More funding, more collateral, more accounting – Leasing Life research reveals extent of parent banks’ switch of allegiance to factoring and leasing.
Parent banks are increasingly turning to secured asset-based lending rather than straight loans for their customers, Leasing Life research can reveal.
This is resulting in more business for bank-owned leasing companies which, in turn, are building up their portfolios with factoring and invoice discounting (ID) products.
Some banks are widening their customer exposure through leasing and factoring products, due to the inherent security behind asset-based products, rather than offering loans to customers.
Under one roof
Companies such as GE Capital, CA Leasing and Lloyds TSB Commercial Finance have already taken steps towards bringing their factoring and leasing arms under one roof – and more are expected to do so this year.
“Factoring is a much cleaner product,” said Godfrey Smith, the former CFO for the EMEA region of Bank of America Vendor Leasing. “You don’t get any problems from bank covenants or debt-to-equity ratios. If the opportunity is there, then banks will clearly look at asset-based lending.”
Smith added that at Bank of America, leasing only formed “around 35 percent to 40 percent” of the vendor finance business, with the rest made up in the factoring of long-term receivables and loans.
In one example seen by this magazine, a large European bank-owned lessor was asked to provide a €25 million factoring line to subsidiaries of an international energy group, as it already had an exposure of nearly €200 million with the bank.
The deal’s application notes made clear that the transaction fitted with its parent bank’s plans to replace ordinary loan facilities with asset-backed deals.
The appeal of factoring for leasing companies is clear: because lessors only buy the debt stream, they do not have to worry about any obligations.
Also, unless a default arises, they can remain undisclosed throughout the length of the contract.
“I also wonder to what extent the appeal of factoring for UK lessors is that you don’t have to worry, as it’s tax-neutral. With leasing, the government keeps playing with the rules,” added Smith.
As well as the increased usage of factoring and ID products, lessors are taking steps to circumvent risk more effectively when writing business, Leasing Life has found.
More and more customers are being asked to provide stronger guarantees for mid-sized and large deals.
Although these requirements had, to a lesser extent, existed in the past, last year’s recession has escalated the number of situations where guarantees have become essential in order for a deal to be approved.
Broadly speaking, there are three main methods for lessors to remove some of the risk from a deal: guarantees from directors or parent companies; collateral in the form of other assets or capital; or subordination clauses in a deal.
Although it certainly was never unusual for a project finance or real estate leasing contract to include guarantees or collateral, it has now become, as one large pan-European lessor put it, a “deal breaker” if lessees do not or cannot provide these.
“It is an essential condition that for the seller risk we should have recourse on the parent or a strong group company,” the lessor said.
‘Riskier’ cross-border deals
The upside of such guarantees is that they could allow lessors to continue to write potentially “riskier” cross-border deals.
These complex deals, which are often structured by local subsidiaries, usually involve finance being sourced from the parent.
But for these deals to work effectively, lessors must also manage the complex accounting issues that are inevitably raised by cross-border transactions.
These can include, for example, measures such as withholding tax, where lessors must ‘withhold’ tax on interest before a cross-border payment back to the parent can be made, and transfer pricing, which addresses funds moved between subsidiaries and parents.
Although the accounting headache of working cross-border often dissuades lessors from doing a deal, these can often be more lucrative because of their “riskier” nature.
The recent growth in larger guarantees or collateral helps to dilute this risk, however, making these deals ever more appealing to lessors.
It only remains to be seen whether this will now lead to widespread growth in cross-border transactions.