EQUIPMENT LEASING ASSOCIATION OF NIGERIA (ELAN)

12TH NATIONAL LEASE CONFERENCE

COMING TO GRIPS WITH MEDICAL EQUIPMENT LEASING

PRODUCT DEVELOPMENTRISK ANALYSIS

TRANSACTION DYNAMICS

Collins David-Ikpe20th November, 2014

• Familiarize ourselves with leasing fundamentals.1

• Explore the subject of Leasing of Medical Equip. 2

• Conclusion3

Overview

LEASING FUNDAMENTALS

LEASING FUNDAMENTALSWHAT IS LEASING?

There are three perspectives from which LEASING can be defined:– Industry– Legal– Accounting

For our purpose today we are shall limit our scope to the industry definition.

LEASING FUNDAMENTALSWHAT IS LEASING?

The Equipment Leasing Association of Nigeria (ELAN) states that “Leasing is a contract between a Lessor and a Lessee, giving the Lessee possession and use of a specific asset on payment of rentals over a period. The Lessor retains ownership of the asset so that it never becomes the property of the Lessee or any other related third party during the tenor of the lease”.

LEASING FUNDAMENTALSWHAT IS LEASING?• Subject Matter is: – an Asset

• Essence is: – the use of the asset

• Principal Parties are: – the Lessor and the Lessee

• Ownership Rights reside with: – the Lessor

• Usage Rights belong to: – the Lessee

LEASING FUNDAMENTALS

WHAT IS LEASING?• The Lessor, as owner, lends the asset not

money;and

• The Lessee who pays rentals does so for the use of the asset not as a repayment of money borrowed;

therefore• A lease is essentially a usage agreement.

LEASING FUNDAMENTALSLEASING AND OTHER FORMS OF FINANCING• The focus on the use of the asset and the need to

ensure that the asset value does not depreciate more than the net investment (or book/residual value) at any time during the tenor of the lease places considerable burden on the Lessor to mitigate the risk of loss.

• This risk of loss is commonly referred to as Ownership risk or Residual risk. It is this risk, which Lessors face, that differentiates a lease from other forms of financing.

• Mitigating residual risk compels the Lessor to wear the cap of an Asset Manager.

LEASING FUNDAMENTALSLEASING AND OTHER FORMS OF FINANCING• This statement is fact whether the lease is a

finance lease or an operating lease.• For example: The Book/residual value of a 24

months lease at the end of month 9 after the lessee had defaulted for 3 months and the asset repossessed is N9.2m. Upon selling the assets in the open market the Lessor realised only N5m. The Lessor may bear the loss of N4.2m and may have no recourse to the lessee. If the lease were a loan the borrower may be held liable for the loss.

LEASING FUNDAMENTALSTYPES OF LEASES• A lease is either a finance lease or an operating

lease.• Where the Lessee agrees to buy the asset at the

end of the lease tenure and the present value of the total rentals covers the cost of the asset, that lease is a FINANCE LEASE.

• Where the Lessee agrees to return the asset at the end of the lease tenure and the Lessor is not recovering the asset cost, the Lease is an OPERATING LEASE.

LEASING FUNDAMENTALSTYPES OF LEASES• Basically, two factors distinguish a finance

lease from an operating lease:– The return provision– The asset cost recovery

• It is important to note that bundling maintenance into a lease does not make it an operating lease.

LEASING FUNDAMENTALSLEASE TERMINATION• A lease may come to an end at maturity or

terminated before the expiration of its tenor.• At maturity:– The lessee pays purchase option if a finance

lease or negotiates to buy in operating lease.– The lessee returns the asset applicable to

both types.– The lessee renews the lease in case of an

operating lease.

LEASING FUNDAMENTALSLEASE TERMINATION• Before Expiration:– A lease may be terminated and the asset

repossessed or recovered from the Lessee before the end of the lease particularly in the event of default.

– When this happens, the risk of loss is most likely to be high if the asset was not well managed when the lease was active or if the asset has a limited use.

LEASING FUNDAMENTALS• Rather than take steps to manage their lease

assets, some Lessors prefer to escape this responsibility by demanding additional collateral or rejecting lease requests for any equipment with limited use.

• Please note that there is nothing wrong with demanding that lessees provide additional collateral or rejecting equipment with limited use.

• Many times it is a policy issue.

LEASING FUNDAMENTALS• The question is:– Can a Lessor really avoid playing the Asset

Manager role?– Has the desire for additional collateral really

reduced the incidence of non-performing leases?– By rejecting equipment with limited use, are

leasing companies finding sufficient business to grow their portfolio?

– Can a profitable lease business be developed and grown from leasing equipment with limited use?

LEASING OFMEDICAL EQUIPMENT

LEASING OF MEDICAL EQUIPINTRODUCTION• Medical Equipment is an example of a lease asset

with limited use.• In leasing, assets with limited use are classified as

specialised Equipment.• Leasing of specialised Equipment requires a great

deal of knowledge and skill.• It also requires clear understanding of the lease

equipment and the relevant industry . • It requires an appreciation of the key success factors

in both the leasing industry and the lessee industry.

LEASING OF MEDICAL EQUIPINTRODUCTIONList of medical equipment that can be leased:• Patient monitoring equipment• X-Ray machines• Medical Aesthetic Lasers• MRI equipment• Ultrasound systems• Exam tables• Lab equipment

LEASING OF MEDICAL EQUIPINTRODUCTIONList of medical equipment that can be leased:• Patient beds• Ambulance VehiclesOthers:• Computer systems• Waiting room chairs and tables• Filing systems and reception desks

LEASING OF MEDICAL EQUIPINTRODUCTIONBenefits of Leasing Medical Equipment• Leasing saves your working capital and pays for the equipment as

it’s used, and most importantly, it allows for shorter payment terms so necessary upgrades to new technologies are more cost effective than purchasing.

