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Jelf TOC Fall 09.Indd OURNAL J OF EQUIPMENT LEASE FINANCING Articles in the Journal of VOLUME 27 • NUMBER 3 • FALL 2009 Equipment Lease Financing are intended to offer TAKING ANOTHER LOOK AT SYNDICATION RISKS IN THE CHANGED ECONOMY responsible, timely, in-depth By Alan J. Mogol analysis of market segments, Risk management is central to the syndication of a fi nancing transaction. The customs and practices of the past need to be reanalyzed. Originators must be aware of the fi nance sourcing, marketing potential issues so they can respond appropriately when asked to change their standard documents. Here is a summary of what funders may ask originators to do, and why. and sales opportunities, liability management, tax A PRIMER ON LEASING TRANSACTIONS IN THE INTERNATIONAL laws regulatory issues, and MARITIME SECTOR By Basil M. Karatzas current research in the fi eld. The Merchant Marine Act of 1920 (Jones Act) has long governed leasing in the maritime Controversy is not shunned. industry in the United States. However, as this article describes, international markets— “blue-water” shipping—have certain distinct differences regarding asset differentiation If you have something and residual value, sources of capital, legal environment, and taxation. important to say and would like to be published in the EVIDENCE FOR THE LEASING VALUE PROPOSITION By James Schallheim, PhD industry’s most valuable Academic research supports the notion that leasing preserves capital and lines of credit, educational journal, call provides tax advantages, and may offer advantages from the transfer of equipment residual risk to the lessor. Less clear, however, is whether there is any support for off- 202.238.3400. balance sheet fi nancing as a value enhancement to lessee fi rms. The Equipment Leasing & Finance Foundation 1825 K Street NW Suite 900 Washington, DC 20006 202.238.3400 www.leasefoundation.org Copyright © 2009 by the Equipment Leasing & Finance Foundation • ISSN 0740-008X Taking Another Look at Syndication Risks in the Changed Economy By Alan J. Mogol here is an old Chinese proverb (blessing or In this article, the author will outline certain com- curse?): “May you live in interesting times.” mon approaches to syndication, identify standard cus- Well, the equipment finance industry is cer- toms and practices, and consider whether the parties tainly living in an interesting time. should reanalyze the risks and rewards associated with TIt is no longer business as usual on those customs and practices. Funders the front end of transactions. Although Funders need to take a need to decide whether they are com- some banks and equipment finance fortable going along with past customs companies say they have liquidity and fresh look at—and apply and practices or whether they should are willing to do business, the reality ask for additional protections from the is that only the most creditworthy cus- a critical eye to—certain originators. For their part, originators tomers, willing to pay heavy spreads, need to be aware of these potential is- are in the running for new financing. issues to be sure they sues in order to formulate responses Many regional banks are restricting when they are asked to change their remain protected, and new business opportunities to com- standard documents. panies in their footprint or companies originators should be As used in this article, the term willing to establish a banking relation- “funder” means assignees, purchasers, ship. prepared to respond to and financiers of lease and loan trans- It should also no longer be busi- actions; the term “originator” means ness as usual with respect to syndica- changed requirements syndicators, assignors, and lessors that tion of equipment finance transactions. originate the lease or loan transactions; Due to the lack of liquidity available in from funders. and the term “obligor” means lessees, the marketplace and the weakened fi- borrowers, and guarantors. This ar- nancial condition of some originators, syndications have ticle uses the terms “lease” and “loan” without regard to also been affected by the current economic situation. As whether the transactions are true leases, financing leases, a result, previously accepted customs and practices— or equipment finance agreements. and allocations of risk—should be reexamined in the current economic marketplace. This is not to say that COMMON STRUCTURES funders will not ultimately remain comfortable dealing In syndicating equipment finance transactions there are with certain originators as they have in the past, but at three common structures: (1) the assignment of the lease the very least funders need to take a fresh look at—and and leased equipment (an “outright assignment”); (2) the apply a critical eye to—certain issues to be sure they re- assignment of the rental stream and certain rights under main protected, and originators should be prepared to the lease (a “discounting transaction”); and (3) the sale respond to changed requirements from funders. of a participation interest in the payments and proceeds