Asset financing in Nigeria is usually used to fund large expenditures like machinery, ships and vehicles. It is attractive because it can be cheaper than the company simply borrowing the money and buying the asset itself. This is because the bank actually owns the asset rather than the company owning the asset and the bank having a security charge over it. So the deal is a lower credit risk to the bank which it reflects in a lower implicit interest rate.
What is Asset Finance
Asset finance is a way of funding the acquisition of an asset by getting the bank to buy the asset and lease it to the company (called the lessee) that lessee) that would otherwise have borrowed the money to buy it. The lease will be for the asset’s useful economic life (say 15 years in the case of an aircraft, 20 in the case of a ship) over the course of which the lessee makes quarterly rental payments until the bank has recovered the cost of the asset and the implicit interest charged over the lease’s length (a bit like a repayment mortgage to buy a house)
The bank also gets tax allowances for buying the asset (developed economies provide tax advantages to encourage companies to invest in plant and machinery and so remain competitive). The bank (as lessor) passes on part of the benefit of these tax allowances to the lessee by way of reduced rental payments (usually lessees don’t have sufficient profits to make use of these allowances themselves whereas banks do). So the overall cost to the lessee can be a lot lower than if it owned the asset itself and bought it with a loan.
The lease contains promises (covenants) by the lessee to pay the rental, maintain and repair the asset, insure it, not to try to sell or charge it and not to jeopardize the availability of the tax breaks – otherwise the lease is collapsed into a loan at a higher rate of interest to reflect the loss of the tax allowances.
At the end of the primary term (the period that equates to the asset’s useful economic life) the bank will have recovered the asset’s cost and interest on it from the rental payments. So the bank has been paid out and really has no further financial interest in the asset.
If the asset has any value left it’s because of the care the lessee has taken to maintain it. So the lessee can either keep using it (the lease is extended for a secondary term at a nominal rent) or the asset is sold and the bank lets the lessee have the bulk of any proceeds of sales by way of rebate of rental (the lessee can’t just keep proceeds otherwise that would imply it was the owner all along and put the tax allowances at risk).
Finance leasing is a huge industry that spans the globe. In some countries the lessor gets the tax allowances, in others the lessee. Clever lawyers and bankers can structure deals so that the bank and its subsidiary are treated as the lessor in one country and the lessee in another, so that two sets of tax allowances become available. This is called a double dip and is a battleground between tax authorities and bankers. As soon as one double dip opportunity is closed by tax authorities, the bankers and their lawyer discover another.
Finance leases should not be confused with operating leases. If you rent a car when you go on holiday, that is an operating lease: it’s not for the car’s useful economic life and you can certainly don’t expect to maintain it or insure it. The hire company does that. Once you’ve returned it, the hire company leases it to another holiday-maker, and so on. However, car hire companies are often themselves lessees under a finance lease which they use to fund their vehicle fleet.