Here is the details of some of the Important Leasing Terms. These terms are used widely in the leasing industry.
A
Accelerated Depreciation
A depreciation method, such as the Modified Accelerated Cost Recovery System, that allows write-offs more quickly than the straight-line method, which allows write-offs in equal increments as tax deductions in each tax year. This depreciation is useful for companies with tax bills that can offset taxable income.
Add-On
A transaction that adds related equipment to an existing lease. Typically, this term is used when the new equipment is financed using the same lease structure (i.e., Fair Market Value, $1.00 Purchase Option, Fixed Purchase Option, etc.) as was used in the underlying transaction except that the lease term for the add-on is set so that it expires coterminously with the original transaction.
ADR System
Asset Depreciation Range. The range of depreciable class lives allowed by the Internal Revenue Service (IRS) for particular classes of depreciable assets.
ADS System
Alternative Depreciation System. Created by Section 168(g) of the Internal Revenue Code of 1986, and amended (IRC), ADS provides a slower deprecation schedule than MACRS. It applies to property predominantly used outside the U.S. during a tax year or by a tax exempt entity.
Advance Payments
Payments made by the lessee at the inception of a leasing transaction, and thereafter during certain constant periods before the use of equipment or other capital asset occurs for which payment is made.
Alternative Minimum Tax (AMT)
A flat tax to ensure that corporate and high-income taxpayers pay at least some tax, regardless of their deductions. An alternative, separate tax calculation based on an individual taxpayer’s regular taxable income, and increased by the taxpayer’s preferences for the year. The resulting amount is called the Alternative Minimum Taxable Income (AMTI). After certain exemptions and offsets, the taxpayer determines the AMT owed, and is required to pay whichever amount is larger: the regular tax or the AMT. Among the preferences that can increase a taxpayer’s AMTI is the accelerated portion of depreciation, thereby making it more likely that a taxpayer who buys equipment may be subject to the AMT rather than to regular tax.
Amortization
A breakdown of periodic loan payments into two components: a principal portion and an interest portion. In tax parlance, amortization refers to IRC Section 197 that provides for specified intangible assets to be amortized over a fifteen (15) year period.
APR
Annual Percentage Rate. The effective rate taking into account compounding and other fees. The nominal rate of interest for a specified period (usually one year).
Asset
Any item property owned by an individual or company that may be subject to a lease or serve as collateral for a loan.
B
Balloon Payment
A large, lump-sum payment scheduled at the end of a series of smaller periodic payments with respect to applicable loan and financing lease transactions.
Bargain Purchase Option
A lease provision allowing the lessee, at its option, to purchase the equipment for a price predetermined at lease inception that is substantially lower than the expected fair market value at the date the option can be exercised.
Basis Point
A unit of measurement equal to 1/100th of a percent. For example, 25 basis points = .25%.
Big-Ticket (also known as Large-Ticket)
A market segment, represented by financing over $5 million.
Broker
A company or person who arranges, for a fee, transactions between lessees and lessors with respect to a particular type of an asset, such as a business jet.
C
Capital Assets
Property used in business for a period of more than a year, including machinery, equipment and other significant property.
Capped Fair Market Value Lease
A Fair Market Value Lease with a predetermined ceiling to limit fair market exposure at the end of the lease term.
Certificate Of Acceptance
A document that serves as proof that goods have been delivered to and accepted by the customer.
Collateral
Assets pledged by a borrower to secure a loan; these assets can usually be seized by the lender in event of default.
Comprehensive General Liability Insurance
A broad form of insurance that protects against all forms of liability, except those specified in the policy.
Conditional Sale (Time Sale)
An agreement in which the seller retains title to the equipment and transfers it to the buyer when all contractual payments have been made.
Coterminous
Two or more leases that are linked so that both will terminate at the same time.
Commercial Paper
An unsecured obligation issued by a corporation to finance short-term credit needs, such as accounts receivable or inventory.
Conditional Sale
Under the income tax provisions, the actual user is treated as the owner of an asset and is entitled to claim the available depreciation for the affected equipment or other capital asset.
Covenant
A clause in a contract, usually required by the finance company, that either requires the borrower to do a particular thing or refrain from doing a particular thing.
Cross Corporate Guaranty
A guarantee by one person or entity to pay the lease obligations of another (often affiliated) person or entity.
D
Default
An event or circumstance in which a customer fails to comply with the terms of the lease contract or other agreement. Generally, after an event of default, the finance or leasing company may exercise all of its rights and remedies under its lease contract or other agreement to repossess property and seek money damages.
