In 2003, U.S. leasing volume dropped from a high of $280M in the mid-90's to a low of $200M. What happened? Basically, companies stopped buying equipment so the need for financing disappeared. As a result, many leasing companies have gone out of business or merged into a larger rival, such as GE, Citicorp or Fleet.
Traditionally, U.S. companies have leased everything from printing presses to power plants, hay balers to helicopters, office copiers to offshore drilling rigs, telecom equipment to large-scale computer networks. Can the leasing markets ever get back to their heydays? Yes, but it's going to take a long time.
Leasing first appeared in the United States in the 1700's to finance the use of horse-drawn wagons. By the mid-1800's, railroad tycoons, battling to extend their private railroads across the country, required tremendous amounts of new capital. Most banks, however, considered railroad financing risky and refused to lend to the emerging transportation industry. Locomotives, cars and other railroad equipment had to be financed using new and creative methods, the forerunners of the equipment lease.
This new scheme involved third-party investors who would pool their funds, purchase railroad cars from a manufacturer, then lease the cars to the railroad in the form of "equipment trust certificates." The railroad would receive title to the equipment after making periodic payments to cover the purchase price plus interest.
By the mid-1920's, manufacturers were basing too many major investment decisions on credit sales. Their failure to recognize this danger helped bring about the Great Depression in the 30's. As many businesses suffered, they became wary of "creative" financing and leasing was placed on hold.
Leasing returned to popularity during World War II. Manufacturers entered into cost-plus contracts with the government. These allowed the manufacturer to recover actual costs plus a guaranteed profit. In order to minimize costs, many of these companies leased special-purpose machinery from the government. Companies discovered that they could return the equipment to the government at the end of the lease, thus protecting themselves against owning technically-obsolete equipment when the war ended.
In the 1950's, consumers started to demand a vast array of goods. They wanted speed, convenience and mobility. Manufacturers utilized leasing to help overhaul old operations quickly and create new facilities for the production of new products like televisions, advanced communications equipment and airplanes.
By increasing tax deductions in the early life of the asset and deferring taxable income to the later years, the Code was intended to enhance the benefits of ownership and encourage capital spending. However, many companies like railroads and airlines that needed the use of large and costly equipment couldn't afford to purchase it outright and couldn't take advantage of these new tax benefits.
In an effort to pump up capital expenditures, Congress introduced in 1962 a new tax benefit, which would provide the leasing industry with its biggest boost. The Investment Tax Credit (ITC) provided purchasers of capital equipment with a tax credit they could use to offset their total tax liability to the government. The purchaser could determine the amount of this credit by taking 7% of the original equipment cost.
Lessors who could establish true leases were also entitled to the ITC. Therefore, a smart lessor would keep the ITC, reduce the monthly rental payments from the lessee, and still show higher after-tax yields.
1970 ushered in a turbulent decade for the economy. The continued emphasis on defense spending and the push for technological advancement left the government with an increasing budget deficit, declining GNP and growing unemployment.
In August of 1971, President Nixon imposed the first peacetime wage and price controls. This resulted in companies jacking up their prices and then discounting them for selected customers in order to stay within the confines of the law. By 1973 the Watergate scandal and the Arab oil embargo had caused the U.S. dollar to be devalued twice.
The prime rate steadily increased during this decade, from 6% to 15.75%. Inflation rose to 12%, discouraging savings and reducing capital available for investment. Corporate profits were sharply reduced, and the economy slid deeper into recession. Research and development, investment in new equipment and the planned replacement of aging assets were usually the first budget items to be cut.
Companies like IBM and Xerox began to use leasing more widely to finance the distribution of their products. They maintained equipment title, offered shorter terms and remarketed the equipment after the lease. These benefits attracted many customers who wanted to avoid the risk of computer and copier technical obsolescence. Vendor leasing quickly spread to other types of equipment including office machinery and furniture, cash registers and restaurant equipment.
In 1976, the Financial Accounting Standards Board (FASB), under pressure by the SEC, issued a comprehensive lease accounting document entitled Financial Accounting Statement No. 13 (FASB 13). This statement classifies a lease as either a capital lease or an operating lease from the lessee's viewpoint. If the lease is determined to be a capital lease, the lessee must account for it as an outright purchase and show the asset on their financial statements. An operating lease, on the other hand, is not reflected on the balance sheet and future rentals are disclosed only in the footnotes.
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