Finance: Asset Finance
By James Dugdale
Published 15 July, 2020
What is asset finance?
Asset finance refers to the financing of assets, which involves lending or leasing to fund the purchase. Such purchases can include high-value assets such as aircraft, ships, and telecommunication equipment. It can also include smaller purchases such as lorries, machinery, and film equipment.
How are purchases structured?
There are two key actors involved in the financing of an asset. The first is the prospective owner or operator of the asset, and the second is the lender or lessor. Whether the second actor is a lender or leaser will be determined by the structure of the deal, which is usually either secured lending or leasing. It is possible for the financing of an asset to involve a mix of the two.
Secured lending is when a lender (usually a bank) provides a loan to the prospective owner. This allows the prospective owner to finance the asset without having to dip into their working capital. The asset being purchased is most commonly used as security for the loan. This means that the lender has a right to the asset should the prospective owner default on the loan. For this reason, the asset usually has to be ‘durable, identifiable, moveable, and saleable’ (DIMS).
Secured lending that involves only one lender is known as a bilateral loan since it involves the prospective owner and a sole lender. Bilateral loans can be advantageous as they reduce the complexity, and thus costs, involved in a deal. Additionally, in a bilateral loan arrangement, the lender does not share the interest on the loan with any other lenders. However, this is accompanied by an increased risk. The larger the sum being loaned, the higher the risk for the lender.
For this reason, a lender may prefer to provide a secured loan with a number of other lenders. This is known as a syndicated loan. Having multiple lenders involved in the financing of a project mitigates the risk for each lender, which is why syndicated lending is most common for the financing of high-value assets where the sum of the loan is particularly large.
Leasing is another form of asset finance, which involves the owner of an asset leasing it out to an operator. There are two primary forms of leasing in asset finance transactions, which are operating leases and finance leases. The key difference between the two lies in the economic ownership of the asset. Economic ownership is held by the party who takes on the risks and rewards of ownership, and in the case of an operating lease, economic ownership remains with the owner (the lessor), whereas in a finance lease the economic ownership is transferred to the operator.
In an operating lease, the owner will lease the asset to an operator, who will in return pay rent for the asset. Once the lease has expired, the operator returns the asset to the owner. Throughout the entire term of the loan, the owner retains the economic ownership of the asset. Operating leases may be an attractive option for companies who seek flexibility in the form of short term leases. This is often the case for companies who require assets only during a specific time of the year, such as passenger airlines who may want to increase the size of their fleet during the summer months.
Conversely, in a finance lease, the operator acquires the asset. In this case, the lessee usually pays in instalments which cumulatively equal the value of the asset, plus a return on investment for the lessor. For the duration of the lease, the operator has economic ownership of the asset, whilst the lessor retains legal ownership. At the end of the lease term, the lessee may be able to acquire the asset permanently, but this is subject to the agreement made at the beginning of the lease term.
Where lenders aim to turn a profit through interest on a loan, lessors generally aim to turn a profit by charging a cumulative sum of instalments that is greater than their original cost of acquisition.
Issues for lenders and lessors
A major concern for lenders is that the asset retains its value. It is for this reason that lenders may seek to minimise risk by applying the DIMS criteria to any assets they are considering financing. This is important for the lender, since if the operator defaults on their payments, the asset will be acquired in order to cover any outstanding payments.
Lessors will also want to ensure that their asset retains its value, particularly if they wish to lease the asset out to more lessees in the future. In this instance, the lessor aims to preserve the value of the asset so that it remains marketable. For this reason, lease agreements generally require the lessee to maintain the asset and only use it under a set of prescribed terms, which may, for example, outline conditions on sub-leasing or insurance.
How does asset finance impact a business?
Asset financing may be attractive to a business since it reduces the upfront costs of acquiring an asset. This can be particularly useful when acquiring high-value assets such as aircraft or ships. The business is, therefore, able to preserve its working capital and can budget accordingly to repay their loan or lease. Asset financing can also be a tax-efficient way to fund the purchase of an asset.
However, this consequently requires the business to make a long-term commitment to repaying the loan or lease. Additionally, the cost of acquiring an asset through asset finance is likely to be higher than buying the asset outright, since the lender and/or lessor will be looking to make a profit.
With regards to lending, in May 2020, the investment arm of the Allianz Group financed a purchase made by GLL Real Estate Partners. The purchase was of Bishop’s Square in Dublin, Ireland, which is an office building in Dublin’s Central Business District.
In June 2019, Goshawk Aviation Limited announced the sale of 18 aircraft to Pioneer Aircraft Finance Limited and Pioneer Aircraft Finance. The 18 aircraft are on lease to a number of different lessees, and Goshawk Management Limited will act as the asset manager.
In terms of long-term loans, ING Capital and Société Générale provided a US$230 million 12-year loan to Ethiopian Airlines in June, 2018. This loan was used to finance the purchase of five Boeing 737-8 aircraft.