Lease Finance

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Why Leasing????
1. Leasing is a source for financing capital assets 2. Why leasing & not owning ? High rate of inflation Severe cost escalation Heavy taxation Meagre internal resources

Leasing- the concept

Is a contract The owner of the asset (lessor) grants to Another party ( lessee) The exclusive right to use the asset Usually for an agreed period of time In return for the payment of rent

Implications for the lessor

Has to deliver the asset to the lessee To legally authorize the lessee to use the asset To leave the asset in the peaceful possession of the lessee during the currency of the agreement

Implications for the lessee

Has the obligation to pay the lease rentals as specified in the agreement To protect the lessors title To take reasonable care of the asset To return the asset to the lessor at the expiry of the lease period

Importance/ advantages of lease financing

Saving of cap- as lease covers 100% of the cost of the asset. Lessee need not make down payment Flexibility- contract can be tailor made as to terms & conditions Simple, easy & hassle free source of finance Free from restrictive covenants ( debt eq ratio etc) & mortgage of assets

 Is a hedge against the inflation as the lease rentals do not change with change in inflation Provides flexible end of the period options- return, extend or purchase Permits equip upgrade at the end of the lease Leasing does not affect the borrowing capacity of the lessee as lease debt is not considered as a direct liability Lease rentals are tax deductible Helps a co to remain asset light

Steps in a leasing agreement

1. Lessee to decide on the asset & its specification 2. Select the supplier 3. Enter into an agmt with lessor with the foll : a) Basic lease period during which lease is irrecoverable b) The timing & amt of periodical rental payments c) Option to renew the lease or purchase the asset d) Details regarding pymt of cost of maintenance, repairs, taxes, insurance etc

4. After the agmt, lessor contacts mfrer & makes pymt to him 5. The asset is delivered to the lessee

Leasing in India
Leasing initiated in 1973 by First Leasing Company of India Ltd 2nd co to be set up was 20th Century Finance Corp in 1980 In 1982 many banks, FIs decided to enter the industry But banks were allowed only in 1994 Post liberalization, GE Capital made an entry

Challenges facing the Indian Leasing Industry

1. Shortage of funds- leasing cos have not been successful in raising loans from banks/ public. Hence they are in trouble due to the lack of funds & inability of the mgmt to raise funds 2. Unhealthy competition leasing cos facing stiff competition from banks & Fis who have access to cheap source of funds. The leasing mkt not developed commensurate to the growth of leasing cos. Hence supply> demand.

3. Lack of trained employees- leading to no of complicated problems. In many cases the top mgmt also does not have wnough knowledge of leasing business 4. Delayed payment of rent & bad debts add to the problem 5. No focused/ dedicated mechanismHousing Finance Corporations / Banks enjoy special recovery platforms such as DRTs / Recovery officers / Securitisation Act 2002

6. NBFC Stigma Credibility issues , Industry brand image 7. TDS on interest payments to NBFCs Not applicable to banks 8. Multiplicity of taxes - Sales tax / Service tax on lease txns

Types of lease

financial

operating

leverage

Sale & lease back

Cross border

Financial lease Lessee uses the asset over most of its economic life The lessor will recover all/most of the cost of the asset from the rentals Contains purchase option

Operating lease some Lessor will have substantial residual value Not so

Lessee is responsible for maintenance Lessor is responsible Lessee selects the asset Risk of obsolescence by lessee Non- cancellable lease Long period lease Lessor does so By lessor Generally cancellable Short period lease

Lessee has the benefits (claiming dep) Lessor has the benefits & risks of & risks( of obsolescence) of asset owning the asset Aircraft, L&B, heavy machinery Fulfills finance function Computer, equip, automobiles Fulfills service function

Leveraged lease
3 parties are involved- the lessor, the lessee & long term lender The lessor is the owner of the asset as well as the borrower of the loan The lessor pays only 20-40% of the cost of the asset. The rest is financed by the lender The borrowing is secured by the 1st lien on the property, assignment of lease & lease rentals

 The lender is paid off directly by the lessee from the lease rentals & the surplus goes to the lessor The lessor is entitled to claim dep on the entire cost of the asset He also claims int on the loan as a tax deductible expense This lease is complex coz of the size of txn, no of parties involved & unique advantage to all the parties coz of the legal exp & adm exp involved, used only for large cap outlay proj

Sale & Lease back

Is a sub part of financial lease The owner of the asset sells the asset to a buyer The buyer leases the same asset to the seller for lease rentals The seller gets the agreed selling price The buyer gets the lease rentals Thus the SELLER = LESSEE The BUYER = LESSOR

 Repair & maintenance have to be borne by lessee An imp adv of this lease is that the seller receives cash from the sale of the asset which can be used for other purposes This type of lease is suitable for assets that appreciate

Cross Border lease

The lessor supplying the equipment is domiciled in 1 country & the lessee is domiciled in another country