The Bold & Beautiful of Asset Lease Finance by Lease Rental Discounting

This is one of the bold innovative financing structures evolved in the field of lending. Urge of Lessors, Lessees, and Bankers to fall in love with it makes it really beautiful. Under an Asset Lease, there is a party who needs some asset(s) but does not want to shell out cash for purchasing the same. One of the reason may be that the balance sheet of the party is already heavily leveraged (i.e ratio of total outside liabilities to networth) and it does not want to further overstress the same. The other reason could be that the asset to be procured are expected to become obsolete after 2-3 years and the party may like to return these assets to the leasing agency and procure new assets (examples of such type of assets may be laptops, computers, servers etc. for office). In order to meet this requirement of the party, there are asset leasing agencies who supply the required assets on lease basis. Under the leasing arrangement, the assets are supplied for an agreed period (generally between 3 to 5 years) wherein the party agrees to pay monthly or quarterly rentals to the leasing agency. At the end of the lease period the party is provided option either to renew the contract for an extended period or return the assets to the leasing agency.

 

Now, the questions comes is that who funds the procurement cost for these equipments. Say for an example that the purchase cost of the equipments is USD 1100 and the party is willing to take these equipments for a one year lease and ready to pay USD 100 per month as rental. Therefore, if the leasing agency procures the equipment and puts on lease for a year it will get USD 1200 during the lease period of 12 months against the procurement cost of USD 1100 and difference of USD 100 will be the profit.  In order to earn this profit of USD 100, the lease agency will need to shell out USD 1100 from its own funds or other option is to take bank finance for a part of the procurement cost. Leasing agency would not like to entirely invest USD 1100 from its own coffers as it would need funds for expanding the business. Therefore, let’s say it decides to fund the procurement through bank loan.

Now the beautiful part of the transactions comes. The banker will discount the future expected monthly lease rentals (let’s assume nominal monthly discount rate of 20%) and arrives at value of USD 1080. So, the bank may provide USD 1050 and the leasing agency will shell out USD 50 (which will be treated as its contribution) for procurement of equipments worth USD 1100. The party to whom the equipments are rented is called Lessee, the leasing agency who procures the equipments for renting is called Lessor and the bank is called the Funder. The Lessor agrees to deposit the monthly rental into an escrow account with the banker so the banker is assured of directly getting the monthly instalment from the Lessee.  By the end of the lease period, the equipments become free from loan and can be put on lease again by the leasing agency. I would like readers to think about the risk factors involved in the transaction, and just to hint I would like to mention that there are many.