office investment, but the former would require blowing up my firm in order to leverage the financial investment, and the latter lacked experience in equipment finance.
In the end, my prior Continental and LaSalle Banking background combined with my 38 years of small business finance experience was a much better fit for a bank partner, so long as that partner had a consistent credit culture and would allow me to continue running the successful Cobra model. Enter Providence Bank & Trust, a $1 billion, Chicago-based organization. It was a perfect fit. Providence bankers fully understood my small business niche and credit culture. It was backed by one of the most impressive entrepreneurial board of directors for a community bank of any size.
I found it more conducive to run a leasing operation within a community bank organization than starting one within a major regional bank, unlike my previous experience with LaSalle. LaSalle was much larger and operationally more complex. As a result, starting the leasing business was more political because of its size, not to mention its foreign ownership. Traditional commercial lenders at LaSalle mistakenly thought I was going to displace their commercial equipment loan volume, even as our financial analysts were able to prove the viability of an equipment leasing model.
While the entrepreneurial transition process from Cobra to Providence Equipment Finance took some time, once any buyer understands both your business model and how you culturally fit within their organization, success is a no brainer.
Radius Equipment Finance
Radius Equipment Finance (REF) was sold to Radius Bank in December 2016 by NewStar Financial, an independent finance company owned by First Eagle Investment Management. The sale process accentuated the benefits and challenges that an array of ownership options entails for an equipment finance company operating in the middle-market. The REF team had to analyze and consider how deal origination, credit underwriting, portfolio monitoring, regulatory compliance, documentation, back office functions and other vital tasks would change under each unique ownership structure. The group of companies that conducted due diligence on the equipment finance division was large and heterogeneous and included other independent finance companies, large global banks based both domestically and internationally, regional banks with a national footprint and small community banks.
Radius Bank was chosen for a variety reasons, but many of those had to do with the belief that leveraging the credit diligence and origination strategies developed under independent ownership with the cost of funds, back office support and other strengths of an online community bank would allow all parties involved to maximize their strengths and profitability. Radius Bank also had the unique characteristic of being entrepreneurial in nature, with a strategy of adding proven asset generating platforms but letting groups operate as independently as possible, further reducing any friction that might have existed during the transition from independent finance company to bank ownership.
The benefits of bank ownership had to be weighed against the perceived challenges, including new regulatory standards that would have to be consistently met and tested to maintain the advantage of a lower cost of capital. Fortunately, the processes and business model established under independent ownership was in near-uniform compliance with the current regulatory bank standards. Only minor adjustments needed for full compliance. Only minimal disruption in normal business occurred, and REF was able to capitalize on a portion of the market that had previously been unavailable.
Now approaching the 3rd anniversary of the change in ownership, the transition has occurred gradually and exceptionally well. The differences in ownership are noticeable and meaningful, but the high standards established as an independent equipment finance company and the time taken to gather information on what the business would look like under different ownership allowed for realistic expectations which helped facilitate the successful transition.
ENGS Commercial Finance
Pre-financial crisis, the commercial finance market enjoyed the benefit of having multiple finance options available to vendors and customers. Banks, independents, captives and brokers were eager to compete for business. That competition was turned upside down overnight during the financial crisis, leaving the commercial lending landscape with limited financing options and dramatically affecting corporate expansion..
We saw this void and knew the market needed greater access to capital, especially from independent commercial finance companies. So, in 2012, we acquired ENGS, a 60-year-old family owned regional commercial finance company.
We had a straightforward investment thesis for the acquisition:
• Institutionalize business with policies and procedures found within Fortune 100 organizations
• Offer a compelling financing solution to vendors and customers on a national basis
• Apply a digital strategy to provide differentiated solutions for vendors and customers, as well as to streamline business processes
• Diversify the product offerings and equipment verticals to service a wide range of vendors and customers to create a well-balanced portfolio.
Our investment paid off. ENGS has grown from $100 million in assets in 2012 to the fourth largest independent finance company in the U.S. with more than $1 billion in assets today. ENGS has provided hundreds of critical vendor relationships and tens of thousands of customers with access to capital to expand their businesses.
Despite the economic rebound and independents’ volume growth, the number of independent financing solutions in the U.S. market continues to be somewhat limited. The large money center banks have become larger. The local regional and community banks have become more active, but much this activity has come by acquiring one of the remaining independent finance companies – leaving fewer independents. Combine that with the dissolution of GE Capital and the migration of the old powerhouse independents into banks such as CIT, the number of independent finance companies may actually be shrinking.
That vacuum offered ENGS an opportunity to fill the gap, a goal made easier by ENGS’ recent acquisition by Mitsubishi UFJ Lease & Finance (MUL).
Through this acquisition, ENGS has reached a new phase of growth with expanded capabilities and obtained permanent, attractive long-term financing. The focus has expanded to vendors and customers around the globe.
ENGS is a more robust organization following its acquisition by MUL. Our strategy and approach have advanced significantly, and our capabilities and opportunities have expanded. The size and scope of transactions that we can pursue are not based upon ENGS’s balance sheet alone, but include MUL’s $65 billion global size and investment grade rating.
Financial Pacific Leasing
Financial Pacific Leasing has been in business for 44 years, 38 as an independent and the last six years as a subsidiary of Umpqua Bank. Its first 23 years were under the direction of the three founding owners of the company. This was followed by 15 years under three different private equity ownership groups. Through experience, the management team knew a private equity ownership structure was typically short term in nature and a more long-term strategy such as bank ownership would be needed.
Umpqua Bank was a West Coast community bank whose growth was driven primarily through acquisitions of smaller banks. One of the gaps they had was an equipment leasing group. As an independent, FinPac had relationships with multiple banks, including Umpqua. As the bank was looking to expand into equipment leasing and we were looking for a longer term sponsor, the match between FinPac and Umpqua came together rather quickly in 2013.
At the start of the Umpqua acquisition, we established a five-year plan to grow the company. We modeled a multi-channel approach to originations that would take FinPac from $250 million in assets to more than $1 billion in five years. FinPac’s sole origination channel relied on partnering with third-party originators across the country to originate small ticket equipment financing leases and loans. Umpqua Bank embraced this channel, and we’ve been able to triple the originations from this third-party channel.
We added two channels to complement the traditional FinPac business. The first addition provided a lower-middle market leasing product to Umpqua’s customers and prospects. The second built out a de novo vendor channel for more traditional bank leasing. Together, these channels have allowed us to exceed our original five-year plan. We are now over $1.5 billion in assets.
Transforming from a long-term independent to bank ownership has been a win-win for FinPac and Umpqua. The bank has been supportive of FinPac and has found the right balance between incorporating us into the bank while allowing us to scale the company to levels unattainable as an independent. FinPac has consistently provided the bank with positive financial results that have affected the bank’s overall results. For the management team and staff at FinPac, we’ve been able to use the experience we’ve gained as an independent and incorporate our team into the bank environment successfully, which has allowed for personal growth and opportunities for many of us. This has been a true, successful “evolution of an independent” story for Financial Pacific Leasing. •