Measuring Credit Risk
Creative Leases a Red Flag?
By Scott Blakeley

Should sale-leasebacks alert vendors that a company is in need of cash? Sale-leasebacks, as well as net leases are increasing. That is partly because companies with weak credit ratings finding it difficult to obtain conventional financing are increasingly turning to real estate as a source of cash. Also, even financially strong companies with solid credit ratings are looking for ways to raise cash to retire debt and improve their financial ratios. A new set of rules from the Financial Accounting Standards Board are expected to encourage companies to convert synthetic leases, by which a company maintains control of the property while gaining tax benefits, into more legitimate true leases, such as sale-leasebacks and net leases. Such lease deals are not necessarily red flags for credit risk. Lease arrangements have downsides. They can increase a company's fixed costs, leaving it less flexibility should it need to downsize and companies lose the chance to participate in the appreciation of the real estate, since a sale-leaseback is basically a one-time maneuver. For investors in a company that is having trouble raising cash, a sale-leaseback may also be a heads-up. Some see sale-leasebacks as another way companies leverage themselves to survive in a business climate that is not improving.

In reviewing a sales-leaseback transaction, the credit professional should question why a company is doing such a transaction. If the company is doing the sale and lease-back of corporate real estate so to pump up earnings, or even as a last-ditch effort to raise cash, it is the red lag that converting from credit to cash sales are appropriate.

This information is not intended to constitute legal advice, nor a substitute for legal advice.

Reprinted with permission from Trade Vendor Monthly, 2/03