GAO 

United States General Accounting Office 

Testimony 

For Release 

on Delivery 

Zxpected at 

1O:OO a.m. 

Wednesday 

August 2, 1989 

LEASE REFINANCING 

Observations on GSA's Proposed Master Leasing 

and Army's Lease Refinancing Programs 

Statement of 

Jeffrey C. Steinhoff 

Director, Financial Management Systems Issues 

Accounting and Financial Management Division 

Before the 

Committee on Government Operations 

House of Representatives 

rm/ ‘3Qu, 

GAO/T-AFMD-89-4 
Mr. Chairman and Members of the Committee: 

We are pleased to be here today to discuss our initial 

assessment of the Master Installment Purchase System (MIPS) 

program proposed by the General Services Administration (GSA) and 

the related Army program of lease refinancings currently 

underway. As you requested, we assessed whether separating the 

purchasing and financing of equipment under a master lease, as 

called for by the MIPS and Army programs, could significantly 

reduce lease finance costs. This testimony is our interim report 

on the structure, scope, and objectives of the proposed MIPS and 

Army lease refinancing programs and the potential for these 

programs to reduce federal equipment leasing costs. 

Both programs have the potential for reducing lease finance 

costs by obtaining financing from private investors based on 

borrowing rates available directly to the government rather than 

the rates available to equipment vendor/lessors. Finance costs 

can be high because, under current federal lease practices, the 

borrowing rates available to equipment vendors/lessors reflect 

their credit rating, rather than the federal government's. As a 

result, vendor/lessor borrowing rates are often higher than those 

available directly to the government. 

A key reason why agencies lease equipment rather than 

purchase it outright is because budget constraints preclude them 

from obtaining the budget authority for outright purchases in a 
single fiscal year. Leases with purchase options allow agencies 

to acquire needed equipment while spreading out the budgetary 

impact of the acquisition cost over several fiscal years. The 

major additional cost to the government of spreading out the 

budgetary impact of equipment purchases through leasing is the 

difference between the rates tied to Treasury securities and 

those available from private sector borrowers. The MIPS and Army 

lease refinancing programs, which involve purchasing the 

equipment from the vendor/lessor and obtaining financing in the 

private sector financial markets, based on the government's 

credit rating, reduce total leasing costs by reducing the lease 

finance cost component. 

My remarks today will cover five areas: information on 

equipment leasing, GAO's prior work in this area, the GSA and 

Army programs, and the proposed automatic data processing 

equipment pilot program included in the Committee's July 20 

discussion draft of the Paperwork Reduction Act reauthorization. 

EQUIPMENT LEASING REQUIREMENTS 

The Federal Acquisition Regulation (FAR) contains guidance 

on the acquisition of equipment by lease or purchase. The FAR 

envisions two primary means for agencies to acquire needed 

equipment: (1) the one-time, outright purchase of equipment and 

(2) the lease (rental) of equipment. 

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Equipment should be purchased when there is an established, 

long-term need for it and the technology involved is not changing 

so rapidly as to render it obsolete in the short-term. The 

underlying premise is that outright purchases result in the 

lowest cost because financing would be based on interest rates on 

comparable Treasury securities. 

On the other hand, equipment should be leased when the 

government has a short-term need for the equipment and/or the 

equipment is subject to rapid state-of-the-art changes and 

advances in technology. In this case, leasing would normally 

cost less than purchasing the equipment. However, since the 

federal budgetary environment and Gramm-Rudman-Hollings targets 

look at cost on a cash basis, an agency is not always in a 

position to make the most cost-effective or economical decision 

on whether to purchase or lease. 

The FAR provides that if a lease is warranted, a lease with 

a purchase option is generally preferable. Such leases allow 

agencies to acquire equipment and to spread out the budgetary 

impact over a number of fiscal years. These leases, however, are 

more costly than outright purchases because they are financed at 

the lessors' generally higher borrowing rates and because lessors 

charge additional fees to compensate them in case agencies 

exercise clauses intended to protect the government's interest, 

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such as the termination for convenience, right of offset, and 

risk of loss. 

