LEVERAGED LEASES: STRUCTURE AND BENEFITS

Leveraged Leases in India: Structure and Benefits

Leveraged leasing is a popular financing mechanism used globally, and its adoption in India has been growing steadily. This article explores the structure and benefits of leveraged leases in the Indian context.

Understanding Leveraged Leases

Definition
A leveraged lease is a financial arrangement in which a lessor uses a combination of equity and debt to finance the leasing of an asset. The lessor provides a portion of the capital (typically 20-40%) while the rest is financed through loans from lenders.

Participants

• Lessor: The owner of the asset who leases it to the lessee.
• Lessee: The user of the asset who makes lease payments.
• Lender: Financial institutions that provide the debt portion of the financing.

Structure of Leveraged Leases

1. Initial Financing

• The lessor identifies an asset to be leased and secures financing from lenders.
• The lessor contributes equity, and lenders provide the remaining capital through loans.

2. Asset Acquisition

• The lessor uses the combined funds to purchase the asset.
• Title of the asset remains with the lessor, but the lessee gains the right to use the asset.

3. Lease Agreement

• The lessor and lessee enter into a lease agreement, outlining the lease term, payment schedule, and other conditions.
• The lessee makes regular lease payments to the lessor.

4. Debt Servicing

• A significant portion of the lease payments made by the lessee is used to service the debt incurred by the lessor.
• Lenders have a security interest in the asset and the lease payments.

5. End of Lease Term

• At the end of the lease term, the lessee may have options such as purchasing the asset, renewing the lease, or returning the asset to the lessor.

Benefits of Leveraged Leases

For Lessors:

1. Increased Return on Investment

• Leveraged leases allow lessors to earn higher returns on their equity investment due to the leverage provided by debt financing.

2. Tax Benefits

• Lessors can benefit from tax deductions on interest payments and depreciation on the asset, enhancing after-tax returns.

3. Risk Mitigation

• By using debt financing, lessors can mitigate their risk exposure since a significant portion of the investment is provided by lenders.

For Lessees:

1. Lower Capital Requirement

• Lessees can use high-value assets without needing to purchase them outright, freeing up capital for other business needs.

2. Off-Balance-Sheet Financing

• Leveraged leases can be structured to keep the leased asset off the lessee’s balance sheet, improving financial ratios and borrowing capacity.

3. Flexible Terms

• Lease terms can be customized to match the lessee’s cash flow and operational requirements, providing greater flexibility.

4. Access to High-Value Assets

• Lessees can gain access to expensive equipment and infrastructure that might be unaffordable otherwise.

Challenges and Considerations

Regulatory Compliance

• Leveraged leases in India must comply with various regulations, including those set by the Reserve Bank of India (RBI) and other financial authorities.

Credit Risk

• The creditworthiness of the lessee is crucial, as it impacts the risk profile of the lease and the willingness of lenders to provide financing.

Complex Structuring

• Setting up a leveraged lease involves complex legal and financial structuring, requiring expertise and careful planning.

Market Conditions

• The viability of leveraged leases is influenced by market conditions, interest rates, and the availability of financing.

Leveraged leases offer a strategic financing solution for acquiring high-value assets while optimizing tax and financial benefits. In India, the growing adoption of leveraged leasing is driven by its ability to provide substantial financial leverage, flexibility, and capital efficiency. Both lessors and lessees can derive significant advantages, making it an attractive option in the evolving landscape of Indian finance. However, careful consideration of regulatory, credit, and market factors is essential for successful implementation.