Lenders navigate underwriting complexities for IT equipment

Lenders are being creative when financing IT equipment as challenges tied to obsolescence and uncollateralized software test underwriting prowess.  

The IT equipment sector is the strongest segment of equipment financing based on investment activity over the past three months, according to the Equipment Leasing and Finance Association’s (ELFA) Investment Momentum Monitor.  

AI-related investments drove a record $14.3 billion in equipment finance originations in July as businesses invested in computers, servers, robots and machine technologies, according to ELFA’s CapEx Finance Index.  

Despite emerging opportunities, the IT equipment sector presents challenges including rising prices, a shaky secondary market and rapid obsolescence due to AI advancements, Simon Harrsen, executive vice president for North America at global equipment lessor CHG-Meridian, told Equipment Finance News.  

How critical is it? 

To mitigate risks, lenders must evaluate how essential an asset is to a business’ operations, David Normandin, president and chief executive of Wintrust Specialty Finance, told EFN.  

For example, “in our business, a front-end loan origination system and a back-end lease accounting system are necessary to be in business,” he said. 

“We’re not asset-driven lenders when it comes to technology because, frankly, we know the residuals, in some cases, are not going to be what you need them to be, or the secondary market value is not your escape to get out of a yield that defaults.” 

Understanding the use case is especially important when only financing the software for an asset, Crest Capital President Mark French told EFN. 

“Software has no liquidation value, so on a software-only deal, you’re really underwriting both the borrower and the seller who might have to support the software and the use case rather than the asset,” he said.  

“Two questions drive it: How critical is the application to actually running the business, and how long can it stay useful before something makes it obsolete? AI keeps shortening that second answer, so terms have to shorten with it.” 

CHG-Meridian’s Harrsen agreed, saying “the higher the software percentage of the overall transaction value, the less aggressive we can be on the residual value.”

However, in some cases, if a software program is essential for a certain type of asset to function, lenders can reinstall the software for a new deal with a different borrower, Harrsen said. 

“Reading and understanding the underlying software that comes with the technology is very important, especially when we talk about autonomous equipment and such,” he said.  

Ongoing support 

With IT equipment, lenders must prepare to finance the entire life of the asset, including software subscription renewals and maintenance support, Wintrust’s Normandin said. 

“It’s the gift that keeps on giving,” he said. “It’s like, how many software renewals can you do right endlessly? Because they’re going to renew. And granted, they’re doing some changes here and there along the way. … If you can’t get used to mid-term changes, technology is not your thing to finance.” 

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