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Equipment leasing: an industry in transition.

The equipment leasing industry in the U.S. and abroad experienced phenomenal growth in the past decade and will continue to grow at an even faster pace. According to the U.S. Department of Commerce, the volume of leasing transactions in this country rose from about $85 billion in 1986 to almost $130 billion last year. According to the Equipment Leasing Association, 80 percent of corporate America uses leasing to acquire some or all of its capital equipment (including 50 percent of all mainframe computer systems).

Leasing Has Advantages

Leasing has several significant advantages over buying equipment outright. The risks of ownership are transferred to the lessor; it is cost-effective because it diminishes the risk of being stuck with obsolete equipment (a lessee can always upgrade or add new equipment); it can be 100 percent financed; and the term of a lease can be matched with the useful life of the equipment. Further, leasing carries tax advantages, and perhaps most importantly, enables a business to conserve operating capital. Cash isn't tied up in equity and lines of credit are kept free for essential uses.

Leasing is an industry that demands rapid and accurate credit analysis. This is important because the industry is highly competitive, and a credit decision put off today may mean a deal lost forever. Knowledge of present and residual (i.e. asset.value at the end of a lease) equipment values is essential. Therefore, in addition to financial expertise, a lessor must be thoroughly knowledgeable about the equipment itself.

Although almost any type of equipment can be leased, certain types are leased almost invariably because of their extremely high cost and the retention of significant value long after the initial lease. Commercial aircraft, magnetic resonance imagers (MRI), heavy construction equipment, railcars, shipping containers, mainframe computers, electric power generating equipment, trucks and trailers, and a lot of office equipment fall into this category.

Leasing Basics

There are four basic types of leasing companies. Banks and the leasing subsidiaries of bank holding companies are among the leading lessors. Also, there are so-called "captive" leasing companies (subsidiaries of major manufacturing firms such as General Electric, Ford, or General Motors).

Independent leasing companies are another component of the leasing industry. Many of these are small and specialized, in niche-markets requiring considerable technical knowledge; others are large, diversified firms. Also, there are investment banks and independent broker/packagers who initiate deals and bring the parties involved in a major lease together.

Most credit industry professionals are familiar with the basics of leasing, but may not be aware that it is an industry in transition, bordering on turmoil. Why? Because the very concept of long-term, predictable asset values has been placed in doubt by factors that no one anticipated a decade ago.

Keep Informed

Consider mainframe computers. Who would have thought only six years ago that networking inexpensive personal computers would have such a damaging effect on the mainframe industry? Mainframes--once the backbone of every computer manufacturer's product line (and, of most lessors blue chip portfolios)--have suffered tremendous erosion in value becoming mere commodity items (as has most computer hardware, no matter how advanced). The reason? Today's information industry is software driven, a development that hardware companies didn't anticipate.

Many equipment lessors deluded themselves by thinking they were funding stable, predictable assets on a long-term basis (three or four years). Actually, those assets were rapidly depreciating because of the advance of new, less expensive interactive technology and the market's acceptance of the new products spawned as a result.

Today, sophisticated lessors know they must keep abreast of each industry's dynamics by being diligent through all phases of equipment management and marketing. They do this by keeping in touch with customers, assessing needs, and securing lease renewals, extensions, and upgrades. In this way, they protect their investments in rapidly depreciating equipment.

Lessors of high technology equipment will have to concern themselves more intensely with technological changes and user trends affecting the future values of all leased equipment. Who can say, for example, what the ultimate effect of a particular advance in software will be on large-scale corporate computer users? Or, what "managed care" will mean for manufacturers and lessors of $2 million MRI machines and other expensive healthcare devices.

In the relatively spartan 1990s, equipment leasing continues to flourish because rapid technological change is making corporations more reluctant to purchase relevant equipment and assume the balance sheet risks of depreciation. However, the lessors providing equipment to corporations will have to drastically change their way of doing business if they want to survive in an increasingly competitive environment.

Future success in equipment leasing will rest with those firms that can "package" their lease portfolios quickly, moving them off their balance sheets, either through securitizations, private placements, or other financial instruments. Tomorrow's lessors will operate like huge, international trading companies, driven by distribution. The asset in which they invest will be determined by what the distribution channels (the "end-users") dictate. Upgrade Your Market Knowledge

When I assumed the post of CEO last year at EQ Leasing Corporation, I determined that the holding period for equipment leasing investments should be no more than 180 days and trading investments no more than three to four weeks. My management team and I knew that this period (considered drastically short-term by many traditional lessors) would provide adequate protection for our inventory lenders and would motivate us to turn over our portfolios efficiently in order to preserve our limited capital and enhance liquidity.

Like other successful independent lessors, we must constantly upgrade our technical and marketing knowledge of a variety of assets. If end-users want refrigerated containers, we access refrigerated containers. If they want jet engines, then we (and our savvy competitors) will obtain them. We evaluate their maintenance status, supply and demand status, and ultimately, discover how to price them for rapidly changing markets.

But none of these investments will be, as in the past, long-term portfolio investments. Except for giants like GE Capital, which has tremendous liquidity, lessors can no longer afford to invest long-term. They must operate as expert but non-specialized traders. To maintain their liquidity, they will generate high quality securitization paper that someday may rival that of Ginnie Mae or Fannie Mae as investment vehicles for institutions and the public. New Advantages for Business

What will these revolutionary changes in equipment leasing mean to corporate America? Veterans of the leasing industry see that there will be no downside for business.

First, lessors will be able to offer more advanced used equipment quicker because their capital won't be tied up. The entire equipment cycle will have been accelerated to reflect a shorter-term relationship between introduction and obsolescence. Lessors also will be more attentive to customer needs and user trends. The leasing business no longer will depend exclusively on capital resources, but on intangible qualities like market intelligence, nimbleness, credit flexibility, and marketing resourcefulness. Thus, independent lessors, like my company, will have the opportunity to become more competitive with giant leasing companies and banks.

This transformation of the leasing industry will enable lessors to become more opportunistic about a variety of niche markets, many of which may not even be on the horizon now. Lessors may also find bank financing more readily available in the new environment because the banks, having themselves been burned by their own long-term lease portfolios, will realize the potential of the trading company concept.

This transformation also has considerable potential for the credit industry. Equipment leasing, both domestic and international, is on the upswing. New generations of computers, aircraft, construction equipment, and other "big ticket" items will require more efficient credit analysis procedures to maintain the momentum. The opportunities are tremendous. Are we up to the challenges? Richard Parkes is president of EQ Leasing Corporation, Westport, Conn.
COPYRIGHT 1994 National Association of Credit Management
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Title Annotation:Credit Technique
Author:Parkes, Richard
Publication:Business Credit
Date:Feb 1, 1994
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