Leasing in a changing landscape
Leasing has evolved in response to market demand and legislation but its advantages remain the same as they were when leasing was first developed in the 50s and 60s.
Latest posts by Derek Soper (see all)
- An evolving trajectory for leasing and asset finance - December 2, 2013
- Leasing in a changing landscape - December 2, 2013
- The evolution of leasing's commercial framework - December 2, 2013
Introduction from Executive Producer LINDSAY TOWN
As part of our Leasing Fundamentals series, Derek Soper, Chairman of IAA-Advisory and of the Leasing Foundation looks at how leasing has constantly evolved in response to market demand and changes imposed by legislation but emphasises how its advantages remain much the same as they were when leasing was first developed in the 50s and 60s.
Who should be interested in this?
New entrants to the leasing and asset finance industry, industry commentators, anyone wanting to understand the context of modern-day leasing.
Leasing in a changing landscape
Advantages to lessees
For the users of assets, leasing offers firstly an additional source of finance with no initial outlay other than the first rental. It extends the range of options for the financing and acquisition of capital equipment and allows companies to adopt a mixed financing strategy using leasing as one of several facilities that can be employed simultaneously to finance capital investment.
Leasing also offers flexibility in the financing of fixed assets. Lease rentals can be tailored to match the anticipated income generated by the use of an asset, thus making the investment “self-funding” with payment periods broadly matching the economic life of the asset. This applies particularly when assets will not generate income evenly, as a result of seasonal trade or delays in commencement of production. Lessors may also build into a lease some form of sharing arrangement with the lessee in relation to any residual value which may be contained in the asset following the end of the lease.
There is usually a certainty of access to credit where a lease is a medium-term facility. Unlike some forms of loan finance, which are repayable on demand, or subject to annual review, leasing finance cannot normally be withdrawn or curtailed in the event of a credit squeeze or a change in economic conditions: except as a consequence of default by the lessee. The lessor cannot normally seek to accelerate the payment of lease rentals during the primary lease period.
Leasing can also have advantages in terms of pure availability of finance. It may on occasion be the only suitable form of external finance available to a company. Leasing facilities on fixed terms can be obtained at times when it may not be possible for a company to arrange a comparable loan for a five-year period, or longer, either at a fixed interest rate or on any other terms.
Leasing gives fiscal efficiency for the lessee as well as the lessor. In most countries lease rentals are fully deductible by the lessee for tax purposes. A lease may be structured to provide after-tax savings for both tax-paying and non-tax paying companies. The ‘capital allowances' that are available on the purchase of most types of plant and machinery are usually claimed by the lessor and the benefits of any resultant tax deferment are normally reflected in the calculation of the rentals. A competitively priced rental stream is attractive to those companies whose taxable profits are insufficient to obtain immediate and full benefit from the allowances to which they would be entitled if purchasing the equipment.
In some countries short-term leasing can also be tax efficient for companies with taxable profits. By entering into a three-year lease the full rental may be offset against the lessee’s profits over the period of the lease, rather than the lessee purchasing the equipment and claiming the allowances over a longer period. It should be noted that these tax advantages have been stopped in a number of countries with the various tax authorities producing tax legislation to prevent ‘tax manipulation'.
Leasing may also help to preserve the lessee’s debt capacity. Leasing facilities are freely available in the market, and as such can be used as additional sources of finance to those available from the lessee’s bankers. Debt-raising capacity may thus remain available to meet working capital or other needs deriving from internal growth or acquisition. A lease is not a loan, and as such may not come under the type of borrowing restrictions that are sometimes found in a company’s Articles of Association, debentures, bond or other loan agreements. A lessor’s sole security is the asset financed and, from the lessee’s standpoint, this may be preferable to the creation of a fixed or floating charge over held assets.
The principal attraction of leasing turns on its price competitiveness when compared with alternative sources of finance. The practice of competitive bidding for business by lessors tends to ensure that leasing transactions are keenly priced with fixed rate terms normally available for periods of up to seven years. When tax benefits are included in the calculations, leasing rates often provide significant cost advantages over traditional forms of borrowing.
Advantages to lessors
Leasing may also provide financiers with the additional security or reward necessary to encourage them to offer asset financing facilities for new types of risk. This may be ‘new customers', or the financing of new technology such as wind farms or waste disposal plants. Ownership of an asset may be preferable to a mortgage or charge, the enforcement of which may be difficult and the cost of registration, if available, high. In this respect leasing differs from most, though not all forms of finance. An instalment-purchase facility can, however, be used to give the financier the same type of security as with a lease; so in this respect leasing is not unique.
Financial institutions, mainly banks, who offer traditional lending such as overdraft facilities, term loans and acceptance credit financing frequently add leasing to their services, thus retaining customer loyalty. New customers attracted by the leasing service can be offered the full range of financial services offered by the bank.
For the lessor, margins achieved on leasing transactions can, through the addition of a range of additional services and possibly fiscal benefits, be greater than those achieved on traditional forms of lending, especially where the leasing option is attractive to the lessee.
Furthermore, as leasing is an asset-based form of finance, additional security is required less often than with other forms of finance and the resulting administration costs can be reduced.
There are also certain specialised forms of leasing – notably sales-aid leasing where substantially higher margins can be achieved than in the leasing market generally. Where the lessee if offered a lease as part of the package for the supply of equipment, the effective cost of the leasing finance, as opposed to the capital cost of the equipment, may be a less sensitive factor in the overall transaction.
In recent years many of the major manufacturers of equipment have formed their own ‘captive' leasing companies who are charged with working alongside the manufacturers sales teams in order to offer attractive leasing terms to the manufacturers customers. This sector of the leasing industry is one of the fastest growing sectors of the business.
Leasing in a changing landscape by Derek Soper is licensed under a Creative Commons Attribution 4.0 International License.