The assessment of the various risks confronted by a lessor (owner of an asset) continues with these:
- ADDITIONAL RISK ELEMENTS
Several other risks may impact the credit decision but may not be apparent at the time of initial risk assessment. These risks are equally important and need to be fully considered.
i. Funding
Funding mismatch is a major risk that may affect the lessor’s operation. A lease may be financed on a fixed or variable rate basis. It is important to have the type of funds that matches the profile of the lease. For instance, borrowing at variable rates whilst providing leases at fixed rates, can lead to losses for a lessor when there is increase in cost of funds during the lease tenor.
Funding mismatch may also arise from equipment upgrade re-financing and agreed early terminations. Therefore, a lessor needs to determine the maturity profile for its assets, which is going to be no more than best estimate of its funding requirements. The level of funding mismatch risk that lessor is prepared to take on its portfolio, will form a major part of its operational strategy.
A further funding risk may arise from the ability of the lessor to access the necessary funding required to finance a lease through its whole term. Clearly, this liquidity risk increases in proportion to the tenor of the lease and the financial strength of the lessor.
Even when the lessor is able to continue to raise the necessary funding, the cost of money may rise, reducing the profitability of the underlying lease, if the extra cost cannot be passed on
ii. Risk of Catastrophe
Downside risk should be adequately assessed in the evaluation process. The lessor should identify the worst-case scenario and then evaluate its probability and the level of any exposure. Providing sufficient protection against downside risk is a component of risk assessment.
iii. Complexity
The lessor must consider the additional risks of entering into a very complex transaction. In recent years, lease transactions have increased in complexity. For example, the technological sophistication of equipment has risen significantly especially for high technology equipment. Also, lease agreements are becoming more detailed. Consequently, the use of innovative structures and increased reliance on tax benefits has raised the level of risk the lessor faces.
iv. Taxation
Tax assumptions such as prevailing tax rates and the value of capital allowances are usually made by lessors when evaluating a lease. Subsequent changes in these key factors of tax based leasing, may impact on the profitability of the lease unless the rental paid can be varied to cater for the lessor’s after-tax margin.
v. Portfolio Consideration
A proposed lease facility should be considered in relation to its impact on the lessor’s lease portfolio. A diverse portfolio spending over a wide base of lessee, equipment types and industries will provide better protection than a portfolio with one major lessee or exposure to only one industry. Thus, a lessor with a total portfolio of N500 million, should be wary of granting a new N750million to a new lessee, even though the lessee and facility assessments have both reached positive conclusion
vi. Fraud Consideration
Risk assessment should give due consideration to the possibility of fraud and appropriate enquiries made before the inception of the lease. The most common forms of fraud perpetrated by lessees, include provision of false information to induce the lessor to provide a lease, multiple lease financing of some assets particularly in a sale and leaseback transaction, unauthorised disposal of leased assets, inflated pricing of asset and financing of non-existent assets.
It is therefore essential for the lessor to exercise due diligence in his relationship with the lessee. This will involve verification of the information provided by the lessee, inspecting the leased assets on delivery to prevent non-existent asset fraud, labeling/plating the asset.
To fully gain foothold on how best to mitigate risks in leasing, contact the experts, 08023176691, 08023179048, info@elannigeria.org, elan_nigeria@yahoo.com