Unit 3 - Topic 4

Question 1

What is interest & calculation?

Answer 1

Cost of borrowing money

Principal x interest rate x term of the loan

Question 2

What must funder consider when pricing?

Answer 2

Diminishing return of money that will be repaid to them
Average transaction size (low average transaction size may seek higher fees from customer to cover its higher relative overheads = economies of scale)
Competitive pressures - different funders have different appetites
Routes to market - brokers means they can offer better pricing bewaring in mind commission to add due to work spent
Disposal routes for assets

Question 3

What is money this year & Money next year

Answer 3

Present value and Future value of money

Question 4

FV what is it and calculation?

Answer 4

Future value

Present value + (x interest rate)squared for two years, etc

Question 5

What to consider with price and margin?

Answer 5

Need to build in margin required on capital but mitigate risk of non-payment
Higher margin when pricing on higher risk
- non payment significant affect on funders
Larger deals means more risk
- Balanced portfolio mixed
- Larger spread of customers
- Improved customer concentration

Question 6

What are the risk factors to assess? 3 points

Answer 6

Assess the asset
The business
Financial information

Question 7

What tools are used for looking at risk- 3 points

Answer 7

Borrower risk profile = Business background and borrower payment history (CAIS used)
Burrower risk profile subjective depending on negotiators experience
Quantitive assessment, using online credit tools that generate a credit quality or risk grade

Question 8

Financial risk analysis? - 3 points

Answer 8

Publicly available financial info and management information
Sometimes produce probability of default
High level assessment by negotiator or more in depth analysis by a risk underwriter

Question 9

Asset security risk?

Answer 9

DIMS test

Question 10

Expected loss? - 3 points

Answer 10

Predicting with reasonable accuracy the probability of default and outstanding balance (Loss given default)
Through historical data from large portfolio of similar leases

Question 11

Age of asset what is important?

Answer 11

Typically apply a loading, increased margin to reflect the rising age of the asset
Have a maximum age for different asset categories
Proposed repayment term is also important when assessing asset age

Question 12

Deposit and affect on repayment terms

Answer 12

An example would be smaller deposit would attract higher loading on repayment periods due to higher risk

Question 13

Different funding scenarios for risk?

Answer 13

Low risk, low return = funding facility for large blue chip company
High return, high risk = new company based on speculative venture
High return, low risk = ideal position but hard to achieve now the tax benefits of highly structured lease transactions have been largely eroded
Low return, high risk = Funders want to avoid this especially when little bad debt

Question 14

What is capital adequacy?

Answer 14

Minimum reserve of capital that a financial institution requires

Question 15

How is capital adequacy assessed (affects pricing)? 8 points

Answer 15

• Level and quality of the capital overall financial condition of the institution.
• Ability of management to address emerging needs for capital
• Nature, trend and volume of the problem lending assets
• Composition of balance sheet, level of intangible assets, market risks with non-traditional activities
• Risk exposure of off balance sheet activities
• Quality and strength of earnings and reasonable dividends
• Prospects and plans for growth and experience
• Access to capital markets and other sources of capital

Question 16

What is CRD IV

Answer 16

The European Commission’s implementation of Basel III, setting out changes in the regulation of regulatory capital and the introduction of liquidity requirements.

Question 17

How does asset finance differ from other lending products?

Answer 17

• Ownership is with the lessor therefore covered if default
• Assets are usually business critical assets - level of asset dependency therefore clients are encouraged to keep up to date with payments
• As asset specialists they know resale market of the asset
• Used to physical collateral whereas banks have are used to non-specific guarantees and deed security which is difficult to realise
• Not all businesses can offer security needed from traditional banks whereas asset finance security is on the asset
• Bank lending can be more expensive leasing to clients having short term cash issues
• Lessors can match deposit payment terms with expected earnings of the asset and useful life of the asset
• Lessors use matched funding to avoid dependency on deposit payments
• Liquidity squeezed as customers rely on overdrafts, asset finance is a longer term solution

Question 18

What is nominal rate

Answer 18

It is the interest rate applied to loan amount without taking into account of any fees and interest compounding (does not take into account inflation)

Question 19

What is the APR and calculation?

Answer 19

Annual percentage Rate
Represents the compound rate of interest plus all charges that customer is obliged to pay
Amount financed + Term/Payment Frequency +
Underlying rate of interest + Additional document, admin, arrangement or option to purchase fees

Question 20

What is the draw back of Flat Rate of interest?

Answer 20

Failed to calculate the way a funder calculated yield and margin
Can be manipulated to understate true cost of borrowing or the reducing balance like a nominal rate
Used to be used in motor industry

Question 21

What is variable rate?

Answer 21

Interest is set in reference to the base rate but actual payable amount can vary for each payment period

Question 22

Positives & Negatives of Variable Rate

Answer 22

+ Can be attractive if high interest market as they can expect a fall later
+ Can be attractive for customers wanting to settle early as there isn’t front load fixed rare interest charges
- Less popular due to low interest rate market which could mean upward trend for the customer in the future
- Customers lack certainty like in fixed rate agreements

Question 23

What rate does Pre-lease or Pre-inception funding use (Close facility)?

Answer 23

• Short term Variable rate loan of acquiring the assets, providing a daily interest funding method for the stage payments to the supplier.

Question 24

Types of Index Rates

Answer 24

Finance House Base rate
Bank of England Base rate
ICE - London interbank offered rate (ICE - LIBOR)

Question 25

Types of re-structuring deals? - 10 points

Answer 25

• Seasonal payment profiles - mirroring the expected seasonal income flow of the business e.g. farming and tourist sectors
• Low start and deferred payment profiles
• High start and stepped payment profiles - Accelerated payments at the beginning when maintenance costs for the assets are at its lowest
• Payment holidays
• Ballon rental
• Payment frequency changes e.g quarterly, etc
• Nil - deposit profiles
• Commission allowance - Paying commission to introducers at the beginning of the agreement = Present Value used to calculate customer payments should be aggregate of the amount financed and the commission
• Subsidies = amount paid by a 3rd party to the lessor to supplement lessor income and adjust the rate charged to the lessee
• Discount = 3rd party may discount the amount paid by the lessor to acquire the leased equipment - sometimes or not disclosed to lessee

Question 26

Benefits of deal structuring?

Answer 26

Helps differentiate offering by the funder from its competitors
Helps customer make choice as it is based on cash flow requirements and payback on the asset

Question 27

What is FRS 102?

Answer 27

• all leases have to be on balance sheet