DOTmed Industry Sector Report: Leasing and Finance
December 29, 2008
by Astrid Fiano
Note: This report originally appeared in the November 2008 edition of DOTmed Business News.
The recent financial institution crashes, plunging stock market numbers and government bailouts has left lending services more cautious about exposing themselves to risks. Potential borrowers/lessors are concerned about how the economy affects options in obtaining new equipment. In the annual industry review of leasing and finance for medical equipment, the economy is at the forefront in DOTmed's survey of financial professionals. DOTmed asks how the current crises affect the leasing and financing market, as well as other factors to consider in financing the acquisition of new equipment.
The Current Economy
One positive point is that the health care sector (including medical equipmentleasing and finance) has historically been isolated from other financial crashes (i.e. the mortgage problems of earlier this year), and will likely continue to be a favored portfolio, although it will take some hits, as will all sectors. Much of the strength in the health care industry is its necessity-medical treatment and equipment will always be needed. In fact, prior to the current crises, leasing in medical equipment was a growing market.
"Before the credit crunch, if you could sign your name you could get $25,000, whether you were a doctor, or a hospital or a start-up," Jim Mousseau of The Laser Network, LLC of Morrison, CO, explains. "Now it is the polar opposite.No one will touch a start-up. If there is any credit issue or if you are not anM.D., you'll get a high interest rate."
"The health care industry has been very strong until very recently," says Ralph Petta, Vice President of Industry Services for the Equipment Leasing and Finance Association, which is headquartered in Arlington, VA. "The demand for leasing to obtain health care assets has also been very strong." Right now, just how much equipment financing will be affected is uncertain. Petta acknowledges, "With what's happening in the economy, we'll know more as months go by-as to demands in equipment and if there is a constraint in the supply of capital."
Martin Zimmerman, President and CEO of LFC Capital, Inc. of Chicago, IL, also says the complete effect on the health care market is a little difficult topredict. "A lot of lenders look at health care as a preferred market with stability. However, that is less true for smaller companies with too-rapid expansion." Facilities that have more leverage are risky to a lender, and therefore will find borrowing more difficult. Keeping a good liquidity ratio is important for borrowers of any kind, Zimmerman notes. "Money is available but lenders will be more stringent with credit requirements. The majority of healthy borrowers will get money, but interest rates will be higher for the less strong businesses."
Matt Klahorst is Director of Marketing for Strada Capital Corporation of Irvine, CA. In Klahorst's experience, a potential borrower in the medical industrywith a low credit score ordinarily might still be considered for financing; but in the current financial outlook, the higher-risk borrower may be cut off from financing options. "Still," he observes, "a potential borrower in the medical industry [due to the historically high performance] has a better shot than in many other sectors. Although every industry is feeling the crunch, the medical industry is less affected." Ultimately, borrowing to finance equipment might be limited to a degree until the economic crisis is past, and borrowers may have to pay more in interest rates if they are perceived as risky.
Financing or Leasing: Should a borrower approach a Bank, OEM or Leasing Company?
The most significant advantages to leasing medical equipment in the currenteconomic market are 1) keeping liquidity (cash or line of credit) available if needed; and 2) the ability to retain important options about keeping or disposing of the equipment. If a facility owns equipment, it must take on the responsibility of selling before upgrading. With leasing, the equipment can be returned or the lease can be extended, depending upon the facility's needs. Therefore, the obsolescence of the equipment is a factor to take into account. Petta explains: "The more sophisticated the equipment, the quicker its obsolescence. This is why sophisticated equipment lends itself to be leased. As newer equipment becomes available, a facility doesn't want to be stuck with older models."
Zimmerman agrees that there are solid advantages in leasing. "Leasing is helpful in times like these because it allows you to finance new equipment on your balance sheet; it improves the current ratio and liquidity measures. Acquiring equipment through a lease is a useful measure to conserve cash and improve ratios on the margin."
"True leasing, where the equipment is rented for period of time," says Patrick Sponsel, Vice President of Sharpe Financial Network of Peoria, AZ, "provides businesses with a guaranteed disposal of assets, lowers overall costs to healthcare practice and provides a medical practice with the newest and best inventory of equipment every two to five years."
