Technology on a lease: Keeping pace while reining in finances
New technological developments are making it possible for cities and counties to operate more efficiently and respond more effectively to the citizens they serve. While there is much to be gained — cost savings, improved record-keeping, better response times to emergencies and more accurate forecasting, for example — technology does not come cheap.
For agency personnel who must manage more (people, processes and paper) with less (money), this presents a formidable challenge.
City and county government agencies have ongoing technology requirements just like any business. However, the process of acquiring equipment can be more protracted, as budgets are settled after considerable deliberation and committee involvement. New expenditures or emergency needs cannot always be addressed through available, approved funds — or without extensive budget renegotiation.
Outright purchases can drain available allocations, limiting overall buying power. For many types of transactions, bond offerings or the use of revenue from an existing offering are impractical. In an effort to enable state and local agencies to acquire technology, an increasing number of financial institutions are offering flexible and easily administered leasing and rental programs.
As equipment acquisition tools, renting and leasing can provide city and county agencies with the means to better serve their populations while conserving valuable capital. Whether the issue is a backlog of replacement needs, a lack of capital to purchase outright or a need to retain substantial cash revenues, leasing provides a flexible funding alternative. In many instances, the strategic use of leasing programs can enable departments to hold or even reduce their equipment budgets.
Bonds, cash purchases and alternative financing
For many agencies, bond issuance is a common means of raising revenues needed for capital equipment expenditures. However, for single purchases or multiple transactions under $1 million, the costs associated with bond issuance often prove impractical. Bonds require taxpayer approval; hours of attorneys’ and underwriters’ time; bond and tax opinions; and issuance and documentation fees. Moreover, it can take months to receive the funds.
The shortcomings of an outright purchase include quick depletion of available, allocated funds, as well as ownership risks such as obsolescence. Obsolescence is especially relevant when acquiring technology equipment, considering the “useful life” of many computer systems. However, if an agency is facing a “use-it-or-lose-it” situation (for example, if funds are left over at the end of a fiscal year), paying cash is often preferable when that asset has a considerable useful life.
According to Linda Kataskas, manager of the Ontario County, N.Y. printing department, which rents a high-speed, high-end digital imaging and duplicating system, alternative financing “is convenient and helps us stay current with technology.” She adds, “It is highly advanced technology, and renting makes it affordable.”
The volume of municipal leasing in 1994 was $8.7 billion, according to Standard & Poor’s. Municipalities lease for many of the same reasons that businesses in the commercial sector lease: to preserve available cash, match equipment use to the useful life of the asset, match payments to cash flow cycles and gain certain tax or accounting advantages.
A municipal lease is a conditional sales contract that obligates a governmental user of equipment to make principal and interest payments on the purchase price over a period of time; the interest is tax-exempt. Upon payment of the final installment of the contract, ownership vests with the lessee for a nominal amount, e.g.$1.
A lease generally is not considered debt due to so-called non-appropriation provisions (or, in California, abatement provisions). Under such provisions, a lessee discontinues its lease payments if funds are not approved for more lease payments. This is not a default, although the lessee does relinquish use of the asset.
Also, the leased asset (such as telecommunications equipment or computer software) should be essential to the operations of the lessee and used for purposes ordinarily performed by the municipality in the normal course of operations. This is key to reducing the risk of non-appropriation. Equipment should be environmentally safe, and the lease term should not exceed the useful life of the equipment.
The “essential-use” test is fairly easily defined. It is highly unlikely, for example, that a 911 system would be approved for use by a library. The types of technology that municipalities lease include:
CAD/CAM/CAE software and workstations;
desktop and notebook PCs;
mobile computer systems;
security systems; and
A recent survey conducted by the Washington, D.C.-based Computer Leasing & Remarketing Association shows that, of the leases that reached the end of their initial terms during the respondents’ most recent fiscal year, an average of 40 percent were renewed by the original lessees; 25 percent involved equipment purchased by the original lessees; 20 percent involved equipment remarketed to a wholesaler; and 15 percent involved equipment that was leased or sold to a different user. In addition, research has shown that 77 percent of high-technology equipment on lease is either upgraded or replaced within 24 months; some 95 percent is upgraded or replaced within 36 months.
Sources for municipal leasing programs include banks, leasing companies, manufacturers and dealers. Agencies should consider a potential lessor’s experience in the municipal market. Lessors who are well-versed in the economics of the public sector can sometimes be more creative in developing acquisition and financing plans that match revenue streams and needs for technology.
Public sector advantages
Significant advantages in cash flow, administration and operation can be realized depending on the type of lease plan selected. These include 100 percent financing of equipment and related items, speedy acquisition and installment, ease of add-ons and upgrades to equipment and flexible payment structures to meet budgets or revenue streams.
Brian Melcer, director of communications for the Lawrence County (Pa.) Emergency Operations Center, leases a 911 recording system. “Price was definitely an issue,” he says. “It’s wise for us. Our department isn’t eligible for certain types of preferred pricing offered through the state, and we don’t want to tap into reserve funds because we’d rather use those for long-term needs such as facility upgrades or emergencies. Moreover, when we investigated trading in our old system, the amount [we would have received] was not substantial enough to warrant applying it to a new purchase.”