Delivery And Acceptance Certificate
A document that evidences the delivery and acceptance of a good, such as equipment, by the customer.
Depreciation
Under Section 167 of the IRC, deprecation refers to the decline in value of property through its use and the passage of time, wear and tear, technological change and obsolescence. Under accounting rules, depreciation also decreases the company’s balance sheet assets and is recorded as an operating expense for each period.
Discount Rate
A certain interest rate that is used to bring a series of future cash flows to their present value in order to state them in current, or today’s, dollars. Use of a discount rate reflects the time value of money from future cash flows.
Documentation Fee
A fee charged for preparing, distributing and storing transaction documents in any finance transaction.
Dollar Buyout
The same as a Dollar-Out Lease under “Types of Leases.”
Down Payment
A sum payable to a seller of property as initial consideration for the purchase of the property. Such amount may be or become non-refundable under certain circumstances as damages for failing to perform under the purchase contract.
E
Early Buy-Out
The purchase of equipment or other assets before the end of the applicable lease term.
Economic Life (Useful Life)
The period of time during which an asset will have economic value and be usable.
Effective Lease Rate
The effective rate (to the customer) of cash flows resulting from a finance transaction. To compare this rate on an after-tax basis as compared to a loan interest rate, a company must include in the cash flows any effect the transactions have on federal tax liabilities.
Equity Participant
The owner participant, trustor or owner of a beneficial interest in a grantor trust or statutory trust.
The equity participant furnishes the equity investment portion of the purchase price of equipment that will be subject to the lease — often in leveraged leases.
Equipment Schedule
A document that describes in detail the equipment being leased, the financial terms and other terms, including the lease term, commencement date, repayment schedule and location of the equipment, as a supplement to the primary terms found in the related master lease.
Estimated Useful Life
The period during which an asset is expected to be useful in trade or business. Used for purposes of calculating the maximum allowable term of a tax lease, for determining whether or not the lease is a Capital Lease, or to determine the method of depreciation for a capitalized leased asset. May or may not be the same as the life used for income tax purposes.
F
Fair Market Purchase Option
An option to purchase leased property at the end of the lease term at its then fair market value.
Fair Market Value
The price for which property can be sold in an “arms length” transaction between informed and willing parties, each of which is acting rationally and in its own best interest based on the assumption that the equipment or other capital asset is in a known or required condition.
FASB
The Financial Accounting Standards Board, which sets accounting rules in the United States, subject to certain oversight by federal governmental agencies.
FAS 13
Financial Accounting Standards No. 13 of the Financial Accounting Standards Board, which establishes standards for lessees’ and lessors’ accounting and reporting for leases. FAS 13 includes the characterization of a lease as an operating lease or capital lease for the lessee’s purposes.
A company’s assets, liabilities and net income will differ depending on how it chooses to structure its leases. The provisions of FAS 13 derive from the view that a lease that transfers substantially all of the benefits and risks of ownership should be accounted for as the acquisition of an asset and the incurrence of an obligation by the lessee (a capital lease) and as a sale or financing by the lessor. Other leases should be accounted for as the rental of property (operating leases).
Fixed Asset
A tangible asset, such as real estate or furniture, fixtures or equipment held for business use.
Fixed Priced Purchase Option
An option given to the lessee to purchase leased equipment from the lessor on the option date for a certain price. Both the date and price must be determined at the inception of the lease. A fixed price purchase option could equal as little as 10-15 percent of the original cost of the equipment.
G
General Partnership
A business partnership in which each partner is responsible for all obligations incurred by the partnership.
Guaranty
An agreement by one party to accept responsibility for a financial obligation of another person. The guarantor’s obligation is generally triggered when the primary person or entity does not satisfy the guaranteed obligation.
Guarantor
One who guarantees a debt or obligation of another person or entity.
H
Hell-or-High-Water Clause
A clause that assures a lessor that it will be paid rent no matter what the circumstances. That remains true even if the lessor allegedly breaches its obligations. The lessor’s wrongful act is treated as a separate and independent event and does not affect the lessee’s obligation to perform under the lease. This extremely important clause turns leases into financial assets that lessors can assign to other financial institutions.
I
Incremental Borrowing Rate
The rate that, at the inception of the lease, the lessee would incur to borrow over a similar term the funds necessary to purchase the leased asset. In other words, the interest rate a lessee would have to pay if, instead of leasing, the lessee finances the purchase of the same asset.
