Equipment leasing - 1991 U.S. Industrial Outlook

Equipment Leasing

Equipment leasing will increase an estimated 8.1 percent in 1991 to approximately $143.7 billion. Varying growth among equipment types will push the overall industry upward. The industry will be more service-oriented and the emphasis will be on new product development. Consolidation, foreign investment, globalization, and competition will shape the industry in 1991.

Equipment leasing grew in 1990, reflecting an increase in capital equipment expenditures for the year. Leasing volume, measured by original cost of the equipment, is estimated at $132.9 billion, compared with $122.5 billion in 1989. Since 1985, leasing has grown almost twice as fast as overall business investment in equipment.

According to an industry survey, growth in 1989 was led by strong demand for the leasing of medical, office, construction, and industrial equipment. Other significant markets were for railroad equipment and electrical power generation equipment. Although the percentage of new leasing of computers and aircraft declined relative to other types of equipment, the two sectors continued to make up the largest market for leasing companies.

Before reading this chapter, please see "How to Get the Most Out of This Book" on page one. It will clarify questions you may have concerning data collection procedures, factors affecting trade data, forecasting methodology, the use of constant dollars, the difference between industry and product data, source and references, and the Standard Industrial Classification system (SIC). For other topics related to this chapter, see chapters 5 (Construction), 20 (Computer Equipment and Software), 22 (Aerospace), 21 (Electrical Equipment), 46 (Medical and Dental Instruments and Supplies).

The Leasing Industry

The equipment leasing industry consists of professional leasing companies that lease or arrange the lease of personal property, usually on a long-term basis, and supply all or a portion of the financing. To a great extent, lessors, as owners, tend to base a lease on the productive capabilities and value of the equipment rather than on the general creditworthiness of the lessee.

The leasing industry as discussed here does not include firms engaged exclusively in real estate leasing or short-term equipment rentals. Because leasing companies are classified in many different industries, aggregate data on leasing are limited. The U.S. Department of Commerce recently began to include questions on leasing activity in economic censuses and investment surveys. Accordingly, more precise data on the extent of leasing and its effect on capital investment should be available in the future.

The vast majority of lessees are business concerns, accounting for an estimated 94 percent of all lease transactions. Public utilities and municipal governments each account for about 2 percent of all leasing.

The two basic types of lease are the finance lease and the operating lease. Generally, if ownership of the leased property transfers to the lessee at the end of the lease term, following payments that represent the full value of the property, it is a finance, or full-payout, lease; otherwise, it is an operating lease.

In a direct-financing or single-investor lease, the lessor provides 100 percent financing for the equipment. About 65 percent of equipment leasing is of this type. The equipment under direct finance leasing has changed little in recent years. On the basis of original equipment cost, computer equipment dominated, representing roughly 20 percent of the total. Office machines were the next highest category, representing approximately 13 percent.

A leveraged lease involves third-party investors who provide debt funding in addition to the lessor's equity - usually 20 to 40 percent of equipment cost - for the initial financing of the property. Leveraged leasing is used extensively to finance the purchase of big-ticket items such as aircraft, oil rigs, and railway equipment. It accounts for approximately 20 percent of the value of all equipment leases. Operating leases, accounting for about 15 percent of new business, are usually for much shorter terms and can sometimes be canceled at the option of lessees.

Operating leases also can include maintenance and service provisions. The recent reduction of tax benefits for equipment ownership has made full-service leasing a more attractive alternative for many equipment users.

Following historical trends, aircraft and electrical power generation equipment were the predominant equipment types in the leveraged lease market in 1989, representing more than 60 percent of the total. Railroad equipment, which nearly doubled from the previous year, now accounts for more than 12 percent of asset types under leverage lease.

In the wake of the Tax Reform Act of 1986, leveraged leasing transactions declined when leasing companies abandoned the field because of low profit margins and the loss of the investment tax credit. Now, however, these companies are re-entering the market to structure deals on such big-ticket items as aircraft and electrical power generation equipment.

Almost 50 percent of all operating leases are for computers. Strong increases in operating leases were evident for rail equipment. But the percentage of operating leases for aircraft dropped from 1988 to 1989.

There are four basic types of leasing companies: banks or bank-affiliated firms; leasing subsidiaries of equipment manufacturers, called captives; independents; and others, such as insurance companies, investment bankers, and independent brokers who bring the parties of a lease together. Several hundred firms engage in leasing as a primary activity, and many more are involved in leasing as a secondary activity.

