ss_blog_claim=bd50edc517cf0b7549fe6b5f63b6b5f8 The SLS Business Finance Blog: February 2009

Thursday, February 26, 2009

More On Collateral

Collateral can be a big factor in the approval process for an equipment lease.

Does collateral affect pricing? Absolutely

If collateral is strong (heavy asset or something with a large active secondary market), then a residual value can be more easily established and profit through the resale of the equipment more easily attained by the lessor. Those things mean better pricing, higher residual value and lower stream rate (interest rate payable on the monthly payment stream).

Why does a higher residual mean a lower stream rate?

Think of it this way, let's say the lessor's required return is 12%. With no residual, the 12% most come from the payment stream. With a good residual value, some of that 12% can come from the payment stream and some from the resale of the equipment (either to the lessee or in the secondary market if the equipment is returned. Here is an illustration with a $10,000 lease over 36 months:

Equip Value 10000 10000
Term 36 36
Residual 1000 1
Payment 329 329
Rate 6.26% 12.03%

Note the difference with the same monthly payment. The lessor only gets 6% of their return from the 36 month payment stream. The client (and lessee) also benefits because if the equipment is returned, then the $1000 residual value is saved since they aren't paying for that as well. A true win/win.

Southern Lending Solutions

Monday, February 23, 2009

Collateral Based Leases

Collateral can be an important factor in both the approval and the pricing of a lease. How so?

There are many companies in the equipment leasing business that make their $$ off the residual values. Many leases, and all true leases, are structured with a residual value and purchase option. Often that purchase option is $1, 10% or Fair Market Value (FMV). So leasing companies can make $$ on the residual if they do a 10% option and their real cost is 5 or 6%. That spread becomes their profit. Since lease rates have to be affordable and competitive, as well as profitable, this means lessors have to be familiar with the equipment type and know how much they can resell the equipment for should the client (the lessee) return the equipment. If the residual value is way too high, then the payments are way too low (at the same lease rate) and the lease isn't profitable so its a balancing act.

There are other factors that influence collateral's affect on pricing as well for future entries.

Southern Lending Solutions

Friday, February 20, 2009

Cash Flow

Everyone has heard that Cash is King and that's never been more true than it is today since companies have less access to credit than they used to. So what's important in analyzing a lease based on cash flow?

By cash flow, we mean cash flow circulating through the business. Cash Flow is one of the 3 primary business financial statements, along with the Income Statement (also known as P&L for profit and loss) and the Balance Sheet. The only exception to this is for startups where there is no cash flow and that cash flow has to come from another income source, other assets or from savings. One of the benefits of strong cash flow is often times, this equates to good business credit, as measured by Paydex, a service provided by Dun and Bradstreet.

In nearly every case we need the previous year's 3 financial statements and sometimes we need 2 years in order to look at trends. Remember, these companies often don't qualify on credit alone so more information is almost always required.

Debt Service Coverage Ratio is the ratio that defines the risk in this type of lease. How much cash flow runs through the business that can be used to service the debt? Most prefer to see a ratio of 2x or 2.0, meaning that the free cash flow covers twice the amount of the lease payment.

By analyzing cash flow of a company where cash flow is strong but credit is weak, we can often use the strength of the cash flow to answer the ultimate question, will they be able to pay this lease back.

Having poor credit makes it tougher but its by no means impossible especially if strong steady solid cash flow is a part of the picture.

Southern Lending Solutions

Monday, February 16, 2009

The 3 C's of Lending

Bankers are taught these in credit training and everyone who is in any money lending business looks at the 3 C's. What are they? They are:

1) Credit
2) Cash Flow (as measured by Debt Coverage Ratio)
3) Collateral

What differs between lenders of all types (even successful ones in different areas) is how they analyze the C's, which they emphasize more and what risk they attach to each C.

Bankers often require having all 3 C's or at least 2 very strong (Credit and Cash Flow usually). What makes equipment leasing different is often strength in only one C can still mean getting a deal done to get a client the equipment they need.

For instance, I use a couple equipment leasing companies that care much more about the cash flow of the business OR the collateral (in this case the equipment being leased) than they care about the credit profile of the owners. This is especially helpful in an environment like we have now where nearly every one's credit profile looks a little worse now than it did a year or two ago.

One company I'm currently working with has a terrible credit history but has good cash flow in their business and their need is for manufacturing equipment that helps increase their output of product. This is an ideal case for us as a banker would never touch a credit profile like this but for us, they have 2 of the C's covered (Cash Flow and Collateral). Two C's means we can find a home for them to get this new equipment that they need.

Most everyone understands the idea of credit based lending and pricing since that's how mortgages are often priced so we'll focus the next couple entries on the other C's of Cash Flow and Collateral and how they play into approvals and pricing for equipment leases.

Southern Lending Solutions

Monday, February 9, 2009

Changes at Marlin Leasing

Reprinted from Leasing News

January 6, 2008 SEC filing:
“On December 31, 2008, the Registrant’s wholly-owned subsidiary, Marlin Business Bank (“MBB”), received approval from the Federal Reserve Bank of San Francisco to become a member of the Federal Reserve System. In addition, on December 31, 2008, the Registrant received approval from the Federal Reserve Bank of San Francisco to become a bank holding company upon the conversion of MBB from an industrial bank to a commercial bank.

The Registrant has three months from the approval date to consummate the transaction unless such period is extended by the Federal Reserve System. Prior to consummating the transaction, the Registrant will seek to modify the Federal Deposit Insurance Corporation (“FDIC”) Orders issued when MBB became an industrial bank to eliminate any inconsistencies between the FDIC Orders and the Federal Reserve Bank’s approval.”

Editor's Note: Marlin had been a Utah Industrial Bank, but this filing allowed them to convert to a business bank and become part of the Federal Reserve system, allowing them to receive TARP funds.

This comes on the heels of them closing their broker division, which according to The Leasing News, is Marlin's most profitable division. These things together spell financial difficulty for the lessor and serve as a red flag to other lessors who have vendor divisions whose policies are too liberal.

Southern Lending Solutions