Indemnity Clause
A clause in which a lessee or borrower, and sometimes the financier, agrees in favor of the other party, to hold the other party harmless and free of liability for specified losses or damages incurred in the underlying transaction. As passive investors and lenders only, financiers typically obtain very broad indemnities from their customers to protect them against any loss, damage or liability associated with lending in respect of, or leasing, equipment or other capital asset. In Ethyl Corporation v. Daniel Construction Co., 725 S.W.2d 705 at 709 (Texas Sup. Ct. 1987), the court defined an indemnity agreement as a “collateral contract or assurance, by which one person engages to secure another against an anticipated loss or to prevent him from É the legal consequences of an act or forbearance on the part of one of the parties or of some third person.” In other words, an indemnity agreement is a promise by one party, called the indemnitor, to safeguard or hold the protected party, called the indemnitee, harmless against existing and/or future loss, damage, and expense or injury liability.
Insurable Value
The agreed or stated value, or other appropriate value, of equipment or other capital assets after all exclusions, such as maintenance or service charges, that an insurance company will provide casualty or property insurance to cover losses or damage to the equipment or other capital asset.
Investment Grade Credit
A company rated highly by one of many recognized credit agencies, such as Moody’s Investors Service or Standard & Poor’s. The rating agencies rate publicly issued securities among other services regarding information for investors.
L
Lease Assignment
The transfer of a lease by a lessee to a third party. Many leases contain clauses that restrict or prohibit lease assignment. Certain restrictions on assignments may not be enforceable under the UCC.
Lease Line
A specific amount of funding arrangement designated by the lessor for a lessee to use over a fixed commitment period typically arranged under a Master Lease.
Lease Purchase Contract
Full payout, net leases structured with a term equal to the equipment’s estimated useful life. Because many lease purchases include a bargain purchase option for the lessee to purchase the equipment for one dollar at the expiration of the lease, these leases are often referred to as dollar buyout or dollar-out leases. Lease Purchases are generally considered to be Capital Leases from an accounting perspective and non-tax leases from a tax perspective due to their bargain purchase option and length of lease term.
Lease Rate (Rental Payment)
A percentage rate equivalent to the periodic rental payment to be paid in dollars (often computed by applying the rate to the lease balance).
Lease Syndication
The process of involving several different funding sources in providing various percentages of a particular lease’s debt and equity components. Also see “Types of Structured Finance Transactions for Equipment.”
Lessor
The party to a true lease agreement who has legal, beneficial or tax title to the equipment, grants the lessee the right to use and possess the equipment for the lease term, and is entitled to the rentals. Also see: “Executive Summary.”
Letter Of Credit
A “commercial letter of credit” is a credit document used by a buyer to pay for goods. The buyer arranges with a bank to issue a letter for the benefit of a third party who can draw funds from the commercial letter of credit to pay for goods it sells in a domestic or international trade deal. A “standby letter of credit” is a financial accommodation independently issued by financial institutions to and for the benefit of third parties for the account of a debtor. The issuer agrees to allow a third party, which is the beneficiary, to draw funds under the standby letter of credit when some contingency occurs, such as a default under a lease or an insurance premium or deductible payment becomes due.
Letters of credit support business transactions in over 160 countries. Lessors may rely on them to enhance the creditworthiness of a lessee in a transaction. Lenders may issue or rely on them to enable companies to fund business worldwide. For more than 70 years, letters of credit have provided the basis for buying and selling goods and financing transactions around the globe in part under rules established by the International Chamber of Commerce (ICC).
In December 2006, the ICC adopted changes to its guidelines for letters of credit known as the Uniform Customs and Practices for Documentary Credits (UCP). The changes, set forth in ICC Publication No. 600, or “UCP 600,” became effective July 1, 2007. UCP 600 will modify its predecessor guidelines commonly known as “UCP 500.” UCP 600 is intended globally to clarify rules that affect both commercial and standby letters of credit primarily in the insurance, banking and transport industries.
Leveraged Lease
A lease in which the finance company invests equity into the purchase of equipment or other capital asset, and borrows the balance from a lender to make the purchase. For example, a lessor may invest 20 percent and borrow 80 percent to buy the equipment or other capital asset.
Limited Guarantee
An agreement by a person or entity to pay the obligation of another up to a cap or limit on the total payment. A guarantor is a surety, a back up person or entity who pays should the original obligor, such as a lessee, borrower or buyer, fail to perform.
M
MACRS Class Life
The life of equipment depreciated via the Modified Acceleration Cost Recovery System.
Middle Market
A market segment generally represented by financing under $5 million and dominated by single investor leases.
