Garry Bartecki What to do in the current Finance, Rental and Leasing world
This should be fun! Here I sit putting my thoughts together on July 27 waiting on Mr. Powell to announce how much Fed Fund rates are increasing this month. I will assume a .75% increase which should make some people happy and others looking for a window ledge to climb out on. Obviously, those that leveraged up to take advantage of the super low rates are trying to figure out how to make the next debt service payment. On the other hand, those that kept their balance sheet in decent shape with adequate cushion to deal with a recession or AR problems caused by customers that leveraged up will continue to move on ready to take advantage of competitors running out of gas (I assume they have no EV’s).
So, what is going on?
Prime Libor Fed Funds
Dec 31 rate 3.25 .583 .250
July 5 rate 4.75 3.57 1.75
% increase 46% A A
A = stupid numbers but you get the idea… increase in interest expense (if you have a floating rate deal), which will eat up your cash flow as well as call for higher EBITDA numbers to meet your Debt Service bank covenants. And these numbers do not have the July 27 rate hike included. You may want to check with your banker to see how this will work out for you. If you have a fixed rate deal with a rate lower than what a current rate deal would cost, you want to do whatever it takes to keep that contract in place. If you have a deal in place that is steadily increasing, you can investigate a swap that provides a “cap” on the rate you pay. The swap can get a little complicated and expensive if the rate you agree to is never reached. So, talk to multiple sources to make sure you understand what is happening.
Just to make things clear the rates shown above are the base rates on which the bank adds another 2-3%. For example, it is Libor plus 2 or Prime plus 3. In either case, you encounter a material increase in interest expense.
Lenders that finance dealers, customer purchases, and lessors have to change their outlook on their operations as well. The rates, as well as collateral values, are moving around on them which has made them nervous. And when you add the recession factor into the equation that scares them even more due to potential defaults and reductions in collateral value should they be required to liquidate collateral.
We have not mentioned the rental segment of the market, but for dealers, this could be a win or a loss depending on your ability to finance an increase in the rental activity.
Looking at the June 2022 Small Biz Optimism Index? ….it does not look good at all.
- They posted a sixth consecutive drop in June with all 10 components declining.
- Owners expect better business conditions in the next six months at the lowest level in 48 years.
- 69% report significant impact from supply chain issues.
- Labor top business problem.
- These business owners have been paying low-interest rates up until now.
- They are in a tricky situation.
This Index leads me to believe that the equipment rental business is going to soar because businesses will not be able to fund Cap-x transactions, and at the same time will want to avoid fixed costs, additional debt, and the high-interest rates associated with the debt. It will pay to keep what they have to avoid the inflation-inspired unit cost increases which also adds to their debt burden without any additional benefit. So, dealers who can provide parts and service for multiple brands, perform refurb work to lower the cost of replacing units, and have the capital to carry a short-term fleet for customers that only need units on a seasonal basis or an up and down work-flow schedule.
As you have figured out already your balance sheet is going to be the determinant factor in how you work your way through this economic scenario you are facing. There are opportunities out there, but do you have the capital to make profitable things happen? Better figure out where you stand because all the noise about prices falling, and a recession that will lower prices and interest rates are all wondering if you have the cushion to make it through the recession. A review of the MHEDA 3-year forecast does not support robust growth for the balance of this year and most of 2023, which supports finding programs to make money without taking on any long-term debt service.
What I would do is:
Dig out all your financing and dealer agreements to make sure you are following the contract terms. Your auditors probably do this as part of their yearly work. So, ask them to provide what they have in their files, and if necessary, ask them to review your covenant calculations to make sure they are correct and in the ballpark.
Along these same lines, you should have a template to calculate your EBITDA number. EBITDA is normally part of the covenant process but is easily misused for “one-time” expenses that should be removed from the calculation as well as monthly non-cash charges over and above depreciation that should also be added back into EBITDA. You may also have “not normal” expenses that could also be added back. For example, if you engage in a lawsuit and incur a substantial amount of legal fees, I would want to add those back since they have nothing to do with operating the business. Personally, a company I worked with closed existing locations and added new locations, incurring a big cost to move the equipment around. That cost was added back. Calculate EBITDA on a TTM (trailing twelve months) cycle and keep updating the annual EBITDA you projected.
And what you really do not need in 2022 is for the new lease accounting rules to appear on your 2022 financials. Making these lease adjustments, should you have any, will increase your debt/equity leverage which could cause a covenant default. Many banks said they would ignore these lease adjustments, but talk is cheap, and you need to know how this will impact your relationship with the bank. Find someone who really knows this issue to back you up.
Increase collection efforts. If you have customers who took advantage of that easy money, they may find themselves unable to remain on the same payment cycle as in the past. Update your collection work to look for these types of problems. You can outsource this type of work. And there are systems out there that monitor your customers to find payment problems with other vendors. Find out what is going on with large customers. How you can help them and find out if they could become a problem child?
Review your cash position daily. Compare to the monthly cash budget you prepared. Calculate your “Days Sales Outstanding” to see if you are falling behind because of billing or collections.
Do not sell used equipment. Rental produces more profits, which you will need if things slow down in your market.
Keep going down your balance sheet including parts, transportation equipment, rental fleets, and maintenance rates to see if rate hikes are necessary.
On the employee side offer finder fees for bringing new hires. Provide a “great “ health plan. I find that folks with stay if you have such a plan even if they are offered more money. Look for pros who may be retired to do part-time or work from home projects. Many techs may not want a full-time job, so give them what they need. These are people you have to have. Do what it takes to accomplish that goal.
For the balance of this year.
- Stay out of trouble with your bank and have others in the wing you can talk to if necessary.
- Assume interest rates and lease rates to skyrocket. Need help to close that “big” deal. Buy down the rate.
- Assume units on order will get canceled or become non-financeable.
- Avoid taking on inventory you do not need.
- Look for opportunities. There will be plenty out there. Private equity funds may help provide financing.
I told you this would be exciting. And I bet Mr. Powell has yet to deliver his decision on interest rates. (He announced a .75% increase later in the day)
About the Columnist:
Garry Bartecki is a CPA MBA with GB Financial Services LLC and a Wholesaler columnist since August 1993. E-mail [email protected] to contact Garry.
