INGREDIENTS OF RISK MITIGATION IN LEASING

In any venture, the question of risk cannot be overlooked in the sense that the investor is taking the chance that the investment might not eventually yield the desired return or the actual cash flow might fall below expectation. Hence, in every investment particularly leasing, risk must be analysed. Risk may be defined here as the possibility that an expected stream of earnings or cash flows may have associated with it, the undesired chance of non-attainment. This non-attainment often referred to as the possible variability in outcome due to uncertainties about the future. As far as risk analysis in leasing is concerned.

For easy understanding, 27 C’s of lease credit for assessing lessee shall be discussed::

  1. Confirmation which is the ability of the lessor to obtain and confirm information supplied by the lessee upon which to base all quantitative and judgemental risk appraisals. Information is obtainable from the audited accounts of the lessee, tax returns, periodic reports made to the Nigerian Securities and Exchange Commission and the Nigerian Stock Exchange, press reports in the financial and economic journals and newspapers, analyst reports and bankers’ confidential reports.
  2. Corroboration which involves the lessor validating the information obtained from the lessee through bank references showing the lessee’s bankers, loans obtained, amount outstanding, payment records, length of banking relationship, highest credit limit and any outstanding leases with other lessors. Of course, the lessee should give the lessor a written authority to obtain information from its bankers.
  3. Catastrophe is the need for the lessor to assess the lessee from a worst-case position and build up the lessee’s potential performance from that standpoint.
  4. Concatenation involves the lessor deciding on what key variables are important in the credit assessment and appraisals process.
  5. Classification involves ranking the key credit variables identified earlier in descending order of importance in an attempt to prioritise them.
  6. Consideration is defined as the extent to which credit standards are achieved based on pre-selected subjective scores attached to each credit variables.
  7. Computation in calculating the scores on each variable and aggregating them for a final decision thus:

Confirmation                         Classification                             Consideration                                   Computation

Past Performance                   0.20                         x                      2                      =               0.40

Future Potential                      0.20                         x                      4                      =               0.80

Payback Record                      0.20                        x                      1                      =               0.20

Economic Risk                        0.20                         x                      3                      =               0.60

Market Leadership                  0.10                         x                      3                      =               0.30

Cash flow Generating

Capacity                                   0.10                         x                     4                      =               0.40

 

EXPECTED VALUE                                                                                                                             2.70

Less than 1.00……………Reject Outright          2.10 to 2.8 ………………… Accept

1.01 to 1.50. ……………..Reconsider       2.51 to 3.00 ………………..            Accept

1.51 to 2.00……………… Accept at  highest

  1. Compilation involves aggregating the weighted average of the computed figures from the computation and then deriving the decision rule for arriving at the credit decision.
  2. Character of the Lessee is the willingness to honour obligations as they fall due based on past experience, references, integrity, honesty and commitment to discharge financial responsibilities even in difficult times. Sources of information for ascertaining the character of a lessee include bankers, creditors, and other lessors with whom the lessee has had dealings and the degree of completeness of the lessee’s financial statements, including disclosure of off-balance sheet financial arrangements.
  3. Capital refers to the soundness of the lessee’s financial position as evidenced by his prevailing debt or capital-gearing ratio. Essentially, capital is a function of the resources at the lessee’s disposal, particularly the physical productive assets in full use. However, to minimise risk, the lessor should be attracted to companies with low debt/equity ratios – that is high net worth and low gearing.

Depending on your particular need, we can arrange a special session for your staff to comprehensively discuss on the risks in leasing business. Contact us today, 08023176691, 08023179048, info@elannigeria.org, elan_nigeria@yahoo.com