Modified Accelerated Cost Recovery System (MACRS)
The Tax Reform Act of 1986 (Tax Act) established a modified accelerated cost recovery system, called MACRS. MACRS is a tax depreciation system that allows a business to recover the cost of income-producing property over a specific recovery periods. The Tax Act established an accelerated system of allowing a business to take deductions fast than in equal amounts (straight line) over a period of years. Equipment cost is recovered over periods based on class lives of 3-, 5-, 7-, 10-, 15- or 20-years.
N
Negative Amortization
An increase in debt that occurs over time when payments made are insufficient to cover the interest due with each payment.
O
Off-Balance-Sheet Financing
Financing that, due to the application of FAS 13, does not appear on balance sheets of a lessee as a liability or asset; rather, the cost of the lease is treated as an expense.
P
Packager
The finance company, investment banker, or broker who arranges a leveraged lease or other lease transaction.
Payment In Advance
Payment made before the actual obligation arises for which payment is due.
Payment In Arrears
Payment made after the obligation arises and payment becomes due has been incurred by the debtor.
Present Value
The current equivalent of payments or a stream of payments to be received at various times in the future. The present value will vary with the discount interest factor applied to future payments.
Purchase Option
A provision by which a lessee has the right to purchase the equipment at the end of the lease. The purchase option may be stated at a specified amount or at fair market value.
Put Option
The requirement of a lessee to purchase equipment at a particular time and at a predetermined price. In a lease transaction, this is a lessor’s right to force the lessee (or some third party) to purchase the equipment at the end of the lease term. IRS guidelines prohibit put options in tax-oriented leases.
R
Recourse Agreement
An agreement with a vendor whereby the vendor will purchase or repurchase the lessor’s interest in a lease, usually upon demand, after default of the lessee. Generally, the lease must be in default and a reasonable amount of collection effort must be made by the lessor.
Refinance
To pay off an existing loan with a new one while using the same property as collateral.
Remarketing
The process of selling or leasing of used equipment or other capital assets performed by equipment management personnel of the lessor or independent parties.
Residual Value
The value of an asset at the conclusion of a lease.
S
Sales/Use Tax
States impose sales taxes on retail sale transactions. States impose use taxes for tangible personal property that is used, consumed or stored in the state.
Securitization
See “Types of Structured Finance.”
Short-Term Loan
Loans usually structured to last one year or less, and often paid at the end of the term in a lump sum.
Single Investor Lease
See “Types of Leases: Single Source and Leveraged Lease.”
Small-Ticket Market
See “Market Segments in Equipment Finance.”
Spread
The difference between funding costs and the rate of return to the lessor on a lease.
Stipulated Loss Value
A schedule included in a lease that states the agreed value of equipment at various times during the term of the lease and establishes the liability of the lessee to the lessor in the event that the leased equipment is lost or rendered unusable during the lease term due to a casualty loss.
T
Tax-Exempt Entity
A business or group that is not subject to taxation, such as a philanthropic organization, state college, governmental subdivision (i.e., city or county) or other government organization.
Term Loan
Financing generally used for working capital, expansion, refinancing and acquisitions; repaid monthly or other agreed interval for a specified term.
Trustee
A bank or trust company that holds title to or a security interest in leased property for the benefit of the lessee, lessor, and/or creditors of the lessor, as appropriate. A leveraged lease often has two trustees: an owner trustee and an indenture trustee. An owner trust owns the assets or interests therein and the indenture trustee represents the lenders that lend funds to the lessor on a non-recourse basis to purchase the equipment or other capital asset for lease to the lessee.
U
Uniform Commercial Code (UCC)
A statute which prescribes very similar rules in almost every state in the U.S. for secured transactions, leasing and other commercial and financial transactions. The UCC is intended to represent the best practices in commercial transactions and, in certain parts of the UCC, consumer transactions.
Upgrade
An improved and/or updated version of equipment or software, most often used with technology assets.
Use Tax
Many states charge a “use” tax in lieu of a sales tax when equipment is leased. In practice, instead of paying a sales tax for purchase of the leased equipment, the lessor collects or lessees directly pay use taxes with respect to each rent period as a percentage of the rentals over the lease term.
Useful Life
The period of time during which an asset will have economic value and be usable. The useful life of an asset is sometimes called its economic life.
V
Vendor
An entity that sells goods and may provide services to customers.
Vendor Leasing
A working relationship between a financing source and a vendor to provide financing to stimulate the vendor’s sales. The financing source typically offers leases or conditional sales and, in some cases, service contracts to the vendor’s customers.
