Defaults are when borrowers, at some point in the loan’s life, cease making their payments. For this post, the reasons why are immaterial – at the end of the day, all that matters is the lender is out not only a (sometimes large) portion of the money they lent, but they are also out of the expected revenue from the interest. Since most businesses use some form of projected/expected income to operate, this is doubly bad for a lender. And no, “writing it off” does not make a lender whole by any stretch.

But it isn’t just the money/revenue lost. Most of the time, there was some form of collateral involved with the loan, which now must be repossessed. This costs money, as someone has to be paid to collect it. One other issue here: Since the borrower is generally in some kind of financial straits, this is typically not a pleasant experience. 

In addition, in most cases, the collateral does not make the lender whole. They still need to sell the item, and they almost never recoup even close to what is owed.

There’s another aspect to defaults that often goes unnoticed by those outside the lending industry: how defaults make a lender look to regulators. Too many defaults will often bring increased regulation on the lender, and increase their capital requirements. Nevermind that perhaps the defaults were an anomaly and not really the lender’s fault. That won’t matter to the regulators; to them, the lender is writing too many risky loans and will be treated as such.

Lenders use an immense amount of data to qualify borrowers, and, much like the insurance industry, attempt to predict default rates based on various lending criteria and borrower/loan profiles. Now, of course, lenders can’t predict which specific borrowers may default, but they do have to honor what the data tells them about the aggregate. These predicted default rates are factored into the lender’s overhead and become part of the rate equation.

Despite the lender’s best efforts and the borrower’s best intentions, defaults in the lending industry are inevitable and must be accounted for.

One thing that’s helpful in understanding this is to look at money lending as an investment for the lender. If it’s a private lender (like Crest Capital), the lender is lending its own funds. And the rate they charge for the risk they take must significantly surpass whatever they could earn safely. 

To see this in action, look at treasury notes. Right now, a 5-year treasury note is paying mid-4’s to close to 5%. So a lender can put their money there with no risk at all. Why on earth would they ever lend it to anyone for even close to that? The answer is, they wouldn’t. Nor would you. Makes sense, right?

Now look at lenders like banks. Banks (generally) do not use their own capital for lending – they use depositors’ capital, which they pay interest on. So whatever they charge has to make sense financially here, too.  And while individual loans and circumstances could be different, in general terms, any lending needs to be well above what they are paying in interest – it’s the only way a lender can survive.

Next we’ll talk about overhead. Like any business, lenders have overhead, from property taxes to the electric bill and more. But what isn’t known is the sheer amount of legwork required for some loans.  Some of the more exotic loans take a lot of paperwork and back and forth. And any smart lender will do at least a little UCC homework on a used equipment financing deal. This costs time, which equates to salary/money.  

Capital requirements are another “cost of money” issue. Lenders are required to keep a certain percentage of capital on the sidelines (earning next to nothing), and different loans can have higher capital requirements, especially if they are of the riskier type. 

We’ll be going over defaults in detail in another post, but defaults DO factor into the overall cost of funds as well.  

No way around it – money costs money, and it’s going to be reflected in the rate a lender charges.

Businesses are going to borrow even more in the next few months. And equipment sellers need to be ready for it. Here’s why:

Awhile back, I discussed how businesses are still borrowing during the pandemic. The reason was in times of uncertainty, companies would rather keep their own cash in the bank, and borrow for needed equipment. 

That thought is going to get magnified this fall. For two reasons:

1. Interest Rates are as low as they’ve ever been. In fact, they almost have nowhere to go but up. So locking in a fixed rate now is definitely seen as a smart business move.  

2. The whole “uncertainty” thing with the Pandemic for fall and winter. We’re optimistic about the future, but the short term is still cloudy. That makes businesses somewhat anxious.

This has led to businesses looking at what equipment they will need in the near future, and deciding to get it now, before the winter comes. Makes sense, right?

Credit Has Never Been More Important – Are Equipment Sellers Ready? 

This is very clear to me: equipment sellers that OFFER a great financing option are going to beat those who don’t. It’s as simple as that. 

In fact, it’s my thought that companies who still won’t offer a credit option here in 2020 will go the way of those few stubborn restaurants that refused to take credit cards. How many of those are left?   

So here’s my advice to companies:

OFFER FINANCING. Whether it’s partnering with a company like Crest Capital or some other way, make sure your customer can apply for financing right at your website.

Second, if you are already offering financing (good for you!), tweak it. Get it on the homepage. If it’s already there, make it more prominent. Get it with your products. If you can, show a “as low as” monthly payment number with a button to apply (hint: that’s sales rocket fuel.) 

In other words, make it as easy as possible for prospective buyers to get financing, and don’t give them any reason to leave your website. 

The Autumn 2020 financing rush is coming. Be ready. 

I know a sizable portion of readers here rely on Fletch to bring them the latest Section 179 news. After all, I’m sometimes called the “Section 179 Geek” by friends and colleagues, and yes, I’m guilty of that. I simply think it’s an awesome business tax deduction that should be utilized each and every year by each and every business in existence. Is that too much to ask?

Anyway, as I’ve mentioned a few times here, Section 179 got a nice boost with the Tax Cut and Jobs Act signed on December 22, 2017. It raised the Section 179 limit to $1,000,000 (which is double the previous limit), and also raised the “total equipment purchased” limit to $2.5 million.

Those were the changes that got the most press. But there were other changes too. For example, the bonus depreciation (which is typically taken after the Section 179 deduction) got boosted to 100%. And it includes used equipment for the first time.

In addition, some improvements to non-residential property can now be deducted (thinking of a new roof or an alarm system? Great – you can now deduct them, amongst other improvements.) Plus, some vehicle expense limits rose, as well as other small changes.

The point of this post wasn’t to outline the changes here, but to direct you to an official IRS Fact Sheet that highlights the recent changes to Section 179.  You can simply click the below link, or copy and paste it into your browser:

https://www.irs.gov/newsroom/new-rules-and-limitations-for-depreciation-and-expensing-under-the-tax-cuts-and-jobs-act

Besides letting you know these changes myself several times, I feel it’s handy to hear them straight from the horse’s mouth. Because while the phrase “Fletch said” carries a lot of weight in my own professional and personal life (ok, it doesn’t, but I can dream), some companies want to see the changes in an official IRS sponsored capacity.

So definitely check out the official Section 179 changes fact sheet, and make sure you use the tax deduction to the fullest this year. Because Fletch said.