Capital-intensive industries, such as manufacturing, pharmaceuticals, automotive, chemicals, and electronics, often use precious metals to serve as a catalyst in their production processes, whereby the metal itself is not actually consumed but used for its chemical properties. Precious metals are limited in availability, and market pricing for them can be quite volatile. As such, the decision whether to purchase or lease these precious metals will have a material impact on the industrial firm’s liquidity and balance sheet.
When precious metals are purchased, the expense is significant, and it exposes the company to commodity price risk and, potentially, currency risk. Therefore, many firms choose to lease precious metals from a leasing company, reducing their capital outlay, while eliminating currency risk and the need for mark to market accounting on the price of owned commodities. When leasing companies can meet the precious metals needs of the manufacturer, leasing is typically a better alternative for most industrial firms.
Under a typical precious metals lease, the leasing company (normally the precious metal division within a trading company, bank, or other lender) holds the risk of the industrial firm failing to return metal at the end of the lease period. This creates non-performance and credit risk for the leasing company, as it will have to seek monetary reimbursement for any unreturned metals in the event the manufacturer fails to perform under the lease agreement.
The leasing company, as secured creditor in many jurisdictions, must decide if it needs to mitigate the risk of non-performance and non-payment by the industrial firm. One alternative is to require the industrial firm to provide a bank letter of credit to mitigate these risks. However, this approach negatively impacts the firm’s liquidity. It also may cost the leasing company opportunities if its competitors are offering leases without the requirement for a bank letter of credit.
We have recently developed credit insurance solutions to assist a leasing client that faced this scenario. The solution was designed to mitigate up to 90% of the performance and credit risks, and provided enhanced capital relief to the leasing company – based on the strong credit ratings of the insurance companies utilized. Ultimately, the solution created a competitive advantage for the firm, allowing them to offer lower rates to their industrial client.
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