… as you can see below, the 90-day and 5-year swap rates are slightly higher. Some of my clients expect a decline in the Cash Rate will mean a lower rate for their Medical Equipment and other Finance. But, the banks set their fixed rates for fixed term loans based on their costs from week-to-week. The RBA Cash Rate is not part of those calculations.
We hear and read about it all the time: the banks’ cost of funds justifies whatever move they make in their published or quoted interest rates. We also hear and read speculation about their true cost of funds. Having watched this closely for quite a while, I can report that most of their costs are in what they pay their local customers for deposits, such as savings accounts and term deposits. A much smaller, but highly publicized, source of funds is international markets.
The third source is what they pay each other to borrow funds, the most common measure of which is Bank Bill Swap Rates, which have fixed terms of 30 days to 5 years. The latter is the typical term for Medical Equipment Finance. So, what range of rates should we expect, assuming a 5-year facility for equipment finance?
I have it on good authority (a banker) that the majors’ cost of funds averages 70-100 basis points (0.7-1.0%) over the swap rate on any given day. Second tier lenders are still disadvantaged by our financial system to the tune of an additional 40-50 points. The 5-year swap rate last Friday was 3.54%, so if we add 100 points, the majors’ cost of funds was about 4.54%. They’ll typically seek a margin of 200 points, so I would expect them to quote a rate to their existing clients somewhere around 6.5%. The second tier lenders will be around 7%, but both rates will be higher for new clients or those with questionable risk profiles.
It’s not enough to be able to easily repay a loan. It’s not enough to pay on time. It’s not enough to have a high net worth. And, it’s not enough to have a position of respect within the community. For a smooth approval process, it’s all about your transparency and ability to document any and all aspects of your finances. That’s the only way to satisfy the lenders’ need to create a ‘Perfect Loan File’, according to Mark Greene in a recent article in Forbes. The meltdown in the real estate market in the U.S. was/is, of course, much worse than here, but the attitude of the banks is the same. If they can’t tick every box on their credit matrix on the first pass, the approval of our application will be slow at best.
So, the way forward is to accept the often redundant documentation requests, remembering that when we were kids, one of our parents’ favourite replies to “Why?” was “Because I said so.”
So, what’s the perfect loan? Well, it’s one that (a) pays back the lender and (b) pays back the lender on time. But, underwriting the perfect loan is not the goal that lenders aspire to today.
The real goal is the Perfect Loan File.
I’m a big fan of Operating Lease Finance for Medical Equipment, especially Ultrasound and Healthcare IT (i.e., PACS/RIS and Teleradiology). It’s particularly relevant for businesses that recognise the needs for regular technology upgrades and appreciate the advantages of renting as opposed to buying. Operating Leases are essentially long term (typically 3-5 years) rentals, and the advantages include lower overall cost, off-balance-sheet accounting, and multiple options during the rental period and at the end-of-term.
Lower cost is due to the lender taking a residual risk position that is more that the borrower would normally take in an alternative facility. That results in lower payments and lower total cost, because the borrower isn’t committed to a residual payment. With Operating Leases, the lender owns the asset, so it doesn’t appear in the borrower’s balance sheet. From a tax point of view, the lender claims depreciation, and the borrower deducts all payments in full as an operating expense.
Income-producing equipment can often be upgraded to further enhance cash flow. With Operating Lease Finance, you have the option to upgrade anytime during the term by simply extending the term, increasing the payments, or a combination of the two. Other facilities require the settlement of the existing loan, which can include the additional expense of break costs, and entering into a separate, new facility.
Operating Lease end-of-term options are:
- Return the equipment/system to the lender without further obligation;
- Extend the term with reduced payments;
- Upgrade or replace the equipment/system with an extended term, adjusted payments, or both; or
- Purchase the asset at the then fair market value.
The last option can be contentious unless there is a fairly active second-hand market for those types of assets.
Systems such as Ultrasound and IT have a relatively short useful life, given the rapid pace of technological improvements that enhance performance, clinical utility, or both. So, unless you have multiple practices and the ability to ‘cascade’ older systems to less busy or demanding locations, Operating Lease is the way to go.
Remember the old saying that goes something like: If an asset appreciates with time, buy it; if it depreciates, rent it.