Managing the Financial Side of Commercial Fleets

Self-Funded Leases: An Option in Tight Credit Markets

The fleet industry has been hit hard by the credit meltdown. At one time, some lessors were refusing to fund new orders. Fleets are scrambling to find alternatives; one may be to self-fund the leases.

March 2009, by Staff

It is an environment unprecedented in the post-World War II era. Although interest rates skyrocketed in the early '80s, money was available, expensive as it may have been. But today, the real estate and banking meltdown has dried up credit as never before.

Fleets are most often funded via floating rate master lease agreements, the rate factors based on instruments such as commercial paper, LIBOR, or Treasury issues. But with banks teetering on the edge of insolvency, both commercial paper and LIBOR have nearly disappeared; neither companies nor banks are selling or buying these short-term money instruments. This pullback in turn has led some fleet lessors to experience a lack of funding for new orders under existing lease agreements and to either limit or cut off altogether customers' new-vehicle orders.

What are fleets to do? They can simply extend replacement until the funding crisis eases, keeping a critical eye on maintenance and buying out-of-stock vehicles, the inevitable result of extended replacement cycles. They can also seek other leasing alternatives. Funding remains available, but the cost versus the major lessors can be a burden. One option is self-funding the lease; that is, the lessee becomes the funding source for the lessor, either internally or externally.

Self-funding uses either cash on hand or bank lines within the company to provide the lessor funding. When traditional lessor funding is scarce, self-funding is one option that can maintain a fleet's lease status.

Self-Funding Differs from Ownership
Self-funding a fleet lease program isn't necessarily the same as company ownership from a tax and accounting standpoint. However, the administrative requirements are the same; vehicles must be ordered, tracked through the process, drop-shipped and delivered, registered, and titled.

A fleet lessor provides both vehicle acquisition funding and required administrative tasks. The lease payment covers the lessor's cost of funds, a monthly depreciation reserve, and an administrative fee to cover such costs, plus a level of profit. Self-funding a lease generally does not contain the same administrative fee as a lessor-funded lease, since the funding source is the lessee, and the lessor is entitled to a reasonable level of profit.

Banks May Provide a Funding Option
Companies who remain creditworthy during tight markets usually have bank lines already in place. These money sources can be used to fund fleet vehicle leases. In addition, a company's lead bank often has leasing products it might be willing to make available for this purpose as well. One way or another, the lessee may be in a position to provide funding to a lessor suffering in one of the tightest credit markets in memory.

The first step is to negotiate a fee structure that covers the lessor's costs with a reasonable profit for handling the administrative and clerical processes it continues to perform. This arrangement will most likely take the familiar form of an administrative fee charged in the lease billing. The fee will be higher than that detailed in the existing master contract. Lessors' profit margins are contained in several steps of a vehicle lease transaction: purchase, funding, and billing. Since the funding portion of potential revenue will be lost, the administrative fee must make up the difference.

The next step is developing a communications process determining order placement and vehicle delivery dates. The lessor (or lessee, depending upon the parties' preferences) notifies the funding source that a funds "takedown" must occur to pay for a vehicle. Further, depending on the fleet's capabilities and resources, the lessor handles the initial title and registration (as it has previously), carries the receivable, creates a billing, sells the out-of-service vehicle, and retires the balance of the debt takedown.

Fortunately, electronic communications channels, unavailable as little as 20 years ago, can now help set up a smooth and nearly automatic process. The lessor's existing order system can remain in place as vehicles are ordered, status tracked, and shipments confirmed. The only difference is the debt takedown necessary to buy the vehicle when it is delivered.

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