Banks and bank related firms have dominated the finance lease markets for the past two decades. Despite a banking law that since 1987 has allowed banks to engage in operating leases, they have not moved strongly into this area. Other players in the leasing business are so-called captives, essentially financial arms of parent companies; and independent leasing companies that range from small specialized firms to large diversified companies that offer a full range of products for lease and sale.

A key advantage of leasing is that it permits 100 percent financing, which is particularly appealing to cash-poor companies. In addition, accounting rules may enable a lessee to classify lease payments as expenses rather than as liabilities, thereby maintaining debt capacity. A lessee also can structure an acquisition with the desired balance of equity and debt without hurting debt capacity. Finally, a short-term operating lease protects the lessee against obsolescence by shifting more of the risk to the lessor. The lessee also saves the cost of disposal or sale of the equipment if possession reverts to the lessor when the lease expires.

Tax reform has had a significant effect on tax-oriented leasing. The 1986 act eliminated the investment tax credit (ITC), modified depreciation allowances, lowered corporate tax rates, and strengthened the corporate minimum tax. The net effect is that the new law reduces the tax benefits of lessor ownership of equipment. This diminishes the advantages of leasing for lessees without taxable income. Also, the alternative minimum tax (AMT) has enhanced leasing for equipment users, so companies that are subject to the AMT may find it advantageous to lease rather than to buy equipment.

In recent years, cash-strapped states have begun looking for new source of revenue to make up for the loss of federal revenue sharing. Some are now eyeing equipment leasing and other service industries for new taxes. In addition, eight states have now adopted UCC Article 2A, which amends the Uniform Commercial Code to include leasing of tangible personal property. The idea is to bring a degree of legal certainty and predictability to lease transactions throughout the states. To comply with the statute, leasing company legal documents will require some modification. Additional states are expected to enact UCC Article 2A in the future.

The leasing industry is constantly changing. Increasingly, leasing is viewed as only one of several means of asset financing. Leasing companies are beginning to move into other aspects of structured asset finance. Large, independent financial services firms are funding high-debt, high-risk projects that federal regulators are pressuring banks to avoid. In addition to issuing senior debt, some leasing companies are also providing venture capital and arranging limited partnerships. In the case of some lessor conglomerates, conventional leasing accounts for only 30 to 40 percent of revenues.

INTERNATIONAL COMPETITIVENESS

Leasing in international markets is an important source of business for U.S. lessors, especially for large leasing companies. Cross-border leasing, in which lessor and lessee are in different countries, is a substantial part of the international market for aircraft, ships, containers, energy equipment, and other big-ticket items. Japanese lessors with abundant low-cost funds are significant cross-border lessors, often of U.S. equipment.

Many banks, manufacturers, and independent lessors have foreign leasing operations. Most have foreign subsidiaries, joint ventures, or foreign sales corporations to conduct international operations. Also, more countries are creating favorable regulatory environments for leasing as they come to recognize its benefits. The Unidroit Convention on International Finance Leasing is an example of efforts to reduce the differences in legal treatment of leasing across borders.

Globalization is becoming important for lessors. Many U.S. corporations are looking for their continued growth to come from overseas operations, not from the domestic market. U.S. leasing operations overseas have been modest during the last several years because returns on investment have been better in the domestic market, but changes in the U.S. economy and EC92 are compelling leasing companies to move more vigorously into Europe, EC92 is the merger of the economies of 12 Western European countries, which constitute a single market of 325 million people with a Gross Domestic Product of $4.5 trillion in 1988. The U.S.-Canada Free Trade Agreement and the possibility of a similar accord with Mexico also offer potential new opportunities.

In 1990, foreign investors appear to have either taken over or have become minority partners in some large, traditionally American-owned leasing firms. And large European and Japanese banks have become major direct competitors in the U.S. leasing market. Foreign capital infusion and euromarket borrowing should enable U.S. lessors to continue funding at competitive rates despite tightening domestic credit.

U.S. leasing companies' main advantage over their foreign competition lies in their ability to create new and innovative financial products. Some companies have used the programs of the Export-Import Bank of the United States and the Overseas Private Investment Corporation to support the lease export of U.S. equipment. The programs are one reason that leasing is becoming a more common method of financing internationally.

