An assets-based financing representing alternative for usual loan financing, whereas Leasing companies are better positioned on the market and better equipped to provide the Client with these tailor-made services. As mentioned, the purpose of Leasing financing is purchase of any specific operating assets that are essential for running the business. In some cases, these may be even a core-assets, which means that Client would not be able to perform a business operations without them. These assets may represent various categories like:
- IT equipment, copy-machines, call center and other related hardware
- Fleet of company cars and transportation vehicles
- Construction machinery (fork-lift, mobile cranes, excavator etc.)
- Agricultural and industrial equipment
- Special vehicles incl. airplanes, railcars, helicopters, yachts etc.
What is quite clear from this list of eligible assets for leasing financing, is that these are hardly representing any collateral that any Bank would be able to finance and work with, especially in case of Client default, as their re-marketability requires certain market expertize. In general, the Bank is able to finance liquid assets like trade receivables or stocks, whereby the Bank gains quite good grip on assets (trade receivables are transformed into cash, which flows through accounts held with the Bank that provides financing). Most common product categories within Lease are:
- Financial lease – truly purchase contract of core assets needed for Client business, that are in the end handed-over from Lessor to Lessee (Client), as the Client will be using these assets even after the lease contract maturity. This is mostly due to the fact that useful life-time of such Assets highly exceed the lease contract tenor. The purchase price is gradually ammortised through lease installments to zero, so that Residual Value may be set to CZK 1,000 or similar negligible value.
- Operating lease – more close to pure rental contract, whereas Lessee is just using the assets for certain time period (maybe even 1 Year) and after the termination receives new assets; typical for assets that are quickly amortizing and their economic value decrease faster (cars, IT hardware).
- Sale and Lease-back – financing solution that is convenient for Real estates or Assets, that need some modernization, so that Client (original owner) sells the Assets to Lessor and then signs the rental contract for utilizing the same Assets for additional period (10Y and more), while the Assets may be modernized and these modernization costs will be included in rental contract installments. E.g., such solution is very common for railcars, whereas the Owner can benefit from the existing market value of the assets, that will be even increased within modernization and receives cash upfront from sale to Lessor.
- Hire purchase – is equivalent of loan financing, the Client has Debt and Assets on his own Balance sheet, so that no transfer of ownership is needed.
Further, vast part of these assets (except for IT equipment and personal cars) may have quite substantial purchase price, and their economic life-time spans over couple of years, so in order to align with that, usually equivalent of LT-financing is required by clients. Therefore, Leasing financing is optimum solution, having following typical features:
- Advanced payment (AP) – this is quasi Own equity contribution to the Purchase price, typically ranging from 10% to 30% depending on assets class and tenor. Certain exemption may be Operating lease, whereas AP can be zero and Client just pays rental fee (in case of Cars consisting of ammortisation, insurance costs and other service costs). However, due to AP not in place, the payment structure with Operating lease usualy leads to higher Residual value (see below details).
- Residual value (RV) – an equivalent of Balloon payment at Deal maturity, which is often used within Lending financing. This represents very last installment before the Lease contract is fully repaid and can be derived from Product type as such (Financial lease has usually RV close to zero, while Operating lease enables to end contract with e.g. 30% RV).
- Fixed period of the contract – agreed upfront, typically to match with depreciation plan of financed assets. However, operating lease provides higher flexibility as it can be even shorter (e.g. 1-2Y), as it represents rather an rental relationship.
- Ownership transferability – unlike typical Lending financing, Lease purchase is featured with change of ownership of the assets, especially in case of Financial lease, such transfer is given by-default and therefore Client is obliged to repay full purchase price. On the contrary to that, Operating lease may have various regimes (depending on which accounting standard is applied – IFRS, UK Gap, CZ local standard etc.) and usually ownership stays with Lessor (Leasing coy).
- RV Guarantee – in light of previously mentioned, the Lessor needs to have solved even before the actual contract start date, how will be Residual value risk carried-out from his own books. For this, usual contractual arrangement concluded with third Party is represented by RV Guarantee or Purchase commitment, whereas for instance in case of Cars fleet financing, the authorized Car Dealer agrees to purchase these assets after the completion of contract. This is very typical structure, as Client usually is renting the cars just for temporary period and needs to renew the fleet on regular basis, but is not keen to solve their re-marketability. On the other hand, Cars Dealer is able to commit to buy these cars as they still represent valuable assets on secondary market.
- Accounting/ Tax principles – representing special treatment that is given by applied Accounting standard or mutual agreement between Lessor and Lessee, where it is allowed naturally. In general, the Assets are held in books of Lessor and depreciated until the end of contract. Lessor also needs to pay relevant Taxes and Fees, while these are usually re-charged on the Lessee. Recently, IASB adopted new guidance for IFRS 16 treatment, which became valid since Jan 2019, whereby almost all lease contracts are recognized as assets and liabilities on the balance sheet (getting closer to the loan financing) regardless whether it is financial or operating leasing, more details to be found here.
Given the total complexity of the Assets-based financing and the fact that Assets are owned by Financing provider (Lessor), this activity can be carried-out by an specialized entity and not the Bank. On the other hand, the Leasing companies are very often subsidiaries or sister companies of commercial Banks, so that they do not represent a competitors but rather a cooperating partners for Banks, that can accomplish the product portfolio within the usual Lending business.