A Lesser Known Alternative Finance Play Offering High Yields
Equity leasing is a form of alternative finance which in the past has been most commonly utilised as a mechanism by large corporations. However, as a result of lending restrictions placed on banks in the aftermath of the Basel III Accord, it is a financial arrangement becoming increasingly turned to by small and medium-sized companies.
Part of the regulatory changes that traditional lenders must adhere to include a tighter categorisation of the kind of assets that can be accepted as collateral against business loans. Banks are required to be more liquid than in the period prior to the global financial crises of 2007/8. This means that recipients of business loans are required not only to own assets that comfortably cover the value to the loan, which they are able to offer as collateral but that those assets must be considered ‘liquid’. Many banks which took possession of assets such as real estate and machinery from companies defaulting on loans faced a lengthy and expensive task to subsequently realise their cash value. Often these assets were sold at significantly below market value due to a glut of repossessions further clogging the market. As a result, banks now require collateral against business loans to match the definition of being easy to value, exchange-listed, traded in active markets, unencumbered, liquid during times of stress and, ideally, central bank-eligible.
Many businesses, small to large, own assets that comfortably cover the required level of collateral but do not meet the narrow definition now assigned to ‘high quality liquid assets’, and subsequently find it difficult to secure a business loan from their bank, or extend current loan facilities. This is where alternative financers have stepped in to fill a market need with ‘equity leasing’ facilities. Generally smaller and more agile operators financed by private equity, providers of equity leasing are unencumbered by the shorter term liquidity demands traditional lenders now find themselves placed under and are able to take a potentially longer position.
If a company owns significant fixed assets such as real estate or machinery, the equity leasing provider will lend assets meeting the bank’s criteria for liquidity to the company, usually through its principle shareholder. These assets are then placed into the company’s balance sheet, usually as a convertible bond, allowing it to qualify for the desired loan.
The equity leasing provider will typically charge an annual fee of 10% to 15% against the value of the loaned, or leased, assets, as well as over-collateralising against the company’s less liquid assets. This both means the return realised by the equity leasing provider is extremely attractive, compensating for any defaults that may occur amongst its portfolio of equity lease loans and any time and expense incurred through converting the less liquid collateral assets into cash.
The equity leasing model both provides a simple and effective solution for companies to begin new banking relationships or extend existing ones despite tight business lending restrictions while providing an attractive and sustainable risk to reward ratio for the lessor.