The Lowdown on Leasing

June 1, 1999
Consolidation and increased competition have affected every facet of the equipment rental industry, including how both large and small rental firms finance

Consolidation and increased competition have affected every facet of the equipment rental industry, including how both large and small rental firms finance their inventories. RER recently asked several leasing executives who serve the rental industry to discuss the changes and how their companies have responded to them.

The questions were posed via e-mail, and some responses were edited because of space constraints. Participants include the following:

* Tim Cetto, branch president, First Sierra Financial/Cascade Leasing, Wenatchee, Wash., and Mike Arness, sales manager, First Sierra Financial/Cascade Leasing.

* Vincent Faino, president of Reading, Pa.-based American Equipment Leasing, a wholly owned subsidiary of EAB (European American Bank) and a unit of the global ABN AMRO network.

* James Galecki, division manager, market development for John Deere Credit's construction equipment finance division in West Des Moines, Iowa.

* Ken Pell, manager of leasing for Case Credit Corp., Racine, Wis.

RER managing editor Tom Nelson compiled the responses.

RER: What major trends have you seen recently regarding lease preferences?

Galecki: The most significant trend has been a move toward equipment use versus ownership. Historically, the dominant mentality was to own the equipment, no matter what. While most of the portfolio at John Deere Credit still consists of retail installment notes, leasing is steadily on the rise. Additionally, within our lease portfolio, the percentage of operating leases has dramatically increased over the last five years.

What does this mean for rental centers? The income for a rental center depends on the spread between what they can charge their customer for the machines on rent and what they have to pay for the equipment made available for rental. Rental centers can afford to have equipment only if they can cover the cash flow obligation. Also, because rental centers want to replace equipment before repair and downtime increase, shorter-term transactions are more desirable. But in order to get affordable payments on shorter term deals, the higher residuals of operating leases are needed.

Pell: Today, customers are looking for early buyout options, bundled services (including extended warranty), limited walk-away ability and predetermined end-of-lease options (nonfair market value). Lessees are also becoming aware of various leasing options historically reserved for larger ticket, leveraged leases (aircraft and facilities) and are asking for access to these options.

Faino: Recently, the trend is growing toward true forms of leasing with fair market value purchase options or fixed-purchase options. However, that does not lessen the importance and the effectiveness of finance leases that more closely resemble loans. In my opinion, trends toward true leasing will continue to increase as the drive toward expansion, consolidation and more intense cash flow management intensifies.

Cetto/Arness: The use of the lease financing is definitely on the rise. Deferred-payment programs, seasonal skip-payment programs and longer terms are now being preferred. Also, higher residual positions such as 20, 30 and even 40 percent are being requested. The clients are becoming more sophisticated and are utilizing this type of financing to match their cash flow, accounting and tax needs.

RER: What about smaller companies? Are they taking a different course in financing than bigger firms?

Cetto/Arness: Not really. Smaller companies rely on outside capital to grow their businesses. The larger companies are doing the same, either through stock offerings or through the use of the lease or conventional financing institutions.

Faino: I am impressed with the financial prowess of the smaller companies today. Now, more so than ever before, the "smaller" stores or yards are examining every financial option available to them.

Pell: Smaller firms have actually taken the lead on leasing because it requires less upfront capital, provides better periodic cash flow and may also limit equipment risk.

Galecki: The considerations are much the same regardless of the size of the company. The same issues of taxes, cash flow, financial ratios, transferring risk, etc., are key concerns. The same finance options are usually available to a business of any size depending upon financial condition.

In the case of smaller companies, often a big concern seems to be credit approval. Not that smaller companies are bad credit risks, but often they tend not to be as well capitalized as the large companies. Factors like liquid assets, equity, retained earnings and cash flow are important to any lender. Because most of the assets of a rental center are made up of the inventory available for rental, there are often not a lot of liquid assets on the rental center's books. Accounts receivable are generally the largest liquid item, but these accounts can be used to pay bills only when they are collected and turned into cash.

RER: Has the consolidation of the rental industry changed the way rental companies are acquiring and/or leasing equipment?

Pell: Consolidation has created larger publicly held companies that must perform to meet Wall Street's expectations. The off-balance-sheet aspect of leasing is a key driver in their choice of leasing as a financing vehicle.

Previously, leasing was not part of most manufacturer-affiliated lease companies' presentations to national account fleet plan managers. Today, we provide lease and financing alternatives as part of the annual planning process with these managers.

Galecki: Rental companies are acquiring much larger blocks of equipment than ever before. Some of the largest companies are looking to national purchasing to create the best transaction prices. They buy in huge quantities and then distribute the units after the order is made, sometimes directly through the manufacturer.

Even though some of these large rental companies are purchasing directly from the manufacturer, the relationship with the local dealer is still important. Many rental companies and equipment dealers are forming alliances. They are working together to provide each other with leads. Sometimes, the dealership determines that the customer needs a piece of equipment for just a few days. They refer that customer to the rental company. Sometimes, the rental company determines that a customer needs equipment for three or four years and that his or her real concern is, "Can I afford the payments?" The rental company refers the customer to the dealership, working together to maximize their respective market shares.

These alliances also provide for unique arrangements such as "rental splits," in which the dealer supplies a piece of equipment for a short period. Often it is a piece that the rental center hasn't had any experience with. The rental center usually has a small monthly payment, and then the two companies work out an arrangement to split the income while the machine is out on rent.

Faino: As rental operations grew in size, either through consolidation by acquisition or usual and customary means of expansion, the demand on the financial sector and the manufacturers to offer creative finance products grew. These have become more prevalent due, in part, to consolidation: one-year, no-interest programs; bullet loans; six-month payment deferrals; and the like. Although I personally do not believe that all of the different products "hitting the street" today are in our collective best interests, they are worth investigating. The other obvious occurrence in this market is the enormous downward pricing pressures that continue to be a factor. The larger corporate buyer traditionally demands lower pricing in any market, and rental is no exception.