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Finance Types

• Leases
• Loans
• Structured Finance

Leases

• Capital Lease
  A lease accounting concept under Financial Accounting Standard No. 13 (FAS 13) and not a legal concept. In accounting parlance, a lease should be classified and accounted for by a lessee as a purchase and by the finance company, or lessor, as a sale or financing, if it meets any one of the following criteria: (a) the lessor transfers ownership to the lessee at the end of the lease term; (b) the lease contains an option to purchase the asset at a bargain price; (c) the lease term is equal to 75 percent or more of the estimated economic life of the property (exceptions for used property leased toward the end of its useful life) or (d) the present value of minimum lease rental payments is equal to 90 percent or more of the fair market value of the leased asset. A lease that fails all of these criteria is an operating lease for accounting purposes.
• Conditional Sales Lease
  A lease that is a disguised financing or conditional sale agreement. Although the document looks like a lease, it typically requires a substantial advance rent or down payment that may cause a court to treat the transaction as a secured loan. It is not a finance "lease" as defined in UCC Article 2A.
• Finance Lease
  A finance lease, in a business sense, is typically a full-payout, non-cancellable agreement in which the customer is responsible for maintenance, taxes and insurance. However, the term "finance lease" also refers in Article 2A of the Uniform Commercial Code (UCC) to a special type of "lease" in which the lessor, lessee and the manufacturer have contractual relationships and the lessor at all times, with the lessees acknowledgement, remains a passive investor where the lessee makes most equipment decisions directly with the manufacturer.
• First Amendment Lease
  A lease that provides the lessee with a purchase option at one or more defined points during the lease term. The customer must renew or continue the use of equipment under the lease if the purchase option is not exercised. The option price is usually either a fixed price intended to approximate fair market value, or is defined as fair market value, determined by the lessee's appraisal, and subject to a price floor that insures the finance company's residual position will be covered if the purchase option is exercised. If the purchase option is not exercised, then the lease is automatically renewed for a fixed term (typically 12 or 24 months) at a fixed rental intended to approximate fair rental value, which will further reduce the lessor's end-of-term residual position. The lessee is not permitted to return the equipment on the option exercise date. If the lease is automatically renewed, then at the expiration of that initial renewal term, the lessee typically has the right either to return the equipment without penalty or to renew or purchase at fair market value.
• Full Payout Lease
  A lease in which the finance company recovers, through the lease payments, all investment incurred in the lease transaction, plus an acceptable rate of return, without any reliance upon the future residual value of the equipment.
• Lease
  A contract that includes an option for the lessee either to renew the lease at fair market rental value or to purchase the equipment for its fair market value at the end of the lease term. Fair market value exists when a willing buyer and a willing seller agree on rent or purchase price, respectively, assuming the equipment is in the condition required by the lease in which the option is granted. A lease may contain either or both options.
• Master Lease
  A lease contract in which the customer leases currently needed assets and is able to acquire other equipment under the same basic terms and conditions without negotiating a new lease contract. Typically, the customer signs a schedule and related documents to add the new equipment.
• Municipal Lease
  A financial contract between a state or local government, such as a county, city, town, state university or municipal authority, or the federal government, and a financier. The financier often encounters specialized risks associated with the governmental rights and powers of the customer.
• Net Lease
  A property lease in which the customer agrees to pay all expenses normally associated with ownership, such as taxes, maintenance and insurance.
• Non-Lease Lease
  A lease in which the purchase option is a bargain and a prudent business person would purchase that results in the transfer of title to the lessee. Such leases are treated as loans because there is no residual value expectation or risk for the lessor at the end of the lease term like risks that owners take.
• Open-End Lease
  A conditional sale lease in which the customer guarantees that the finance company will realize a minimum value from the sale of the asset at the end of the lease. See TRAC Lease.
• Operating Lease
  A business concept (not the accounting concept under FAS 13) in which the lease lasts for short-term of use of equipment by the lessee. The finance company retains ownership of the equipment and expects the lessee to return the equipment at the end of a term of three to 10 years. The lessor realizes its return through higher rents and residual value, which usually requires and results from sales or re-leasing of the returned equipment. Additional services, such as maintenance and insurance, may be provided by the lessor.
• Sale-Leaseback
  An arrangement in a finance company purchases equipment from the business using the equipment. The finance company then becomes the equipment owner, and leases the equipment back to the original owner, which continues to use the equipment without disruption.
• Step Lease
  A financial contract in which the rent may change during the term of the lease contract. The rent change is known at inception, and is agreed upon by the financing company and lessee. Often a step-up lease allows the lessee to pay less initially and more later in the term. A step down lease works in the reverse manner, allowing the lessee to pay more initially and less later as the payment amount decreases over the term of the lease contract. These contracts are sometimes referred to as a "low-high" and a "high-low" lease structure, respectively.
• Synthetic Lease
  A financing agreement structured to be treated as a lease for accounting purposes, but as a loan for tax purposes. Synthetic leases may be used by corporations seeking off-balance sheet reporting of the asset-based financing, and which take the tax benefits of owning the financed equipment.
• Tax Lease or Guidelines Lease
  Revenue Procedure 2001-28 (Rev. Proc. 2001-28) establishes criteria for classifying a lease as a true lease for federal income tax purposes. It is the successor to Revenue Procedure 75-21, 1975-1 C.B. 715 and other related revenue procedures. Technically, Rev. Proc. 2001-28 establishes criteria for obtaining an advance ruling from the Internal Revenue Service (IRS) that a lease is a "true lease" as contrasted with a conditional sale. It is also used to determine whether a simple lease between a lessor and a lessee is a "true lease" for tax purposes, which entitles the lessor to take tax benefits arising from the purchase and lease of equipment to the lessee.
• TRAC Lease
  A lease that contains a special provision called a "terminal rental adjustment clause." TRAC leases apply to motor vehicles (including trailers) used more than 50 percent of the time in the trade or business of the lessee. Sometimes called an "open-end lease," a TRAC lease requires the lessee to make an unknown (open-ended) payment to the lessor at the end of the lease term. This "terminal rent" payment makes up any shortfall due to the lessor if the lessor does not receive proceeds of a sale or other disposition of the vehicle sufficient to recover its investment plus its return on the investment. The transaction looks and works like a balloon loan because the lessor transfers all residual value risk to the lessee. The lessor realizes residual value either when the lessee exercises an option to purchase the asset at the end of the lease at a stipulated amount or when the lessor sells the asset to a third-party. If the disposition of the vehicle results in excess proceeds, the lessee generally retains the excess.
• True Lease
  A lease is generally described in state law as a lease of property as described in UCC Article 2A-103(1)(j). However, a true lease involves other considerations. Section 1-201(37) of the UCC (1-201(37)) includes a "per se" or "bright-line" test to determine whether a transaction should be treated as a true lease or disguised security agreement. This test requires an objective analysis and is supposed to disregard the documents' labels and the parties' intent. Current law also includes an "economic realities" test designed to evaluate the facts of each transaction to determine whether the transaction is a lease or disguised financing. The bright-line and economic realities together have created confusing and inconsistent law affecting the leasing industry in determining whether a transaction constitutes a true lease.