TAKING ANOTHER LOOK AT SYNDICATION RISKS JOURNAL OF EQUIPMENT LEASE FINANCING • FALL 2009 • VOL. 27/NO. 3 payable under the transaction documents and from the the originator’s rights under the lease, the rental stream, equipment and any related collateral. and the equipment. Because the originator/borrower remains the owner Outright Assignment of the leased equipment and the lessor under the lease, With respect to the first typical structure, the outright the originator/borrower incurs contractual obligations to assignment of the lease, most parties wait until the lease the funder/lender. The nonrecourse loan is evidenced by and the equipment schedule have been signed, the a promissory note from the originator/borrower to the equipment has been delivered and accepted, and the funder/lender. As with the outright assignment structure, price has been paid for the equipment. When the as- the originator/borrower makes certain basic representa- signee pays the consideration for the assignment, the as- tions with respect to the underlying lease transaction signor conveys legal title to the equipment and assigns and, if those representations prove to be untrue or are all rights under the existing equipment schedule arising breached, there is limited recourse back to the origina- after the lease transaction has been closed. tor/borrower to the extent of any damages resulting from However, there is an alternative approach that in- the breach of those representations. There is, however, volves the assignment of certain rights under the proposal no recourse with respect to the credit of the lessee. This or commitment before the equipment alternative structure is less advanta- is purchased and leased. Using this ap- Because the originator/ geous to the originator, since the origi- proach, the funder acquires the equip- nator incurs certain limited recourse. ment directly from the vendor or the borrower remains the lessee (in a sale-leaseback), and the Participation Interest equipment schedule is executed in the owner of the leased In the third common structure, the par- funder’s name directly. The principal ticipation interest, the originator sells equipment and the lessor advantage of this alternative structure to a participant an undivided propor- is that title to the equipment does not under the lease, the tionate share in either (1) the payments pass through the originator (so there and proceeds to be received pursuant should be no lien issues and no risk of originator/borrower incurs to the transaction documents and from the originator’s subsequent bankrupt- the collateral or (2) the rights under cy), but the disadvantage is that the contractual obligations to the transaction documents, includ- originator may lose some control over ing the payments and proceeds of the the lessee relationship. The alternative the funder/lender. transaction documents and the collat- structure is preferable if the originator eral. Due to tax concerns, this structure has a blanket lien on its assets so that a lien release would is usually used with a loan, a synthetic lease, or a nontax be required, or if the originator is unwilling to confirm lease. It is not typically used with a tax lease because, if that it is conveying clean title. the participation interest includes a proportionate share of the ownership interest of the leased asset, the Inter- Discounting Transaction nal Revenue Service (IRS) may take the position that the In the second common structure, the discounting trans- originator and the participant, now sharing ownership action, the typical approach involves an outright assign- of the leased assets, have formed a partnership for tax ment of the rental stream becoming due under the lease purposes. payable by the lessee, together with the grant of a securi- This position could adversely affect the availability of ty interest in the leased equipment to secure the payment the modified accelerated cost recovery system (MACRS) and performance of the lessee’s obligations to pay the deductions with respect to the leased assets claimed by rent. The originator incurs no independent obligation to the originator and the participant, because the IRS could the funder. The alternative approach involves a nonre- argue that if a partnership has been created, depending course loan made to the originator, which is secured by on the point in time during the calendar year at which a collateral assignment and grant of a security interest in the partnership is deemed to have been created, the 2 TAKING ANOTHER LOOK AT SYNDICATION RISKS JOURNAL OF EQUIPMENT LEASE FINANCING • FALL 2009 • VOL. 27/NO. 3 partnership may have a short first fiscal year, preventing Obligor’s credit. It is generally accepted that the origi- the originator and the participant from claiming the full nator is not responsible for the creditworthiness of the year’s MACRS deductions to which they would other- obligor or the accuracy of any financial information for- wise have been entitled. Also, under this structure, the warded with respect to the obligor.
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