Stephen Indictor, President of Top Group Capital Corp., of Hobe Sound, FL, offers other considerations in the choice to lease or buy. "Keep in mind that a lender will want a down payment of 25% to 30%." One obvious advantage to obtaining a loan, Indictor observes, is that in putting a deposit down, the borrower will get an interest rate slightly better than with a lease. In addition, a direct advantage in approaching a bank is foregoing the "middle person" such as a broker. However, that also limits options if the bank ultimately declines. Leasing companies often have several other options, Indictor says. "If our primary financing source turns us down, we will go tosecondary sources and maybe to a third and fourth source. We take away the need for the customer to do the searching."
"A lot of companies make a mistake to use cash for buying equipment, obtaining loans at a variable interest rate rather than a fixed rate," says Max Frodge, President of Ambassador Financial, Inc. of Carmel, IN. Any available line of credit with one's bank might be better used for other purposes. Jim Mousseaualso points out that if a facility is saving cash and credit lines through leasing, it can utilize the cash for other important aspects of business, such as payroll or marketing.
In Klahorst's experience, a leasing company can help facilitate a transaction. "We can put together the equipment for a large hospital or a doctors' office. We have partnerships with whom we can shop around the application." In addition to conserving a bank line of credit, Klahorst says, using leasing programs may limit credit exposure as well, as some programs are not reported to the main credit bureaus.
In considering a third party lender versus leasing from an OEM, Frodge says thedifficultyis in negotiating with the OEM about both the equipment and incidentals that might be bundled, such as the service agreement; in controlling the financing the OEM may drop prices but raise rates to meet their bottom line. Often a borrower is better off negotiating equipment and servicing separately. "You need a professional to guide you through the decisions," Frodge advises. "You need someone who is not just interested in closing the deal."
What should a facility take into account before financing or leasing? Sponsel says, "The cost of the financing is paramount, but additionally the [lending] firm's reputation, its track record, its experience in the field, and the length of the equipment's useful life versus its depreciable life. Take into accountthe amount of cash that is required up front, the additional unplanned expenses such as installation, remodeling or training, and the initial time to derive revenue from the utilization of the equipment. Loans generally require more paperwork, the qualification standards tend to be tighter with balance sheets and profit, and compensating balances [to be kept on deposit at a bank] are required with covenants for maintenance of financial ratios during the loan term."
Most of the financial professionals agree that lessors, including OEMs, often are well-versed in the medical industry and can work with various situations and needs, whereas a bank might have significant difficulty in flexible options for a loan at the current time. However, a borrower might want to utilize the benefits of a close banking relationship. Bringing one's CPA into the decision is a good idea, to fully understand the financial situation and the best lender/lessor to approach.
Should a borrower pursue a Fair Market Value or Dollar Buyout Lease
With a Fair Market Value (FMV) lease, at the end of the lease term you have the option to buy the equipment for the price the equipment would bring on the open market. By comparison, under a Dollar Buy-Out (DBO)lease, the leasing company owns the equipment till the end of the term, and the lessee has the option of acquiring the equipment for one dollar.
Whether to opt for FMV or DBO depends upon tax concerns and other factors, such as the borrower's intention tobuy the equipment. Klahorst says, "A Fair Market Value has the lower monthly payment, and at the end of terms the borrower can buy the equipment, return it or lease it again, and be able to write off the entire lease payment tax-wise. With the Dollar Buy-Out, the equipment is fixed to be purchased at the end. If you have a situation with technological obsolescence, you're better off going with an FMV lease, which also leaves you more cash flow, and at the end you can return the equipment or upgrade to a new lease. If you are planning to use the equipment for years, you are probably better with the Dollar Buy-Out. One option is not more right than the other, it all depends upon what your goals are."
Zimmerman says lessees might pursue a FMV lease because it's less costly. For instance, consider the situation of a small institution that wants to obtain a quad CT scanner, but also might want to move to a 16-slice in five years. To avoid having to sell the quad scanner on its own, it gets a FMV lease and then negotiates the cost. This gives the borrower a predetermined cost and a lot less obligation. With a Dollar Buy out, it might have to pay 50 to 60 % of the costat the end. FMV can add additional flexibility. "It's not a bad thing to ask about to see if it applies," Zimmerman recommends. Again, looking at the tax benefits of ownership or leasing is important.
As a final word regarding taxes, several of our experts surveyed noted that borrowers should consult their CPA regarding the tax stimulus package which can still offer tax advantages until the end of the year. The stimulus provides for bonus depreciation equal to 50% of the cost of new equipment put into service in 2008, and the limit for Section 179 expensing will be increased from $125,000 to $250,000, offering significant savings when applicable.