“We pay an annual payment over a five-year term,” Melcer continues. “Eighty-five hundred dollars [per year] over five years is much easier than $46,000 up front. We are planning a considerable upgrade of equipment over the next few years, and we have to be very selective in the way we allocate these funds.”
Leasing offers other benefits that are particularly germane to the public sector. A lease is considered an operating expense and not treated as debt; therefore, debt ceilings and referenda do not come into play. Leases also can supplement other sources of capital such as grants, taxes and revenue bonds; this can prove especially helpful if allocations are depleted due to an emergency situation. Also, financing is usually matched to the useful life of the asset, and financing rates are competitive with bonds.
Consider, for example, a county library system requiring about $150,000 worth of new equipment, ranging from servers at main and branch locations, workstations for visitor use and a multimedia lab for the children’s department. Increases in population and equipment aging necessitate upgrades and additions; however, the yearly appropriation for equipment and technology is only $100,000. In this situation, leasing offers significant savings over an outright purchase. (See chart)
Leasing is especially attractive to the public sector because it usually offers a streamlined and expeditious acquisition process.
A typical lease under $150,000 requires only the approval of the governing body of the issuer. It necessitates minimal documentation and generally does not require immediate issuance costs. In addition, the administrative level of approval for a lease is typically lower than that for other types of financing. Many lessors, understanding the public sector’s paper-intensive environment, have tried to be especially sensitive to this area; consequently, documents are simple and straightforward, requiring only basic information such as a description of the equipment and proof of insurance.
Many lessors can make decisions on transactions within a few hours of submission, depending on the deal’s size and complexity. Naturally, the sooner a decision is obtained and the lease executed, the sooner technology will be installed and operational. Service and maintenance are key issues. Agencies should be certain the vendor is reliable to service technology over the long term before entering into any type of acquisition arrangement — purchase, rental or lease. By using the latest generation of equipment, quality and productivity can improve while operating costs are held to a minimum or reduced.
Leasing is not confined to hardware or technology equipment. Software, both custom and “off the shelf,” can be financed as well.
In fact, software leasing is rapidly increasing in popularity, having nearly doubled in volume from 1994 to 1995, according to the Arlington, Va.-based Equipment Lessors Association. Many CAD software packages, for example, sell for well into the thousands of dollars, making affordability a real concern. Proprietary programs can also be quite costly.
Types of leasing plans
Many types of leasing plans are available, and the options vary from lessor to lessor. When financing an acquisition, five key considerations should be kept in mind: budget; revenue stream; projected useful life of equipment; desire for eventual ownership; and obsolescence.
“Leasing not only helps us spread payments over several fiscal years to comply with our budgets, it increases our overall acquisition ability,” says Larry Littlefield, superintendent of the Kittery, Maine, school district.
When an agency is fairly certain it wishes to purchase equipment at the end of a lease term, several options exist. The most common is the one-dollar buy-out option, in which equipment is purchased for one dollar at the end of a lease term.
In a lease/purchase plan, the agency makes periodic payments that can be tailored to suit individual cash flow situations. Like other municipal leases, lease/purchase plans offer tax-exempt interest rates and uncomplicated, steady cash flow, but it functions like an installment purchase plan, with provisions toward ownership. No deposits are required, and only the aggregate lease payments for the current fiscal year need to be included in the budget. As a result, capital equipment budgets can be held flat or trimmed.
Many public agencies often use a master lease agreement to accommodate changing short-term requirements. A master lease permits multiple transactions and allows existing equipment to be upgraded or new equipment to be added for the duration of the lease term. With each addition to the original lease, payments are simply adjusted upward to reflect the cost of new equipment. This can be very helpful from an administrative perspective, because the documentation and approval process is significantly streamlined.
A master lease also accommodates the equipment of several vendors. If an agency is working with a single financing source, it can structure a plan that will be approved for the entire transaction and, as new departments receive equipment payments, will increase to reflect the addition.
Other plans that may prove useful in meeting unique budget or revenue situations include: step lease programs, which permit agencies to either increase (step-up) or decrease (step-down) their lease payment in any given year to better meet their cash flow needs; skipped payment leases, which require the customer to make payments only during certain months or periods each year.
Deferred payment leases contain a 30-, 60- or 90-day deferment of the first monthly payment. Deferred payments are often used when the entity wishes to have equipment on stream for use in the current fiscal year for payment in the next fiscal year. Annual, semi-annual and quarterly leases permit the agency to make payments in advance in order to initiate the lease process.
Ron Castleton is credit manager, Advanta Public Finance, Draper, Utah. Cindi Petreshock is national municipal leasing representative, Advanta Business Services, Voorhees, N.J.
