Leasing: a value added financing tool for all corporates
Commerzbank Corporates & Markets examines the benefits of leasing in corporate finance
Author: Eoin Moore, Managing Director, Structured Asset Solutions Team, Commerzbank Corporates & Markets
Lease financing, alongside bank lending, has long been a complementary source of financing for the capital expenditure requirements of companies, ranging from large multinationals to SMEs.
There has been strong growth in the European leasing market in recent years. Lease Europe estimates that new leasing volumes grew 9.5% in 2014, and by a further 9.1% in the first half of 2015. Leasing is estimated to have financed 23.5% of total new investment in equipment and vehicles in Europe in 2014, up from 22.1% in 2013.
Below we look at some of the benefits of leasing that are leading to increased use of this funding tool by companies throughout Europe.
A flexible financing solution for asset investment
Compared to financing via a traditional loan, leasing is a highly flexible means to fund the acquisition of assets or equipment. Deal size, repayment profile and term can be tailored to the underlying assets acquired and the client’s specific financing requirements.
Financing is provided for 100% of the acquisition cost of the assets. Relative to bank loans, there is also a higher degree of flexibility on deal size. Unlike bank loans, leases may not have covenants on the company given the security of the underlying asset.
Drawdown and repayment terms can be tailored to match the revenue generation profile of the assets. Funding may be drawn during a construction phase, with repayments delayed until revenues start to come on stream or structured to reflect a ramp-up period or seasonality.
The term of lease facilities is also often longer than bank loans. For assets with long economic life, long term repayment periods can be negotiated. In addition to the security of long term committed funding, this substantially reduces the size of individual repayments.
As an example of the bespoke nature of lease financing, a European energy company recently approached Commerzbank regarding funding for a new plant. Following assessment of various alternatives, we concluded that a structured lease facility would best achieve the client’s objectives. Lease financing of over €100m was provided to the company, with a repayment term of over 15 years satisfying the client’s requirement for long term funding. The facility included a drawdown period spanning a construction phase of several years and a highly customised amortisation profile to match the forecast financial profile of the project.
Transfer of asset risk and additional services
Leasing also enables companies to benefit from full economic use of assets without bearing the risk of ownership. Operating leases and contract hire provide temporary and flexible use of assets, with risks like asset depreciation or obsolescence borne by the lessor. The rent payable is also reduced due to the residual value of the asset at maturity. Operating leases are typically off-balance sheet for accounting purposes which is attractive for lessees, but accounting standards are due to change in this regard. Going forward, usage-based leasing arrangements are expected to increase.
Leasing therefore provides a cost-effective solution to companies that require the use of an asset for a period shorter than its useful life. This can apply to many assets, and Commerzbank has provided operating leases of varying sizes to clients in a broad range of industries.
In addition to reduced exposure to risks of asset ownership, a range of additional services can be provided as part of a leasing facility. Maintenance services and asset insurance are frequently included. Lessees can also have an option to upgrade assets. At the end of the lease term, various options may be offered regarding disposal of the asset. Such services are becoming more important in the context of environmental concerns. Leasing therefore helps companies outsource their key asset management needs, freeing up time and resources to focus on their core business.
Release of capital tied up in existing assets
In addition to funding the acquisition of new assets, leasing is also a very effective means of using existing assets to raise capital for deployment in other areas of the business.
Capital tied up in unencumbered fixed assets can be unlocked via sale and leaseback arrangements. The lessor purchases the asset at an agreed value and leases it back to the company, with the lessee potentially having the option to repurchase the asset at a fixed future value. The company is free to invest the sale proceeds in its business. This can be a quick and efficient way of raising new funds, potentially at lower cost and including the benefits of leasing such as attractive term and repayment profile.
Capital can also be released via refinancing vendor finance that companies provide to their customers. Similarly, vendor programmes from lessors provide a key source of sales support for many manufacturers.
Customer service agreements that have a fixed payment stream may also be applicable. This can be a very attractive form of financing as it releases capital, provides the liquidity benefit of upfront payment and can enable customers to manage credit exposure with larger customers.
Commerzbank was recently approached by a global IT services company seeking to monetise certain receivables relating to an IT outsourcing contract with an international customer. By working closely with the company, we were able to isolate the fixed component of the payment stream and acquired these receivables on a non-recourse basis. This provided the client with a significant liquidity benefit from up-front payment, improved returns on capital and reduced credit exposure to the underlying customer.
An increasingly important source of financing for SMEs
Leasing is an important means of financing for larger corporates. However, it plays an even more important role for SMEs. Recent research indicates over 40% of European SMEs use leasing, thereby financing a higher proportion of SME investment than any other individual form of bank lending.
The financial benefits of leasing detailed above are particularly attractive for smaller companies. In addition, as longer term committed funding, leasing is typically viewed as more secure than bank overdraft facilities.
Banks are the key providers of lease financing to SMEs. However, at the smaller end of the SME segment, independent leasing companies also play an important role. In the years following the financial crisis, these leasing companies experienced a significant contraction in their sources of funding. In recent years, financing conditions for small ticket lessors have improved, which has enabled strong growth in this market. Commerzbank recently provided an innovative structured debt facility to Kennet Equipment Leasing, a small ticket leasing company in the UK. The permanent wholesale finance facility, tailored to the profile of business that Kennet originates, will enable the company to quickly grow its lease portfolio creating a new independent lessor of scale and providing much needed finance to SMEs in the UK. Commerzbank partnered with the European Investment Fund on this facility.
For any company involved in asset acquisition, lease financing is a flexible and value-added addition to the financing mix that can provide a much more tailored financing solution than traditional bank loans. As such, the strong growth in new leasing volumes in Europe is likely to continue.
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