Benefits of Independent Analysis of Lease Portfolios

June 2019

By Rick Daubenspeck, Managing Director – Tangible Assets – Valuation & Business Analytics, BDO USA, LLP

In today’s business landscape—an environment of perpetual change—the potential for a lease transaction to go wrong remains a constant. Generally, equipment lessors keep their portfolio reviews in-house to avoid the expense of an outside appraiser. However, as a result of recent economic events and growing pressure from management to assure that any shortfalls or potential losses are recognized and resolved early enough to avoid any unpleasant surprises, bringing in outside advisors is becoming more of a necessity—and can help to mitigate greater potential losses.

A potential loss from a lease transaction is often a result of an occurrence that could not have been predicted with the inception of the lease, or one that falls within the gray area of the contract language. If this is the case, obtaining an opinion from an independent party can provide an opportunity to plan for a resolution and potentially eliminate loss or risk exposure. An independent appraiser might also provide an option that the Lessor didn’t consider.

Here are a few examples where an external approach helped to mitigate unexpected risks. Equipment managers should be on the lookout for scenarios like these:
 

The Hidden Risks in ‘Current’ Leases

When performing a review of a lease portfolio that included a mix of leases at risk and leases where payments were current, the biggest surprise came from the lease that had been current throughout its term. The Lessee was a textile business that made its lease payments for office furniture as scheduled every month. Through the due diligence of an independent analysis, it was discovered that the Lessee was being sued for age discrimination and had moved from its original location into a five-year lease term. The assets were still located at the previous corporate headquarters as if it were business as usual, and the Lessee had arranged for an individual to show up and clean the furniture once a month. After three years of timely payments, the Lessor was notified of the situation and was able to initiate action to avoid any losses under the existing lease agreement. In this case, the Lessor had no idea of the current situation since the client was never delinquent. The Lessor was able to put an action plan into motion that allowed recovery of the assets in accordance with the documented lease language with a predetermined disposition scenario. By being proactive about bringing in an outside advisor, the Lessor was able to avoid a scenario where the outcome could have been less than positive.
 

A Second Set of Eyes on Your Third Party

If a Lessor has contracted with an outside provider to manage its lease portfolios, the responsibility of monitoring the portfolio falls to that third-party, including providing timely updates of values and potential exposure. In one case, while looking at a portfolio under these circumstances, it was determined that the external manager was not fulfilling the responsibilities as indicated in the contractual agreement. Delinquent accounts were not being followed-up in the manner expected, and the health of the portfolio was suffering. By bringing in an independent appraiser who discovered the situation, the Lessor was able to tighten up the management of the portfolio and become more proactive in addressing any potential exposure.
 

Ensuring Proper (and Complete) Documentation

With the pressure to execute as many transactions as possible, it’s common for critical identifying information for equipment leases to be missing. In this example, after reviewing and comparing information critical to multiple items of equipment that were purchased and installed to operate as a stand-alone system, it was noted that key items required for the system to operate were not included in the asset listing attached as an exhibit to the lease contract. Without these specific items, the Lessor was left with a disjointed grouping of equipment that was incapable of operating as a stand-alone system. With this risk identified through an outside assessment, the Lessee was able to revise the documentation to ensure that all assets that comprised the system would be kept together.
 

Assistance Getting Ahead of Problematic Assets

Often Lessors do not have the resources to go out and actually inspect the equipment on lease if there are concerns surrounding the assets. Such scenarios could include the Lessee’s ability to make payments, equipment that operates in an industry in decline, or the Lessee choosing to return the asset nearing completion of the lease term. In these situations, the Lessor may seek out an independent party to look at the equipment at the Lessee’s location to provide the Lessor an overview of the condition of the assets. While most of the time there isn’t an issue with the assets, there have been cases where assets were stored outside or in an area not protected from the weather, resulting in damage or dilapidation of the assets to a point that they were no longer able to operate. For example, there have been instances where a roof leaked on the leased assets, causing excessive water damage to all or a portion of the assets on lease.
 

Ensuring Proper Maintenance, Not Just a Paint Job

Every lease contract includes language requiring the assets be maintained in “a manner in which the manufacturer intended,” or similar language. Again, for the most part, the Lessee is compliant with the language and will often have the records showing that assets were maintained as required. There have been situations where the Lessee did not maintain the assets to the level required in the lease contract, and then tried to cover this up by painting the assets prior to their return to the Lessor. In this case, an independent appraiser noticed excess paint on the ground in the same color as the asset and signs of tape being used on the floor around the base of the painted asset. Other times, the Lessee leasing multiple identical assets has cannibalized several of the assets on lease for parts to keep the other assets operating.

These are just some of the problems that can crop up in lease transactions, and solutions showing how outside counsel was able to ameliorate a negative situation. It’s evident through these examples how independent, outside counsel can be beneficial. Otherwise, without an independent analysis, having the review for potential exposure or losses being performed by the same individuals who are initially setting the residuals is analogous to having students grade their own exams. From a Lessor’s perspective, a new set of eyes looking at transactions and an alternative viewpoint can sometimes provide pertinent information that can assist in the avoidance of a potential loss.

While equipment personnel are busy working on potential new business, the use of an outside opinion provider to review existing transactions can allow for the personnel to remain focused on performing their primary responsibilities, while still protecting the company from risk and potential losses. Remaining diligent and continuing reviews of existing deals should be a consistent priority.