• Leasing also retains your bank borrowing capacity, lowers your monthly payment, and in many cases, equipment lease payments are a fully tax deductible expense since your payment becomes a liability on the balance sheet instead of a business asset.

• With the cost savings from leasing, you can afford to have more equipment, such as ultrasounds and x-ray machines available in your office. What does this mean to you? More procedures that you can bill for, which means more opportunities to increase your bottom line instead of your stack of referrals paperwork.

LEASING OF MEDICAL EQUIPPRODUCT DEVELOPMENT – STRATEGIC ISSUES– Specialisation• A leasing business that desires to succeed in

leasing Medical Equipment must consider specialisation. The Company, a Division, a Department, a Unit should be dedicated to the business.

– Asset Management• An Asset Management or Lease Admin

department should be created. They will be responsible for managing all aspects of the lease assets.

LEASING OF MEDICAL EQUIPPRODUCT DEVELOPMENT – STRATEGIC ISSUES– Choice of Supplies• Attention should be paid to the quality of

the equipment, return provisions, buy back guarantees and terms of credit.

– Funding Strategy• Consider leveraged leases, back to back

leases, syndicated leases and other sources such as insurance companies, venture capital organisations.

LEASING OF MEDICAL EQUIPPRODUCT DEVELOPMENT – STRATEGIC ISSUES– Sound credit department• To filter out potential delinquents and retain

viable prospects.– IT/application software• The use of technology promotes efficiency

and satisfactory customer service.– Organisational structure & highly trained work

force.• It is important that efficiency permeates the

entire organisation.

LEASING OF MEDICAL EQUIPPRODUCT DEVELOPMENT – MARKETING ISSUES

1. Gather information - understand and observe the market, the clients, the technology, and the risks.

2. Synthesize the information collected and design customer oriented lease products with potential risks reduced to the barest minimum .

3. Periodically evaluate and improve the lease products.

4. Implement design changes.

LEASING OF MEDICAL EQUIPPRODUCT DEVELOPMENT – DOCUMENTATION ISSUESThe relationship between the lessor and the lessee are usually defined by the written agreements. However, the agreements must provide for these essentials: – Maintenance provision– Inspection rights– Return provisions– Termination options

LEASING OF MEDICAL EQUIPRISK ANALYSIS• There are basically two forms of risks in lease

transactions:– Credit Risk– Residual Risk

LEASING OF MEDICAL EQUIP• Credit Risk – This is the risk that the Lessee will not meet

financial obligations as they fall due. This occurrence is commonly referred to as a default.

– It is not uncommon for lease agreements to provide for punitive charges to discourage defaults.

– Where the default continues then repossession/recovery becomes an option.

LEASING OF MEDICAL EQUIP• Residual Risk– It is sometimes called ownership risk because

it derives from ownership of the equipment.– This is the risk that the residual value (market

value) of the equipment will fall below its book value (residual value).

– This risk may crystallise as result of excessive wear and tear or as a result of the specialised nature of the equipment.

LEASING OF MEDICAL EQUIP• Risk Analysis– Both types of risks are applicable to leasing of

Medical Equipment.– However, the residual risk is most critical due

to the limited use of the equipment.– This is particularly so in the case of pre-

mature termination.– Almost always the Lessor will not be able to

recover the balance of his investment from selling the repossessed equipment in the open market.

LEASING OF MEDICAL EQUIP• Mitigating the Risks– Where a finance lease is desired, then greater

emphasis should be placed, by the lessor, on mitigating credit risk to ensure that the lessee does not default in rental payments.

– Buy back arrangements entered into with the supplier can go a long way in reducing the risk of loss.

– Developing a secondary market for lease of used equipment is another way to forestall loss.

LEASING OF MEDICAL EQUIP• Mitigating the Risks– A lessor may wish to limit its lease

transactions to operating leases to ensure the lessor is in firm control of the equipment.

– Lessors may want to consider providing combined leases to guarantee affordability of the associated rentals by the lessees.

LEASING OF MEDICAL EQUIP• Mitigating the Risks– Lessors may choose to create the environment

and provide the conditions or services that will increase the chances of business success for the lessee and indirectly guaranteeing rental payments.

LEASING OF MEDICAL EQUIP• Mitigating the Risks– Lessor may ask for higher equity contribution(?),

security deposit, advance rentals.– Lessor may demand for additional collateral.– Lessor may require a personal guarantee– Lessor may require key man insurance– Lessor may require local letter of credit.

LEASING OF MEDICAL EQUIPTRANSACTION DYNAMICS• Lease proposal• Lease application• Credit application• Commitment letter• Lease agreement• Supply contract• Landlord’s waiver• Operator recruitment• Delivery, Installation & Commissioning• Maintenance Contract• Inspections• Rental Collections• Purchases option payment or return or negotiate sale• Change of ownership

LEASING OF MEDICAL EQUIPSUMMARY• A lease is a usage agreement.• Residual risk distinguishes leases from other forms

of financing.• A lessor is an asset manager and must take steps to

act as one.• Medical Equipment fall into the category of

specialised equipment.• Major issue with specialised equipment is the

higher probability that the residual risk will crystallise.

• Residual risk can be mitigated by supplier guarantees or hedging against credit risk.

QUESTIONS?