Criteria lessors use to evaluate a lessee’s ability to pay
Moody’s rating of Baa or better
positive fund balances
annual lease payment is minimal in proportion to the total operating expenses (i.e. <5 percent)
per capita funded debt (total funded debt / population) is $1,000
no adverse public information (i.e. bankruptcy, non-appropriation, scandal, bribery, mismanagement)
verifiable legal name of municipality
municipality must be qualified as a muni by meeting the following:
a) entity was created by or pursuant to state law
b) entity was organized for a public purpose
c) no net earnings will inure for private benefit
d) entity possesses substantial sovereign powers of taxation, eminent domain and police authority
unusual legal issues for a particular entity
negative public information such as prior non-appropriation, scandals, mismanagement, non-payment, bribery, bankruptcy, lowered Moody’s rating
lease signer does not have authority to sign lease
the leasing source (vendor) is questionable
downward financial trends or deficit fund balances
lack of required approval documentation such as attorney opinion letters, if necessary
Acquiring new equipment
|Yearly Budget Allowance||$100,000||$100,000|
|Result with Cash Payment||Only 66% of needed equipment is obtained||100% of needed equipment is obtained|
|(Lease terms: 3 yearly payments in advance of $58,500)|
Rentals meet L.A.’s daily and emergency needs
Like many California utilities, the Los Angeles Department of Water and Power is preparing for the deregulation of the utility industry in 1998 by downsizing, trimming capital and operating budgets and finding new ways to optimize revenues.
“It just makes good business sense to rent heavy duty construction equipment rather than buy it,” says John Sharp, manager of the fleet operations business group for the LADWP.
LADWP — the largest municipal utility in the nation, serving a population of 3.6 million — has been renting heavy duty equipment to supplement its owned fleet for more than 10 years. Officials from the utility say renting has proven to be both convenient and cost-effective.
“We rent everything from forklifts to aerial platforms to perform new construction and scheduled maintenance on facilities ranging from power plants to water tanks,” Sharp says.
Sharp adds that renting has also helped in times of crisis. “Following the 1994 Northridge earthquake,” he says, “water and electricity services were cut off to San Fernando Valley residents. In response to customer needs, we rented water trucks and trailers for hauling ice and drinking water to designated areas to assist customers.” In addition, rental equipment was necessary to complete timely earthquake-related infrastructure repairs in the months following the temblor.
Michael Breatore, LADWP’s fleet operations supervisor, is in charge of coordinating rentals with vendors and dispatching the equipment to various job sites in the Los Angeles area, Owens Valley and Las Vegas.
“With contracts in place, most equipment rentals are available within 24 hours or sooner. The vendor will deliver the equipment to the job site and pick it up when the job is finished, freeing up crews for other work assignments,” Breatore says.
Breatore spends about 75 percent of his time on coordinating and administering the LADWP’s rental equipment program. “Currently, the fleet operations unit has 85 rental units in use by field crews, in addition to LADWP-owned units that are in service,” he says.
“Our crews are using rented aerial platforms to wash the high-voltage insulators at the Sylmar Converter Station and replace a roof on a water tank located in the Hollywood Hills. Earth-moving equipment, including Cat 245 excavators and articulated off-road dump trucks, also are being used to remove 250,000 cubic yards of silt and debris from a streambed that feeds into Castaic Power Plant Reservoir,” he says. “We use rental equipment for various jobs everyday.”
Breatore says renting is most effective because there is no capital investment and because the equipment does not require maintenance. “It only costs money while it’s being used. And, if it breaks down during the rental period, the vendor, not the LADWP, is responsible,” he says.
Breatore says the utility spends between $1 million and $2 million a year on rentals even though it has top-quality equipment in its own fleet. Jobs often out-number equipment resources, and specialty equipment is sometimes called for, such as 170-foot bucket trucks for work on transmission line towers.
Also, LADWP recently needed equipment to pull fiber optic cable for telecommunications projects. “If we invested in this type of equipment, it would be extremely costly,” Breatore says. “When you add in the time such equipment is idle and the cost of scheduled maintenance, rentals are very practical and cost-effective.”
Renting equipment, says Breatore, saves the LADWP an estimated $1 million year, he says.
“The cost of purchasing this equipment would be prohibitive. Some of the units cost in excess of $250,000 each. With our broad vendor base and large volume of usage, we receive very competitive rates from the vendors,” Breatore says. “By maintaining a close watch on outstanding invoices, we can keep the vendors enthusiastic about dealing with us.”
LADWP rents equipment from vendors including Hertz, U.S. Rental and Constructors Equipment.
In an effort to increase revenue, LADWP’s fleet operations unit offers the use of its top-quality services, as well as its rental expertise and coordination services, to other government agencies at competitive rates. The LADWP unit also offers its utility equipment and its operators when they are available. “We want to be the service provider of choice,” says Breatore.
For more information regarding LADWP’s fleet services, call John Sharp at (818) 771-4013.
When to avoid leasing (or at least think twice)
to circumvent voters — debt or not, they still pay the bills
when the use is non-essential
when the term is excessive to the asset
when credit is weak
if the money to purchase is available (still evaluate the useful life of the asset)
when there is political turmoil.