The costs of those items can be daunting at times, especially for lessors, since equipment leasing companies are traditionally undercapitalized and can take advantage of “leveraged leases.” That provides significant opportunities for full-service commercial banks to serve their financing needs by discounting the stream of leasing payments and providing the lessor bridge loans, working capital loans, equity loans, or equity investments on a residual sharing basis.
Smart Business talked to Brian Griffin, senior vice president with MB Financial Bank, to learn how equipment leasing companies and lessees can utilize banks’ services to leverage and expand their businesses.
How do lessors benefit from the bank’s role in the leasing process?
Since most lessors are not well capitalized, they often offer leveraged leases to their customers (lessees). The lessor determines the amount of equity he feels is appropriate for a transaction, based on his estimate of the value of the equipment at the end of the lease term, and invests that amount into the lease. The bank provides the ‘debt side’ of the transaction to the lessor by lending (on a nonrecourse basis) the difference between the equipment cost and the equity, and takes an assignment of the lease payments from the lessee and the underlying equipment as their collateral.
How does such a partnership work?
For example, if a piece of equipment the lessor wants to purchase costs $1 million, and he determines that the amount of equity to invest in the transaction is 10 percent, based on the estimate of the residual value of the equipment at the end of the lease term, he will invest $100,000 into the transaction. Then, the lessor asks the bank to discount the stream of the rental payments from the customer. If the bank agrees, it will provide the balance of the remaining costs, secured by the assignment of the rental stream from the lessee, as well as the underlying equipment.
When can lessors take advantage of beneficial loans?
If a lessor needs to close a transaction before lease funding is available, a bank can provide a bridge loan. Similarly, if the lessor wishes to finance his equity investment or spread his risk, a bank can provide equity loans or consider sharing in the equity with the lessor.
How do lessees benefit?
Leasing equipment frees money from a business’ excess cash balances and allows it to be used for other purposes, like research and development. Leases are often carried off balance sheet.
Timing is also an issue. A lessee may need a specific piece of equipment, but on a short-term basis only. Thus, it makes more sense to lease the equipment than buy it. Conversely, the lessee can lease a piece of equipment, decide it needs the equipment on a long-term basis, and purchase it. In either case, the outcome gives the lessee flexibility, which is an additional benefit to the leasing strategy.
How important is creditworthiness in the leasing process?
Lessors and lessees alike must maintain the highest investment-grade credit ratings possible. Banks’ decisions to provide loans are based primarily on their creditworthiness. High credit ratings can sometimes speed up loan committees’ approvals, and the better a company’s credit, the better pricing it will get on its leasing transactions.
Companies without the highest ratings are eligible for loans as well. Some banks will look at full three-year audited financial statements and current interim figures for unrated companies.
Are legal documents complicated in a lease transaction?
Some lease structures are a bit complex, but most small- to middle-sized transactions are not overly sophisticated. So most leasing companies utilize a standard set of documents. They must be completed diligently, though, since regulatory agencies are giving closer scrutiny to documentation and conforming to laws and guidelines.
What criteria should lessors and lessees consider when selecting banks for equipment leases?
The size of its lease funding portfolio, its minimum and maximum levels of funding transactions and lease funding history, what types of companies the bank typically finances, whether the bank will consider equity financing or investments and provide bridge loans, and flexibility in funding leases.
Some banks specialize in three- to five-year leases, for instance, but might grant longer terms for selected transactions. Other factors are the bank’s longstanding relationship in the leasing community and membership in organizations such as the Equipment Leasing Association (ELA) and Information Technology Resellers Association (ITRA).
BRIAN GRIFFIN is a senior vice president with MB Financial Bank. Reach him at (847) 653-1874 or firstname.lastname@example.org.