Strategies To Offset Higher Financing Costs On Motorcoaches
By Matt Hotchkiss, Senior Vice President, Bus Division Sales Manager, Commercial Vehicle Group, Wells Fargo Equipment Finance
The motorcoach industry has always had its fair share of challenges, typically brought on by major economic events. The most recent impact to the U.S. economy was the COVID-19 pandemic, and prior to the pandemic, companies had to navigate other significant financial setbacks such as recessions, 9/11, and the global financial crises of 2008.
Following COVID, the motorcoach industry is trying to navigate additional challenges such as acute driver shortages, historic inflationary cost increases, production supply chain issues, and rapidly rising interest rates. Time should solve these problems, but they will remain a challenge in the short term. Although these factors make it more expensive to operate a new coach, this article will focus on the impact of higher interest rates and new coach prices.
The dynamics that impact market interest rates vary. The most prominent dynamic over the last year has been the Federal Reserve’s rapid increase in the federal funds rate. The federal funds rate is the rate at which banks borrow from the government in overnight lending, which in turn influences a consumer’s or business’s market rate.
Since March 2022, the Federal Reserve has raised the federal funds rate nine times with an aggregate increase of 4.75 percent, or what has been the fastest pace of tightening since the early 1980s. The Fed implemented the increases to slow the economy down and control rampant inflation. As the market anticipates federal funds rate increases, the various market rates also increase.
A new dynamic came into play in March 2023 when the banking crises rattled the markets, potentially creating a two-fold effect. First, it will likely influence the quantity and duration of Federal Reserve interest rate increases as the health of the banking industry becomes its top priority. Second, the banking crises caused an immediate tightening of liquidity and credit, which could have the effect of slowing the economy and therefore causing interest rates to decrease.
From a historical perspective, interest rates are currently at an average level; however, they are considerably higher than they were over the last five years. When you couple high interest rates with higher motorcoach prices, the impact on monthly payments is significant. To illustrate that point, let’s walk through an example. The price of a new motorcoach in 2023 is approximately $75,000 more than it was in 2019. We know that interest rates continue to be volatile, but for this example we will say that borrowing costs are 3.5 percent higher than in 2019. For a new motorcoach, this would make the monthly payment $800 higher for a seven-year fully amortizing loan. That’s $9,600 higher over one year and $67,200 over the finance term. In a business where margins tend to be thin and most often multiple coaches are purchased or leased at once, these higher payments are significant.
There are some strategies a coach operator can employ to offset higher payments. A company can use cash as a down payment to bring the financed amount down and achieve a monthly payment that comfortably fits into a budget. Between government programs (i.e., Coronavirus Economic Relief for Transportation Service [CERTS], Employee Retention Tax Credit [ERTC], and Paycheck Protection Program [PPP], and others), as well as stronger margins coming out of COVID, companies that have a healthy cash position might consider using cash as a down payment to effectively deploy that cash. The cost of the funds to borrow is significantly higher than interest earned on cash, so it may be a good decision to put the cash to work in the form of lower borrowing amounts, particularly if a company is sitting on excess cash reserves.
A second option is to consider using a Terminal Rental Adjustment Clause (TRAC) lease product to finance your coach. Under a TRAC lease, the lessee (buyer) transfers the depreciation benefits to the lessor (lender). The lessee, however, writes off 100 percent of their lease payment for tax purposes. The depreciation benefits that the lessor utilizes can be passed on to the lessee in the form of lower rental payments, thus improving cash flow. Although there are many factors, which vary by lender, that affect payments on a TRAC lease, the cash flow savings over a loan could save a lessee hundreds of dollars on an 84-month term for a new coach.
Last, lessees should consider the projected trajectory of interest rates and how that factors into current loan decisions. As referenced earlier in this article, interest rates have been on a steady increase over the last year. Many economists are forecasting that rates will start coming down as early as late 2023 or early 2024. Economists within Wells Fargo are currently projecting that the Fed will begin decreasing the federal funds rate by the end of 2023 and project it will continue to cut rates throughout 2024.
Of course, how this ultimately plays out will be dependent on economic data, including a potential recession and inflation. For our third scenario, let’s assume a decreasing rate environment, as stated above, which would create a floating rate loan option — a strong financing product that is worth consideration. A floating rate would be a spread over a certain index (for example, a 30-day Secured Overnight Financing Rate). As the federal funds rate decreases, the index generally follows, causing the loan rate to decrease. This would allow the borrower to take advantage of potential changing market conditions. Although a floating rate loan rate may be higher in the near term and contain an element of risk if rates continue to rise, there could be benefits if the market rates do follow current projections and decrease in the future.
These suggestions are just a few ideas on how companies can combat the rising costs of financing in today’s markets. Keep in mind, the current volatility in the market due to the interest rate landscape may be very different from when this article was written to when it publishes. It is highly recommended that you talk to a tax professional as well as your current lenders to discuss these options and determine if any of them — or others — are right for your business.
The information contained herein is general in nature and not intended to provide you with specific advice or recommendations. Contact your attorney, accountant, tax or other professional advisor with regard to your individual situation. The author’s opinions do not necessarily reflect those of Wells Fargo Bank, N.A., Wells Fargo & Company or any other Wells Fargo entity.
About Wells Fargo Equipment Finance
Wells Fargo Equipment Finance helps companies acquire the equipment they need by providing a wide range of flexible loan and lease solutions, from small and high-volume standardized financings to large and highly-structured transactions, bringing together equipment and industry experience, customized offerings, and relationship management to serve the needs of our customers through all business cycles.
About The Author
Matt Hotchkiss (firstname.lastname@example.org) has spent his entire 30-year career in the equipment finance industry including the last 25 years in the motorcoach industry. He is the Bus Division Sales Manager at Wells Fargo Equipment Finance, with a team that originates new business through manufacturers, dealers, and end-users in the bus industry.