April 2009, Fleet Financials - Feature
Fixed or Floating: Which Lease Funding is Best?
Lease rate funding instruments have become more and more complex. Most lessors recommend floating rate fleet leases. Is there a place for fixed financing any more?
By Staff
Thirty years ago, fixed-rate fleet leases were the norm. "X over/under Prime" was the standard proposal when fleet lessors presented their proposals to the fleet manager.
Then, however, things began to change. Lessors started offering rates that floated, i.e., changed as the underlying debt changed. Loans based on the Prime rate (floating rate money, contrary to what is often believed) were joined by:
■ LIBOR funds: LIBOR is an acronym for London Interbank Offered Rate. These are funds loaned between banks for short-term needs.
■ Commercial paper: These short-term debt instruments are bought and sold between companies, and are also used to fund short-term needs.
■ Treasury issues: This is debt sold by the federal government.
Fleet managers found themselves nearly overwhelmed by the menu of funding possibilities.
The question became one of the fleet industry's fundamental questions: fixed or floating, or even both?
Reviewing Fleet Lease Basics
The open-end terminal rental adjustment clause (TRAC) lease is unique to the fleet leasing industry. There are open-end leases, and there are TRAC leases for other categories of leased assets. However, a combination of the two is the most common method used by companies that lease fleet vehicles.
The fleet lease contains several basic terms and conditions:
■ The lease payments consist of a reserve for depreciation, an interest charge, and an administrative fee.
■ The lease has a short (usually 12-month) minimum term, after which the lessee can terminate the vehicle lease at any time.
■ Vehicles are amortized in a straight line. When replacement is anticipated, the unamortized balance represents the vehicle's fair market value on the open market.
■ When vehicles are sold, the proceeds are applied to that balance. If the proceeds are greater, the lessee receives the excess. If they are lower, the lessee must make up the difference.
The flexibility of the typical fleet lease is its greatest benefit. Vehicles have different missions, drive in different geography, and accumulate mileage at different paces. Fleet managers must be able to replace vehicles at different points in their lifecycles. The open-end TRAC lease enables this flexibility.