Definition of Leveraged Lease
In a leveraged lease, the lessor invests some money from his pocket to purchase the asset and arranges for the rest of the money required from a lender in the market. The leveraged lease is a lease in which three parties are involved: Lessor, Lessee, and the Lender. Here, the lender is the third party but enjoys the benefit of the interest in the asset acquired.
In this type of arrangement, the lender will have a secured interest in the asset since he is investing money to acquire the asset. When the assets are taken on lease, the lesser will be obliged to make the payments to the lender of the leased asset. The lease agreement is actually assigned to the lender of the leased asset in this type of arrangement. The leveraged lease is also a tax advantage for the lessor since the lessor takes a loan from the lender to purchase the asset while the payment from the lessee will directly go to the lender. Thus they are saving tax in this entire process. This type of arrangement is mostly seen while purchasing high-value assets.
Structure of Leveraged Lease
The leveraged lease is designed in such a way that almost 20% to 40% of the money is arranged by the lessor of the asset and the rest is borrowed from the third party known as the lender of the leased arrangement. The lessor’s benefits are generally associated with the actual cost of the asset, therefore, this entire process is called Leveraged. Another aspect of this vehicle is that the lessee will pay the rental payments to the lender directly which makes it a special kind of lease arrangement. The lessor will be free of any obligation due in favor of the lessee in case of any default.
Difference Between Leveraged Leasing and Leveraged Financing
- The basic difference between Leveraged leasing and leveraged financing is that in leveraged leasing there are three parties involved the lessor, the lessee, and the lender. However, in leveraged financing, there are only two parties involved lessor and the lessee.
- In leveraged leasing, the obligation for the payment lies with the lessee to the lender whereas in leveraged financing the burden of payment lies with the lessee to the lessor only.
- In leveraged leasing, the lender has the right to the asset whereas in leveraged financing the right is kept with the lessor only.
- The process of leveraged leasing is somewhat difficult to understand whereas the process of leveraged financing is very simple and straight.
Characteristics of Leveraged Lease
Characteristics of Leveraged Lease are given below:
- In the leveraged lease, the finance provider which is lender is without recourse to the lessor.
- The lender holds the asset since it carries the payment obligation.
- The lessor will be free from the obligation of the payments to the lender the payment is directly done to the lender by the lessee but in case of default, the lessor will be obliged to pay the dues.
- The small portion of the fund is arranged by the lessor and the majority portion of the fund which is required to obtain the asset is borrowed by the lender.
- The lender will have more rights in regard to the sale or resale of the asset in comparison to the lessor.
- One of the typical characteristics of this type of vehicle is that the lender can check the financial position of the lessee that whether the lessee will be in a position to pay the rentals or not and if not the lenders will opt for recourse loan payment where the lessor will be obliged to make the payments.
- The leveraged lease is generally used when any company wants to purchase some high-value assets.
- In this type of method of leasing the lessor will be the one who will get benefitted by tax also. It will receive some tax-related benefit of ownership of the asset. Although the rights are also lying with the lender of the asset according to lessee agreement.
Leveraged Lease Accounting
The accounting treatment of the leveraged lease is segregated in three parts
- Pretax income of the year
- Tax credit and its amortization
- The post-tax income of the year.
The difference of the tax element between the pretax income and the post-tax income is adjusted in the deferred tax treatment as per accounting policy.
Difference Between Leveraged Lease and the Operating Lease
- In the leveraged lease, the risk and obligation are with the lessee whereas in the case of Operating lease the risk and obligation are with the lessor only.
- In a leveraged lease, there are three parties involved i.e. Lessee, Lessor, and the Lender whereas in case of the Operating lease there only two parties involved i.e. Lessor and the Lessee.
- The lease agreement of the leveraged lease cannot be canceled whereas the lease agreement of the Operating lease can be canceled.
- In leveraged lease some funds are arranged by the lessor of the asset and rest is funded by an outside party known as lender whereas in case of the Operating lease 100% funds are arranged by the lessor of the asset.
- In the case of the leveraged lease, the leased payments can be treated as interest and thus will be shown under the balance sheet as Leased assets, whereas the Operating lease payments are not treated as interest and the asset will not be shown in the balance sheet at the year-end.
The technique of the concept called Leveraged lease is a very advanced and sophisticated financial vehicle used nowadays. It is considered as one of the complex mechanism to settle the finances. The tax burden is somewhat less in case of lessor borrowing funds from outside. When a company decides to buy the high-value asset to increase its productivity and returns they may opt for this type of financial arrangement. This technique is very much time saving also because the assets are purchased when they are required and the business operations are continued without any delay caused due to fund deficiency.
This is a guide to Leveraged Lease. Here we discuss Structure and Characteristics along with Difference between Leveraged Leasing and Leveraged Financing. You may also look at the following articles to learn more –
- Difference between Buying vs Leasing
- Education Required for finance
- Key Differences between Lending vs Borrowing
- Statement of Retained Earnings Example