Lease structuring is done after the lessor has established the risk profile of a particular
transaction. Sometimes the lessor might not be sufficiently certain that the lessee will
meet his rentals as they fall due. To overcome this uncertainty, it may be necessary to
require some form of credit enhancement. However, credit enhancement should not be
the reason for entering into a lease with what otherwise would be unsatisfactory lessee.
The following techniques are used to compensate for increased credit risk in a particular
transaction:
a. Additional Security – This can take a variety of forms. The most common form is guarantee, which may be personal guarantee from directors, bank guarantee, bank letters of credit, cash collateral and charges over properties.
b. Financial Covenant/Credit Rating Triggers – Financial covenants or credit rating triggers can be included in the lease documentation. These provide the vehicle for ongoing monitoring of the lessee’s credit worthiness using objective criteria which if breached, enable the lessor to take specific action to properly protect his position. The inclusion of such clauses provides the lessor with early notice of potential difficulties.
c. Adjusting the Lease Yield – Some lessors may be motivated to take increased risk if they receive adequate compensation. However, a higher yield does not guarantee a good deal.
d. Use of Advance Payment – The lessee may be required to make some advance rental payments at the beginning of the lease to serve as a buffer against rental default.
e. Reduced Lease Tenor – A shorter lease tenor reduces the lessor’s exposure as he recovers his investment more quickly. Also, the fair market value of the equipment provides residual value protection to the lessor.
f. Security Deposit – The lessor may demand security deposit which will be refunded at the end of the lease if the lessee satisfactorily performed his obligations. In the event of default, the lessor can use the deposit to mitigate his loss.
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