Creative financing and fleet rotation

David May
Business Development Manager
Tatonka Capital Corporation
Denver, Colorado
Presenter, 2005 APWA Congress

As the public sector faces tighter budgets, innovative financing strategies are allowing communities to continue to provide the necessary services residents demand while staying within budget.

When budgets tighten the first thing that is typically cut back or postponed is the acquisition of capital equipment. Unfortunately, equipment doesn't last forever and becomes more and more expensive to purchase and maintain as time goes on. At some point, equipment is no longer repairable or the expense to do so cannot be justified and a purchase must be made. When this time comes, many administrators are caught off guard at how much capital equipment costs, which can further postpone the necessary acquisition. Many department heads know what I'm talking about and have pulled their hair out trying to convince the administration that the timely replacement of capital equipment should not be an option but a necessity.

A solution to this dilemma is preparing, presenting and committing to a long-term (20-year) fleet rotation program. Such a program can be structured to fit within a particular budget (level funded) and the equipment will be replaced when it has realistically exhausted its useful life. This is done by mapping out the replacement of your fleet and adding a creative financing structure to the mix. Financing plays a key role in the program because it eliminates the need for large sums of money when numerous purchases are necessary within a given year.

Types of financings primarily used and considered are intra-governmental fund borrowing, debt issues and lease/purchase financing. Some entities allow for the general fund to borrow from an enterprise or revenue fund in order to have the money to make a purchase or complete a project. The general fund will then pay back that enterprise or revenue fund over time. Debt issues are typically used for larger projects and require voter approval. Even though the lease/purchase concept has been available since the 1970s, many administrations are now just starting to adopt this concept. Lease/purchase financing provides an avenue to ownership without creating a debt obligation. Lease payments are considered a current operating expense, not long-term debt, because of a funding-out clause or non-appropriation language in the lease agreement.

Lease/purchase financing has been viewed in the past as a last resort and only used by mismanaged entities. That mentality is changing and it is now being used as a powerful tool to improve communities. The cost of the equipment or project is spread over many years so those residents living in the community over that time will pay for the equipment or project instead of just the residents living in the community today. Because government entities can borrow at tax-exempt interest rates, lease/purchase financing can actually be cheaper than saving and paying cash because of the time-value of money. Generally speaking, as long as inflation and increased cost factors on equipment or projects are greater than the rate of interest you pay on the loan, buying the equipment today and financing it is cheaper than saving over time and paying cash.

For example, a $100,000 piece of equipment will cost $112,486 in three years if you have a constant rate of inflation and increased cost factor of 4%. Let's say you purchased that piece of equipment today and financed it over three years at tax-exempt interest rates. Your first payment would be due one year from delivery and your total cash outlay would be $109,132 (three annual payments of $36,377). Therefore you would actually save $3,354 in the cost of the equipment, not to mention the savings incurred by eliminating costly repairs over that three-year period. (Which brings up a good point about repair costs: In the above example, the interest expense is $9,132; on a big piece of equipment a major repair cost like a new engine or transmission could dwarf that interest expense.)

Some entities don't realize the impact inflation as well as increased cost factors has when postponing the acquisition of a large piece of equipment. A fire department I worked with didn't plan on financing their new apparatus, but it was their only choice after they postponed the acquisition for three years. The department head was asked by the administration to acquire bids for the purchase of a new apparatus. After receiving and reviewing the requested information, the administration decided that they couldn't afford the apparatus after all and the acquisition was postponed. Three years later the administration was now ready to purchase the apparatus. To their surprise, the cost of the apparatus had risen 10% (on a large piece of equipment, 10% can mean $20,000 to $80,000) and once again they couldn't afford to pay cash for the acquisition because of the increased cost.

Entities that have fallen behind in their fleet rotation will benefit most by financing and implementing a long-term plan. A cash purchase of $100,000 can be leveraged to a $285,000 purchase with three $100,000 payments, a $455,000 purchase with five $100,000 payments, a $610,000 purchase with seven $100,000 payments and an $820,000 purchase with ten $100,000 payments. One public works director I worked with was asked to rank in order of preference which piece of equipment he would like to replace this year based on their typical appropriated amount of about $125,000. Instead of choosing just one item, we presented a seven-year lease/purchase option that allowed him to purchase seven items for the Public Works Department and four items for their Solid Waste Department. The payment per year was around $125,000 and the total equipment cost was in the $750,000 range. The Board was impressed and the acquisitions were approved.

One of the additional benefits to the financing that the Board mentioned was that equipment purchases for the next several years could be taken off the agenda because they just fulfilled his wish list. This forward-thinking mentality is what allows for good intra-governmental relationships because allocating money seems to be the number-one conflict between departments and administrators. A long-term fleet rotation plan will eliminate the yearly struggle to have funds allocated to buy equipment because the amount funded each year is predetermined based on the implemented plan.

If you plan on attending this year's APWA International Public Works Congress and Exposition in Minneapolis, come to our session where you can hear more about the above topics and hear directly from Paul Fredette, Director of Public Works for the City of Claremont, New Hampshire. Paul implemented a 20-year fleet rotation plan three years ago and has replaced two-thirds of his fleet since and has stayed within budget. Our session is on Wednesday, September 14, at 9:30 a.m.

For more information or to discuss your particular need, please contact David May, Business Development Manager, Tatonka Capital Corporation, 1441 18th Street, Suite 400, Denver, CO 80202, (888) 224-7578, dmay@tatonkacapital.com.