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Loans

• Asset-Based Loan
  A secured business loan in which the borrower pledges as collateral any or all of the assets used in the conduct of its business. In equipment finance, sometimes categorized as a type of asset-based finance, the asset could be virtually any capital asset, including a computer, furniture, fixtures, facilities (mixed real and personal property such as a power plant), aircraft, vessels, rail cars, vehicles and software.
• Line of Credit
  An arranged amount of credit that a lender may advance a borrower under various types of credit agreements. Such advances may be based on several factors, such as inventory, accounts receivable and equipment as collateral and creditworthiness of the borrower.
• Non-Recourse Loan
  A type of loan for which the sole payment source is the collateral or its cash flow; and the only remedy available to the lender in the event of default is to foreclose on the collateral. The borrower is not personally liable for repayment. This type of loan is most often seen in leveraged leases and in various loans made in respect of lease interests in equipment or other capital assets.
• Unsecured Loan
  A loan that is not secured by assets, but is based solely on the creditworthiness of the customer.
• Conditional Sales
  A loan, deferred sale or lease which, in each case, refers to a sale in which the lessee (conditional buyer) takes possession of the equipment, but the lessor retains legal title to the equipment until the lessee makes the final lease or sale payment. After lessee makes the last payment, the lessor (conditional seller), without further payment, transfers title to the lessee (conditional buyer). Hence, the sale is conditioned on payment in full over a time period set at the inception of the transaction.

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Structured Finance

• Asset Securitization
  A securitization is the aggregation of large pools of financial assets, such as aircraft leases, credit card receivables, equipment leases, mortgages and student and other loans which serve as collateral for securities issued by a special purpose entity. The investors (which could include the public) purchase an interest in the pool in the form of bonds which are typically rated by one or more rating agencies. The bonds represent debt obligations of the issuer. They are secured or "collateralized" by the pool of assets. Because the issuer is almost always a special purpose entity with no other source of payment, the cash flow from the pool of assets usually provides the only means to repay the bonds.
• Syndications
  Participations of financial institutions in a sale and/or assignment of all or part of an underlying lease or loan transaction. For example, the lease rentals from a transaction originated by a lessor may be assigned to another financier as collateral for a loan to the assigning lessor or as an outright sale of lease rental stream.
• Project Finance
  A transaction in which capital is provided to the customer to finance a specific project. Usually a complex transaction, the project often involves non-recourse debt to the project company which owns the capital asset. The project company's cash flow from the project and project capital assets provide most, if not all, of the security to financiers advancing funds to pay for the project's assets. The sponsor typical makes an equity investment and is paid its return after the debt service has been paid as negotiated by the parties. A project financing may be composed of one or more loans, including subordinated debt, and/or a lease of real estate, equipment or other capital assets.
• Leveraged Lease
  A lease in which the finance company invests equity into the purchase of equipment or other capital asset, and borrows the balance from a lender to make the purchase. For example, a lessor may invest 20 percent and borrow 80 percent to buy the equipment or other capital asset.

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