PRIOR GAO REVIEW 

ON LEASE FINANCING 

In a 1985 report,1 GAO addressed the issue of leases with 

high finance costs in relation to computer leasing practices. 

We pointed out that agencies generally lease ADP equipment from 

the manufacturer using the following three types of leases: 

-- Rental lease. The lessor retains title to the equipment 

throughout the system life, and the leases are annual 

leases with options for annual renewals. 

-- Lease with option to purchase. The lessor retains title 

to the equipment until agencies exercise lease purchase 

options. Under these leases, agencies earn rental or 

purchase option credits which are used to reduce the 

purchase price of the equipment. These are also annual 

leases, and agencies are under no obligation to continue 

the lease beyond each annual lease period. 

1Effective Management of Computer Leasing Needed to Reduce 

Government Costs (GAO/IMTEC-85-3, March 21, 1985). 

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-- Lease-to-ownership plans. Title transfers to the 

agencies after payment of a predetermined number of lease 

payments. These are annual leases with annual options to 

renew. Agencies are not obligated to renew the leases. 

GSA's proposed MIPS and the Army's current lease refinancing 

programs are both responsive to our 1985 report. Both 

initiatives use the principles of a sale/leaseback transaction 

discussed in our 1985 report to separate the purchase of the 

equipment from the acquisition financing to support the 

equipment purchase. 

PROPOSED MIPS PROGRAM 

COULD REDUCE FUTURE 

EQUIPMENT LEASE COSTS 

Conceptually, GSA's proposed MIPS program can reduce the 

government's leasing costs. However, there are still some issues 

to be resolved before the program can be implemented. 

The MIPS program involves only new leases for information 

technology (IT) equipment. Under the, MIPS proposal, an agency 

would solicit equipment purchase and lease prices from 

vendor/lessors. If the agency has sufficient budgetary 

authority, it would generally purchase the equipment. If not, it 

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could agree to lease the equipment through the proposed MIPS 

program. 

The MIPS proposal would separate equipment procurement from 

lease financing. Specifically, GSA would retain a private 

contractor to develop and implement the MIPS program under which 

GSA and the contractor would periodically pool equipment that 

agencies intend to acquire under a master lease. The contractor 

would purchase the equipment and raise the funds to support the 

purchases by selling financial interests in the master lease to 

private investors. GSA and the contractor would jointly develop 

a standard master lease that GSA would use when entering into a 

multiyear agreement with the contractor under the IT Fund's 

multiyear contracting authority. GSA would lease the equipment 

back to the agencies under an interagency agreement. Agencies 

would make lease payments to GSA's IT Fund from which one lease 

payment would be made to the contractor who would repay the 

investors. At the end of the multiyear lease term, GSA would own 

the leased equipment. 

Under the MIPS program, potential savings result from 

arranging lower lease financing than is available from the 

equipment vendor/lessor. The proposed MIPS program facilitates 

the use of private financial markets to finance lease 

acquisitions by the creation of pools of leased equipment with 

aggregate dollar values large enough to attract investors and to 

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allow offerings through established private securities markets. 

In addition, MIPS program pooling of equipment helps spread the 

financial risks investors may have on any one item of equipment 

that the government may lease because the government will be less 

likely not to renew an entire pool than it would be to fail to 

renew a single lease, thus making them more attractive 

investments. 

MIPS-type master financing lease programs have been 

successfully used by states and large cities to reduce their 

leasing costs. Florida, Michigan, New York, and West Virginia 

have used master lease programs to fund the acquisition of 

capital assets. 

The Office of Management and Budget (OMB) has objected to 

the MIPS program for two reasons. First, OMB views such programs 

as installment purchase contracts which are more costly than 

outright purchases and enable agencies to purchase equipment 

without fully disclosing the total acquisition costs. Second, 

OMB maintains that such programs may violate the AntiDeficiency Act since agencies, in effect, would be entering into 

multiyear installment purchase contracts that commit the 

government to pay for the entire cost of the equipment 

acquisition while obligating only annual costs. Although all of 

the details of GSA's MIPS program proposal have not been 
finalized, we believe that GSA can develop a MIPS program 

consistent with the Anti-Deficiency Act. 

