Answers to your finance questions: Part II

Editor’s Note: In this issue, Canadian Metalworking reveals Part II of its leasing/financing questions as answered by expert Ken Hurwitz. This is a selection of the most common themes and most interesting questions. To get your questions answered in a future issue, please send them to Editor Joe Thompson at jthompson@canadianmetalworking.com.

Check out Answers to your finance questions: Part I

Q: What do you think interest rates will do the rest of the year and how will that affect your rates?

A: My sense is the Bank of Canada now has inflation under control for the most part. If we do see any more rate hikes, I think they will be nominal unless something unforeseen happens.

From a leasing perspective, rates were extremely low for a very long time until March 2022. I have funding sources that had not updated their rate cards since 2017, so to be honest, an adjustment was long overdue.

Q: I have a leased machine sitting idle and making me zero money. What are my options?

A: If you find yourself in this unfortunate situation, the first thing is to confirm with your funder if there is a buyout available and what your balance owing is. Once you know this, the current cost of the equipment is set and the next steps are to investigate the marketplace and sell the machine.

One of the reasons machine tools are so popular with lenders is because a good brand-named machine tool holds its value for a long time. If the machine has an active lease, then it is most likely a relatively new machine. As long as it has been maintained and is in good working order, it still is a valuable asset. Depending on how far you are into the lease, it’s possible that the machine sells for close to what is owed to the funder.

Another option is to find a local shop that can make use of the machine and have it pick up the remaining lease payments.

The funder still needs to credit adjudicate the new potential owner, but if approved, it essentially can take over the lease and make all the remaining payments.

Last, if there is even a chance that some new business could be landed, there is an option to rewrite the lease, which takes the remaining payments and starts a new lease so that the rest of the payments are stretched out over a longer term.

For example, let’s say you are 30 months into 60-month lease for $100,000 with payments of approximately $2,000 per month. If the lease is rewritten over a five-year term, the monthly payment comes down to approximately $1,250.

Q: I have leased a machine and now wish to replace it before the term is up. Can I do this?

A: Yes. In the leasing world this is called a trade-up.

Let’s use the example of a machine with an existing five-year lease. If after three years the needs of the shop have changed, requiring a more efficient machine, then the path of least resistance is to approach the machine tool seller and offer the existing one as a trade. New equipment sellers are always looking for good used machines.

In our scenario, the existing machine costs $300,000, is worth 50 per cent of its original value, and has a monthly payment of $6,000. The new machine costs $350,000, which means the seller is looking for a net amount of $200,000.

Because 24 payments of $6,000 are still owed on the lease (a total of $144,000), this is added to the net amount required for the new machine, and the leasing company then arranges a new five-year lease on a total of $344,000.

The effect on the payment is minimal, in relative terms; it now costs $6,700 per month. However, now there is a new machine on the floor that is well-suited to the work.

Another option if the seller does not want to take in a used machine on a trade is to get a buyout from the funder for the remaining lease payments. Selling the machine for close to the buyout is preferred, and you can use this money as a deposit for the replacement machine and arrange a lease for the balance.

Q: Can I lease a used machine?

A: This is a common question that I have been asked lately, simply because COVID-19 affected the machine tool supply chain. For a long time, new machinery was unable to be manufactured in the demanded quantities, so many manufacturers installed used equipment to increase capacity.

Also, new machinery, when available, is very expensive. Manufacturers can save a significant amount of money by sourcing a good used piece of equipment.

Leasing companies that do business in the manufacturing industry will have no problems arranging financing for a used machine. One of the main reasons why is that this type of equipment already has depreciated.

A new machine, like any other mechanical asset, will depreciate the most in the first year. After the first year, however, the depreciation levels off because a brand-named machine that has been serviced and maintained properly holds its value for a very long time.

A lender’s first concern when financing any asset, new or used, is its exit strategy in the event that the deal goes sideways. They want to know the asset can be resold quickly and with a significant portion of the financed amount recovered.

Leasing companies look at a transaction and, if the equipment is a brand name, quality machine tool, it knows there is value. I have seen many cases in which a bank rejects an application solely because the asset is used.

Ken Hurwitz is vice-president of Equilease Corp., 416-499-2449, ken@equilease.com, www.equilease.com.