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May 1, 2008updated 12 Apr 2017 4:54pm

Caution favours the bold

Buying leasing portfolios in the current climate could be an attractive option Grant Thornton partner Tarun Mistry runs through the potential pitfalls and how to avoid them.

By Tarun Mistry

Buying leasing portfolios in the current climate could be an attractive option. Grant Thornton partner Tarun Mistry runs through the potential pitfalls and how to avoid them.

 

Acquisition is a quick and popular way to grow any business. Now, more than ever, caution must be observed when negotiating that next corporate transaction. This article explores the general key risks associated with acquiring a leasing business. Obviously, specific issues with an individual transaction will need to be considered.

Funding risk

While many transactions historically occurred as an asset portfolio and debt facility package, many sales are now offered without a debt facility in place. A number of financial institutions, for example, are seeking to liquidate their asset leasing portfolios as a means of generating liquidity. As a result, acquirers may need to secure a debt finance facility at the time of acquisition.

It goes without saying that debt funding in the current environment is difficult. These difficulties will be magnified if there are concerns about the business model.

Also, acquirers should expect to contribute greater levels of equity than they have in the past.

Asset risk

The market value of any leasing portfolio is subject to a degree of uncertainty. Determining the value will result in lengthy discussions between vendor and potential acquirer. Market values must be determined with respect to recent asset remarketing evidence where available, and acquirers must bear in mind that most asset values have decreased in recent times and a level of uncertainty will remain for some time. Specific consideration should be given to return conditions, assets approaching the end of their lease term, and those subject to default and vulnerable to voluntary terminations.

Credit risk

The credit risk inherent in a portfolio is likely to be greater than recent historical experience. Therefore future losses will be difficult to predict. Detailed analysis of underlying asset categories and customer types should be performed. Any exposures to large customers should be subject to even more in-depth investigation.

The underwriting policies of many asset leasing organisations have been relaxed gradually over the course of the past few years. The impact of such practices may not yet be evident in the results of lessors.

Acquirers should ensure that any changes to underwriting policies do not expose the business to significant losses post acquisition.

Other major issues to consider are what covenants exist in the portfolio, and whether there are any early-warnings in the leases that might highlight potential losses in the future.

Cross-defaults should also be considered where the lease may be triggered in-line with the lessees’ other facilities. Indeed, the lease may trigger other facilities, placing the acquirer in a crowd of other creditors.

Service risk

The ability of the target company to continue to provide contractual services, and the possibility of it facing penalties in the future, should be evaluated. The service cash flows need to be considered, especially in a run-off or ageing portfolio scenario. Thorough review of contractual agreements and associated side letters will hopefully identify all potential service liabilities and their timing.

Other risks

Acquirers should also undertake a thorough review of forecasts and their underlying assumptions, investigate any foreign exchange exposures, review financial reporting procedures, gain a thorough understanding of the business operations, and consider commercial, taxation, compliance and information technology risks.

While there are significant risks associated with acquiring an asset leasing business in the current environment, a thorough due diligence process will ensure any exposures are understood. Certain transaction values are currently low by historical standards and acquisitions could generate significant synergy benefits. However, without a thorough due diligence process, numerous issues may arise in the future.

Buyers, be wary, and don’t underestimate post-acquisition integration issues.

The author is head of leasing and asset finance at Grant Thornton UK

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