Although finance leases may be viewed as collateralized lending and assessed using similar risk-rating criteria, the lessor’s ownership of and ability to repossess the leased asset, its relationship with the vendors and the secondary market for the asset distinguish the credit analysis of finance leases from secured lending. Whereas credit models for bank lending measure a client’s likelihood to repay a credit obligation, models for standard equipment leasing also consider the following factors:
- Lessors legally own and have legal title to the leased asset, whereas banks generally take a lien against the asset;
- In the event of lessee default, lessors can generally repossess leased assets much more easily and quickly than seizing collateral;
- Lessors work closely with vendors in vendor programs to finance standard equipment, where some vendors provide buy-back guarantees that reduce the risks of defaulted transactions; and
- Standard leased equipment generally has a liquid secondary market, allowing lessors to estimate the fair value of an asset over the lease term with reasonable accuracy.
Lease credit models must also consider the transaction costs and expected income from selling repossessed assets. Unlike bank lending, credit models for leasing allow lessors to balance the probability of default and the probable profit or loss from asset sales in the event of default. Since a lease in default may yield a profit for the lessor, leases can be underwritten and structured such that those that go bad can still be profitable.