LEASES

Leases as Lessor

We lease revenue earning equipment to customers for periods ranging from three to seven years for trucks and tractors and up to ten years for trailers. From time to time, we may also lease facilities to third parties. The majority of our leases are classified as operating leases. However, some of our revenue earning equipment leases are classified as direct financing leases and, to a lesser extent, sales-type leases. The net investment in direct financing and sales-type leases consisted of:



	December 31,
	2012			2011
	(In thousands)
Total minimum lease payments receivable	$	629,919		561,772
Less: Executory costs	(201,777		)	(181,820	)
Minimum lease payments receivable	428,142			379,952
Less: Allowance for uncollectibles	(703		)	(903	)
Net minimum lease payments receivable	427,439			379,049
Unguaranteed residuals	60,764			63,472
Less: Unearned income	(96,280		)	(92,637	)
Net investment in direct financing and sales-type leases	391,923			349,884
Current portion	(76,395		)	(68,896	)
Non-current portion	$	315,528		280,988

Our direct financing lease customers operate in a wide variety of industries, and we have no significant customer concentrations in any one industry. We assess credit risk for all of our customers including those who lease equipment under direct financing leases. Credit risk is assessed using an internally developed model which incorporates credit scores from third party providers and our own custom risk ratings and is updated on a monthly basis. The external credit scores are developed based on the customer’s historical payment patterns and an overall assessment of the likelihood of delinquent payments. Our internal ratings are weighted based on the industry that the customer operates, company size, years in business, and other credit-related indicators (i.e. profitability, cash flow, liquidity, tangible net worth, etc.). Any one of the following factors may result in a customer being classified as high risk: i) the customer has a history of late payments; ii) the customer has open lawsuits, liens or judgments; iii) the customer has been in business less than 3 years; and iv) the customer operates in an industry with low barriers to entry. For those customers who are designated as high risk, we typically require deposits to be paid in advance in order to mitigate our credit risk. Additionally, our receivables are collateralized by the vehicle’s fair value, which further mitigates our credit risk.

The following table presents the credit risk profile by creditworthiness category of our direct financing lease receivables at December 31, 2012:



	December 31,
	2012		2011
	(In thousands)
Very low risk to low risk	$	193,123	121,836
Moderate	177,400		190,070
Moderately high to high risk	57,619		68,046

	$	428,142	$	379,952

The following table is a rollforward of the allowance for credit losses on direct financing lease receivables for the twelve months ended December 31, 2012:



	(In thousands)
Balance at December 31, 2010	$	784
Charged to earnings	867
Deductions	(748		)
Balance at December 31, 2011	903
Charged to earnings	812
Deductions	(1,012		)

Balance at December 31, 2012	$	703

As of December 31, 2012 and 2011, the amount of direct financing lease receivables which were past due was not significant and there were no impaired receivables. Accordingly, there was no material risk of default with respect to the direct financing lease receivables as of December 31, 2012 or 2011.

Leases as Lessee

We lease vehicles, facilities and office equipment under operating lease agreements. Rental payments on certain vehicle lease agreements vary based on the number of miles run during the period. Generally, vehicle lease agreements specify that rental payments be adjusted periodically based on changes in interest rates and provide for early termination at stipulated values. None of our leasing arrangements contain restrictive financial covenants.

We periodically enter into sale and leaseback transactions to lower the total cost of funding our operations and to diversify our funding among different types of funding instruments. These sale-leaseback transactions are often executed with third-party financial institutions not deemed to be VIEs. In general, these sale-leaseback transactions result in a reduction in revenue earning equipment and debt on the balance sheet, as proceeds from the sale of revenue earning equipment are used primarily to repay debt. Sale-leaseback transactions accounted for as operating leases will result in reduced depreciation and interest expense and increased equipment rental expense. During 2012, we completed a sale-leaseback transaction of revenue earning equipment with a third party and the leaseback was accounted for as an operating lease. Proceeds from the sale-leaseback transaction totaled $130 million. During 2011, we completed a sale-leaseback transaction of revenue earning equipment with a third party and the leaseback was accounted for as a capital lease. Proceeds from the sale-leaseback transaction totaled $37 million. We did not enter into any sale-leaseback transactions during 2010.

Certain leases contain purchase and/or renewal options, as well as limited guarantees for a portion of the lessor’s residual value. Certain residual value guarantees are conditional on termination of the lease prior to its contractual lease term. The amount of residual value guarantees expected to be paid is recognized as rent expense over the expected remaining term of the lease. Facts and circumstances that impact management’s estimates of residual value guarantees include the market for used equipment, the condition of the equipment at the end of the lease and inherent limitations in the estimation process. See Note 19, “Guarantees,” for additional information.

During 2012, 2011 and 2010, rent expense (including rent of facilities but excluding contingent rentals) was $148 million, $154 million, and $156 million, respectively. During 2012, 2011 and 2010, contingent rental expense comprised of residual value guarantees, payments based on miles run and adjustments to rental payments for changes in interest rates on all other leased vehicles was $(1) million, $(2) million, and $(2) million, respectively.

Lease Payments

Future minimum payments for leases in effect at December 31, 2012 were as follows:



	As Lessor ⁽¹⁾			As Lessee
	Operating Leases		Direct Financing Leases	Operating Leases
	(In thousands)
2013	$	823,369	107,890	106,688
2014	620,533		87,459	96,402
2015	475,226		73,507	54,414
2016	348,897		60,254	34,261
2017	230,016		40,109	21,365
Thereafter	172,756		58,923	58,765
Total	$	2,670,797	428,142	371,895

____________________

(1)

Amounts do not include contingent rentals, which may be received under certain leases on the basis of miles of use or changes in the Consumer Price Index. Contingent rentals from operating leases included in revenue during 2012, 2011 and 2010 were $319 million, $303 million, and $294 million, respectively. Contingent rentals from direct financing leases included in revenue during 2012, 2011, and 2010 were $11 million, $11 million, and $12 million, respectively.

The amounts in the previous table related to the lease of revenue earning equipment are based upon the general assumption that revenue earning equipment will remain on lease for the length of time specified by the respective lease agreements. The future minimum payments presented above related to the lease of revenue earning equipment are not a projection of future lease revenue or expense; no effect has been given to renewals, new business, cancellations, contingent rentals or future rate changes.