PROPOSED PILOT TO TEST MIPS-TYPE PROGRAM FEASIBILITY 

Section 203 of the Committee's discussion draft directs GSA 

to establish a pilot program designed to reduce the financing 

costs of leasing ADP equipment. We have two general comments to 

offer the Committee in connection with its consideration of this 

section. 

First, section 203 mandates that GSA establish a MIPS-type 

program. As you may know, GSA in the past has considered 

various proposals to reduce ADP lease financing costs, most 

recently its MIPS proposal, but has not yet implemented a 

proposal. Section 203 would require GSA to implement such a 

program on a pilot basis. 

Second, the language of section 203 of the discussion draft 

is not entirely consistent with the MIPS concept as we understand 

it. For example, the discussion draft appears to contemplate 

that GSA will only aggregate agency leases instead of either 

aggregating agency leases or new equipment under a master lease. 

Also, the discussion draft suggests that GSA would be performing 

several of the functions that under the MIPS proposal, as we 

understand it, would be performed by the third-party contractor. 

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To improve the technical precision of the Committee's 

proposal, we would be happy to work with the Committee to revise 

section 203 to more closely reflect our understanding of a MIPStype program. 

ARMY'S PROGRAM OF LEASE 

REFINANCINGS COULD 

APPRECIABLY REDUCE CURRENT 

EQUIPMENT LEASE COSTS 

The Army program of refinancing existing leases could reduce 

the costs of such leases. Its program covers all types of 

equipment currently leased by the Army, including ADP and 

telecommunications equipment, vehicles, and construction 

equipment. The program entails 

-- identifying equipment leases with purchase options and 

high finance costs: 

-- establishing pools of high finance cost leases and 

exercising the Army's equipment purchase options: 

-- financing the equipment purchases by selling financial 

interests in the pools of leases to private investors; 

and 

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-- leasing the purchased equipment back to the Army, at 

lower costs, under a standard master lease agreement. 

The Army's program uses a master lease concept similar to 

the MIPS program, but it has several fundamental differences. 

Specifically, the Army's program: 

-- Will not result in a multiyear contract. The master 

lease may be renewed on an annual basis at the option of 

the Army. 

-- Is not an installment purchase program for new equipment, 

but instead is a program to exercise purchase options 

contained in existing equipment leases and lease the 

equipment back. 

-- Makes existing leases more economical by reducing their 

finance costs. 

Army does not have the requisite data for estimating how 

much couid be saved by implementing its lease refinancing 

program. Army and Department of Defense (DOD) financial 

management systems for leases do not contain the detailed 

information needed to identify equipment leases with high finance 

costs. Army is in the process of identifying these leases. The 

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time-consuming effort is still underway and must be completed 

before Army can pool these leases for refinancing and estimate 

cost savings. 

While information is not available to estimate potential 

lease cost savings, lease financing concepts such as MIPS and the 

Army program have the potential for appreciable dollar savings. 

OBSERVATIONS 

The outright purchase of equipment, financed through 

issuance of Treasury debt, is the lowest cost method of financing 

equipment acquisitions. If, however, outright equipment 

purchases are not feasible, and a lease is selected as the means 

to finance equipment acquisitions, a MIPS-type program has the 

potential to reduce equipment leasing costs. If properly 

structured and implemented, a MIPS approach appears to be a 

reasonable compromise to fit equipment acquisitions within 

budgetary authority, outlay, and deficit reduction targets and 

to reduce the high financing costs associated with the current 

financing leases held by the government. A pilot program as 

envisioned by section 203 of the discussion draft provides a 

mechanism to test the feasibility and cost-saving potential of a 

MIPS-type program. The Army program of lease refinancings 

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appears to be a reasonable remedial method to reduce the 

financing costs associated with existing lease purchase 

contracts. 

The next phase of our review for the Committee will focus on 

assessing the feasibility and potential benefits of implementing 

MIPS or an Army-type lease refinancing concept DOD-wide. 

Mr. Chairman, this concludes my prepared statement. I will 

be happy to answer any questions you or members of the Committee 

have at this time. 

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