Equipment and Asset Finance

A business that carries freight needs trucks before it has carried the freight. A workshop needs the machine before the machine has cut anything. The money for these goes out on one day and comes back over years of use — the same permanence a term loan exists for — but with one difference that changes the whole product: the thing being financed can be found, valued, repossessed and sold. Equipment finance is term lending built around that fact. The asset is the security, the asset's life is the tenor, and the asset's second-hand price is the last line of defence.

That is why the product is cheaper than an unsecured term loan and faster to approve, and why it is offered by lenders who would not lend to the same business on any other basis. It is also why the product goes wrong in one particular way. A lender who believes the asset is the loan stops reading the business; a business that believes the asset is the loan stops asking whether the payments can be carried. Both forget the order every credit desk works in: the asset's earnings repay the loan, and the asset's sale is only the second way out.

Amount — a share of the asset's cost, rarely all of it: the borrower's deposit is the first buffer against the asset being worth less than the debt on it the day it leaves the yard. New assets are advanced against more of their cost than used ones; generic assets against more than specialised ones. Tenor — the asset's working life for this business, not its physical life: a linehaul truck that will be replaced on a five-year cycle is a five-year loan whatever the odometer could survive. Amortisation and residual — level payments to zero, or to a balloon set inside the asset's expected resale value, so that at every point in the schedule the debt sits below what the asset would fetch. Rate — commonly fixed for the term, which suits an asset with a fixed earning life and brings the break costs a fixed rate carries if the asset is sold early.

Security — a specific security interest over the financed asset, registered so it can be found, and often a general security agreement behind it; for a company, the directors' guarantees are usual. The legal form — a loan secured on the asset, called a chattel mortgage in this market; a finance lease, which reaches the same economics by a different route; or an operating lease, where the lender keeps the asset and its residual risk. The form changes tax, accounting and who carries the resale risk; it does not change whether the payments can be carried. Covenants — usually lighter than a revolver's, because the exposure falls with every payment; the monitoring that matters is of the asset itself: insurance, maintenance, and that it is still where the register says it is.

The rate is the visible cost; the residual is where the money hides. A constructed illustration, every figure invented for teaching — a truck costing US$300,000, financed over five years at 7.00% with a 20% deposit, so US$240,000 is borrowed:

The balloon buys US$1,000 a month of breathing room and costs a quarter more in interest, which is a fair trade when the truck will sell for well over US$72,000 in year five and a trap when it will not. The number to check is not the payment but the gap between the balloon and the honest resale value — and “honest” means the price a dealer would pay for a five-year-old truck with this business's mileage on it, not the price in the brochure. On a fit-out or a machine built to one customer's specification, the honest resale value can be close to nothing, and a balloon against it is a loan the borrower has not yet been told about.

The business first, the asset second. The payments come out of operating cash flow, so the first read is the same as any term loan's — debt service cover on the whole book of the business, including the new payments, through a bad year. An asset that will hold its value does not make a loan affordable; it makes a default less expensive.

Generic or dedicated. The question underneath every asset is who else could use it. Trucks, standard plant, vehicles and generic machinery have a market of buyers who were never party to this loan, and their value survives the borrower's failure. A fit-out cut to one customer's racking, a machine tooled for one product, a vehicle liveried and modified for one contract — these are worth what that customer will pay and nothing to anyone else. The desk advances less against them, amortises them faster, and asks whether the earnings they produce are as dedicated as the asset is.

The commitment behind the asset. Where the asset serves one contract, the loan's real tenor is the contract's, not the asset's. A five-year truck financed over five years to serve a customer who can walk on ninety days' notice is a ninety-day loan wearing a five-year schedule. This is the whole of Issue 05: a US$6.0m request for eighteen linehaul units and a distribution-centre fit-out, all serving one customer who has grown to 58% of revenue under a contract with a 90-day break clause. The senior read funds the generic trucks fully, funds the dedicated fit-out conservatively, and puts the amortisation inside the contract's term rather than across the assets' physical life. The age of what is already there. A fleet averaging 6.8 years with replacement deferred, as Meridian's is, tells the desk that the new trucks are not adding capacity so much as catching up — and that the next replacement wave is already on its way.

The loan that outlives the asset. Seven-year money on a five-year machine, or five-year money on a contract with a ninety-day exit. The tail years are where the asset has stopped earning and the payments have not stopped, and they are where this product's losses cluster.

The balloon nobody priced. A residual set to make the payment fit, on an asset that will not fetch it. The loan performs for years and then fails at maturity, on schedule, when the borrower discovers that refinancing a balloon on a worn asset is a credit decision someone has to make.

Sale-and-leaseback as a cash substitute. A business that sells the plant it already owns to a financier and leases it back has raised cash, and a desk should read that cash as the working-capital request it really is — often one the cycle arithmetic would not have supported on its own terms.

The asset that moved. A truck sold on to another operator, a machine shifted to a related company's premises, plant registered against the wrong entity. Equipment security is only as good as the register and the annual check that the asset is still where the register says; a lender that relies on the asset and never looks at it has security in theory only.

Issue 05 is this product at full difficulty — eighteen trucks and a fit-out, one customer, one break clause — and its file appendix carries the numbers the senior read used. The customer's side of that contract is read in the customer's chair, and the MD who has to live with the structure in the MD's chair. The general form of the product is the term loan; the ratio that decides whether the payments can be carried is worked in Debt Service Coverage; and what a bank takes as security, and what it is worth, is the subject of LVR, Security and Collateral.