Outlook for 1991

Overall equipment demand should grow by 4.9 percent in 1991. Leasing volume once again will follow this growth pattern, increasing 8.1 percent to $143.7 billion in original equipment cost. Rates of leasing growth will vary among equipment markets, but demand for the leasing of computers, aircraft equipment and other hi-tech equipment will remain strong. Even with the possibility of a drop in equipment investment, demand for leasing, which is somewhat countercyclical, should increase both absolutely and relative to other means of equipment acquisition.

Mergers and acquisitions of leasing companies over the past couple of years will continue to shrink the number of players. A report on the views of prominent industry executives stated that consolidation will continue because larger firms can achieve cheaper funding and better economies of scale. Eventually, the report says, the industry will consist of a number of very large organizations focusing on global operations and a number of relatively small firms filling niche markets.

Continued stiff competition will encourage the more entrepreneurial lessors to develop innovative financial products and explore growth opportunities in financial service businesses other than leasing. By emphasizing value-added service and pursuing a more customer-focused strategic direction, some lessors will be able to differentiate their products. Growth will depend largely on effective equipment management and remarketing. In many cases, equipment management can provide the value-added services necessary to differentiate a leasing company from its competition.

Foreign investment will play an important role in 1991, as leasing companies turn to foreigners for capital. U.S. leasing companies will also keep looking overseas, particularly Europe, for new clients and new investments.

Specific developments and opportunities will stimulate much of the growth in the industry in 1991 and beyond. For instance, organizations that have relied on government grants for purchasing equipment outright are turning to leasing as an alternative. Health care facilities are especially interested in operating leases for high technology items with short life expectancies.

Pending environmental legislation also will open new markets for lessors. For example, leasing companies could provide a significant portion of the financing that may be needed to overhaul up to $50 billion of equipment to comply with new environmental standards. However, the pending legislation could be a doubled-edged sword. That is because lessors with older equipment that does not conform to proposed environmental standards may have to bear the expense of updating their inventories.

The recent curtailment of the junk bond market bodes well for equipment leasing companies. In the mid- to late-1980s, junk bonds pushed leasing aside as a method of financing equipment. Now, companies that previously leased equipment and then switched to junk-bond financing will turn again to leasing.

Long-Term Prospects

The next three to five years will see a modest growth in equipment leasing. Historically, growth in leasing has depended on overall equipment investment. Rates of growth vary by industry or business, but manufacturing, medical, data-processing, communications, and aircraft and other transportation sectors are expected to be strong. Leasing will continue to be most attractive in the hi-tech areas, though there will be opportunities in other sectors as well.

Growth will be fragmented, depending on the specific market, lease product, and transaction size. Providing superior or different services and taking more risk will be a strategic option for the more entrepreneurial lessors. The industry will move more toward offering lease products that involve a range of financing, accounting, servicing, and risk-sharing characteristics. The focus for lessors will not be whether equipment leasing is becoming a mature industry, but which products are maturing and what it will take to maintain vigorous growth for specific leasing products.

Local and regional finance companies will focus on small-ticket leasing for local equipment markets. Lease financing programs to assist manufacturers will become more prevalent, and captive lessors will concentrate more on the products of their parent companies.

Leasing has become a global industry. Foreign opportunities for U.S. lessors will increase during the next several years, but foreign leasing companies will continue to enter the U.S. market, predominantly through the full or partial acquisition of established leasing companies.

Conditions in the industry remain fluid with consolidations continuing - albeit at a slower pace - in the foreseeable future. Many factors will influence the industry over the next few years, including overall economic conditions, tax policy, and accounting rules. - M. Bruce McAdam, Office of Service Industries, (202) 377-0346, September 1990. [Tabular Data Omitted]

PHOTO : Construction machinery is among the many types of equipment available from the equipment leasing industry. Environmental legislation, now pending, is expected to open new markets for equipment lessors.

Additional References

American Association of Equipment Lessors, 1300 17th Street N., Arlington,

VA 22209. Telephone: (703) 527-8655. Equipment Leasing, Practicing Law Institute, 810 Seventh Avenue, New

York, NY 10019, 1988. Telephone: (212) 765-5700. Asset Finance & Leasing Digest, Euromoney Inc., 24th floor, 2 Park

Avenue, New York, NY 10016. Telephone: (212) 696-1223. World Leasing Yearbook 1990, Euromoney Inc., 24th floor, 2 Park

Avenue, New York, NY 10016. Telephone: (212) 696-1223.

COPYRIGHT 1991 U.S. Department of Commerce
COPYRIGHT 2004 Gale Group