Lenders are warning that the cost of financing construction equipment is set to reach levels unseen since the credit crunch. The Federal Reserve’s plan to raise borrowing rates further this year is expected to result in higher overhead costs for rental companies, impacting the financing of machinery acquisitions. Let’s take a look at the potential consequences of rising borrowing rates on the construction equipment financing sector.
Impact of Increasing Borrowing Rates
The Federal Reserve’s announcement of raising borrowing rates multiple times in the coming months is likely to affect rental companies, which rely on loans or long-term leases for equipment financing. Around 80% of equipment transactions are financed through leases and loans, according to the Equipment Leasing & Finance Association (ELFA). As borrowing costs increase, banks tend to pass on the additional expenses to clients, resulting in higher interest rates for rental purchase loans.
Rising Financing Costs
Traditional rental purchase loans, a popular method for construction equipment financing, now carry interest rates ranging from 8 to 9% annually, compared to the previous range of 3 to 4%. This significant increase in interest rates translates to higher overhead costs for rental companies. For instance, the interest payments on a $200,000 excavator purchased through rental purchase would rise from approximately $6,000 to $16,000 per year.
Potential Impact on Rental Companies
The financing costs for rental companies, which often purchase entire fleets of new machinery, can amount to millions of dollars. While delinquencies in loan payments have not increased significantly yet, lenders caution that a worsening economy could lead to a sharp rise in arrears. The anticipated economic downturn and rising inflation are factors that lenders believe may contribute to a higher rate of delinquency among construction equipment borrowers.
Declining Confidence in Equipment Finance Sector
The ELFA has issued a warning that customer spending on new construction equipment purchases made with loans or leases is expected to decline in the second half of 2023. Although investment in construction machinery has increased in recent months, indicating industry growth, trust across the sector has somewhat diminished. This suggests that the market may have in fact reached a peak, as reported by the ELFA.
Demand for Asset Financing
Despite the higher borrowing costs, banks note that there is still a strong demand for asset financing in the market. Many large rental clients are looking to update their fleets due to supply chain disruptions caused by the pandemic. Asset financing allows businesses to purchase equipment before prices rise further, as inflation rates remain high. The urgency to acquire assets before rising costs impact profitability contributes to the sustained demand for equipment financing.
Captive Finance and Flexible Lease Models
Manufacturers and financing companies are working to keep costs low for customers by leveraging captive finance arrangements. These arrangements enable manufacturers to offer promotional rates that absorb a portion of the increased interest rates. Additionally, flexible lease models, such as ‘lease by the hour,’ are being introduced to provide clients with more options to reduce monthly expenses. While operational leases have historically been less common in the construction equipment sector, they are gaining popularity for certain types of machines.
Future Trends and Fintech Competition Despite the current market conditions, fintech competition in the heavy equipment asset finance market has yet to materialize. However, lenders anticipate potential changes in the near future. Manufacturers and lenders are exploring digital-driven lease models and leveraging telematics data to provide more flexible and cost-effective financing options. Fintech companies are actively looking for ways to disrupt financial markets, indicating a potential shift in the construction equipment financing landscape.