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Analytical Techniques for Lease Financing. Session Speaker: Mohammad Shafiullah Lecturer, BIBM. What is Leasing?. Leasing , in general, is viewed as a method of financing for acquisition of capital equipment.
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Analytical Techniques for Lease Financing Session Speaker: Mohammad Shafiullah Lecturer, BIBM
What is Leasing? • Leasing, in general, is viewed as a method of financing for acquisition of capital equipment. • Leasing involves a contractual relationship under which the owner (lessor) of an asset or property provides it to a firm or a person (lessee) for the purpose of using it for a specified period of time, usually against an agreed sum of rent.
Some Conceptual Differences: Sometimes peoples are misguided Leasing Hire Purchase Installment Purchase
History of Leasing Business: • Leasing begins in 2010 B.C. • However, modern leasing began in the 1950s • Industrial Promotion and Development Company of Bangladesh Ltd. (IPDC) in 1981 (First) • 1986 by setting up of the second leasing company named Industrial Development Leasing Company of Bangladesh Ltd. (IDLC).
History of Leasing Business: Contd… • This is followed by the establishment of United Leasing Company Ltd. (ULC) and UAE-Bangladesh invested company Ltd. (UAEBICL) in 1989. • Subsequently, First Lease International Ltd. (FLIL) came into being as a leasing company in 1993. • In 1995, two new leasing companies namely Uttara Finance and Investment Ltd. (UFIL) and Phoenix Leasing Company Ltd. (PLC) were formed. • A boom has been observed in this area in 1996. Five new companies entered into the leasing industry
Types of Lease • Basic Types: • Operating Lease • Financial Lease / Capital Lease • Other Types: • Leverage Lease • Sale and Leaseback • International Lease • In-House Lease
Operating Lease • Operating Lease: When benefit and risk associated with the ownership of the leased assets are not transferred to the lessee. Operating lease, sometimes called service lease.
Other issues related to Operating Lease • As a owner of the asset, Lessor will bear the maintenance & insurance cost. • A cancelable clause will be inserted in the contract. • Report depreciation expenses only in the book of lessor. • Rent and period of lease would be fixed. • Lessor bears the risk of obsolescence.
Financial / Capital Lease • Financial Lease: It is defined as a lease that transfer the risks and reward incidental to ownership of an asset to lessee. • Ownership would be transferred at the end of the lease period • Lease contains bargain purchase option • The lease term is equal to 75% or more of the estimated economic life of the leased property • PV of rental is 90% of the fair market value
Other issues related to Fin. Lease • Lessee will bear the maintenance & insurance cost. • Lessee bears the risk of obsolescence. • Report depreciation expenses or rent expenses in the book of lessee but not both. • Rent and period of lease would be fixed.
Diagram of Criteria for Lease Classification Lease Agreement NO OL Is there a Bargain Purchase Opinion? Is there a Transfer Of Ownership? Is Lease Term >/= 75% of Economic Life Is PV of payment >/= 90% of Fair Value? Yes Capital Lease
Other Lease • Leverage Lease: The leverage lease arrangements are made when very large and capital-intensive assets are to be acquired as nuclear power plants, telecommunication units etc. These agreements are generally made when a single lessor cannot provide the entire purchase price of the assets. • Sale and Leaseback Leasing: under sale and leaseback leasing agreement, a firm sell an asset to another firm, generally a leasing company, which in turn leases it back to previous owner.
Other Lease International Leasing: • Cross Border Leasing: Leasing across national frontiers is Cross Border leasing. Cross Border leasing exists where the lessee and lessor are domiciled in different counties. It includes export leasing. • Overseas Subsidiaries: When a financial institution sets up leasing subsidiaries overseas, each conducting purely domestic business involving lessees in the same country they are called overseas subsidiaries. • Import Leasing: Import leasing is an arrangement by which a leasing company, a manufacturing company or the government enters into an agreement with a foreign company to acquire sophisticated equipment’s on the lease basis. In fact, this activity requires a lot of government support and suitable changes in the import regulations
Other Lease • In-House Leasing: When a holding company promotes a leasing company for the benefit of companies in the same group, that company is known as ‘In-House Company’. The leasing activity of aforesaid company is known as in house leasing.
Banks’ Entry in Leasing Business: • Commercial banks started their journey effectively in 1995. • Prime Bank Ltd as a commercial bank is the pioneer in this turning point. • It sanctioned Tk. 15.26 crores against lease finance during that particular year. • This amount reached Tk. 92 crores in the year 2002, with an annual growth rate of 25.18%. • Dhaka Bank Ltd. introduced lease finance in 1997. • NCCBL in 1998, Uttara Bank Ltd. and Mercantile Bank in 1999. • EXIM Bank in 2001.
Non-performing Assets in Leasing: • Loan defaults have remained the major problem in the financial sector on Bangladesh. The classified loan as percentage of total loans of the banking sector was 15.38% in 2008. • But leasing companies are free from this culture. The average percentage of non-performing loan of leasing companies is about 2% of their total portfolio in 2008.
When to go for a Lease • The lease offers a financial advantage as well as a tax advantage. • The lease has a financial disadvantage but offers a tax advantage and the later is more than the former. • The lease offers a financial advantage but has a tax disadvantage and the former is more than the later.
Cost of Owning (Purchase through borrowing)
Cost of Leasing (Use of Asset through Leasing)
Other issues to go for a Lease • High debt-equity ratio • High risk of obsolescence. • Security requirements • Restrictive Covenants • Interest rate variation clauses
