Chapter 8 • Sources of long-term finance
There is no particular reason for asset-backed finance and securitisation to be a
problem and it is no doubt unfortunate that the practice may be linked with the sub-
prime difficulties. It is a perfectly legitimate and practical way for a business to raise
finance.8.10 Leasing
It may seem strange to see leasing referred to as a source of long-term finance, but in
fact it is very similar to secured lending.
Leases may be divided into two types:l Operating leases. It is often possible to hire an asset, say an item of plant, that is
perhaps required only occasionally, rather than purchasing it. Usually, the owner
carries out any maintenance necessary. The decision whether to buy the asset or
to lease it will perhaps be affected by financing considerations. Basically, though, it
is an operating decision, which would be made according to which approach would
be cheaper.
l Finance leases.Here the potential user identifies an asset in which it wishes to invest,
negotiates price, delivery and so on, and then seeks a supplier of finance to buy it.
Having arranged for the asset to be purchased, the user leases it from the purchaser.
Naturally, the lease payments will need to be sufficient to justify the owner’s expend-
iture, in terms both of capital repayment and of interest.The nature of finance leasing
It is finance leasesthat concern us here since they are effectively term loans with cap-
ital repayable by instalments. This is an important source of finance, which has been
estimated to provide as much as 20 per cent of the total finance for new capital expend-
iture by businesses over recent years (Drury and Braund 1990).
In the past, finance leasing has been believed to be popular with users partly
because, while it is tantamount to borrowing, neither the asset nor the obligation to the
owner appeared on the balance sheet of the user business. Those trying to assess the
business’s financial position could overlook such a source of off balance sheet fin-
ance. However, accounting regulations have now put leasing on the balance sheet.
Businesses are now required to show both the leased assets and the capital value of the
obligation to the owner on the face of the balance sheet.
Another feature of finance leasing, which was apparently a major reason for the
growth in its popularity during the late 1970s and early 1980s in the UK, was its con-
siderable tax efficiency in some circumstances. Lease payments are fully deductible for
corporation tax purposes by the borrowing business. This includes the capital portion
of the payment.
Until 1984, the capital cost of items of plant attracted 100 per cent first-year capital
allowance in their year of acquisition. As far as the borrowing business was concerned,
leasing rather than buying a non-current asset would deny it the opportunity to claim
the first-year allowance. On the other hand, leasing would still enable the business
to claim 100 per cent of the cost of the asset, but over its life, rather than in the first
year. In many cases, however, even where businesses were to buy the asset by raising
finance from, say, a term loan, profits were insufficient for the full benefit to be gained‘