What are the pros and cons?

The first advantage of conduit financing is that it is usually significantly cheaper than hire purchase or agency lending even after allowing for the spread kept by the sponsor bank.

The reason for this low margin, which is also a possible disadvantage, is that the conduit only finances the “top” portion of the funding requirement , leaving some risk and some funding requirements to the originator.

This may be off-set using mezzanine financing, which provides funding for most of the unfunded portion of the leasing – clearly at a cost but reducing the funding requirement of the leasing company.

Another reason why conduit financing is cheaper is because, at least until now, the sponsor bank has lower capital requirements for the liquidity facility it provides to the Conduit, compared to the capital required if the same loan was kept on the balance sheet of the bank.

Conduit financing provides a clear, committed facility for a definite period of time (e.g. 3 years plus the time to run off the remaining contracts at the end of the 3 years), thus insulating the leasing company from fluctuations in the supply of bank credit.

This may be particularly relevant in the leasing space where one banking group is one of the major providers of funding to the industry, is itself a major player and is a relevant investor in another player.

Given how tight margins are in the leasing industry, if you can achieve a better cost of funding, you can probably expect to see your business grow considerably, and conduit financing also offers the opportunity to scale up the business significantly, given that the CP market is worth about $1 trillion.

Conduit financing is more complex than a traditional bank facility, Agency facility  or hire purchase and is not appropriate for smaller leasing operators since the minimum size of the facility is usually around £50m.

How do you set up a Conduit?

Implementing a Conduit financing line can be challenging for a tightly run organization who is already fully occupied by its day-to-day business.

 There are several complex steps which include contacting and obtaining clear terms from the possible Conduits, calculating the expected advance rate based on the characteristics of the leasing portfolio and the Conduit requirements, modeling and comparing the financial benefits of each Conduit option over several years and determining if Conduit financing is an appropriate solution at all.

It is also important to identify and manage experienced lawyers to support the process, negotiating the terms and implementing whatever changes may be necessary from an operations perspective to accommodate the requirements of the conduit in terms of reporting, auditing, tax, IT and process robustness.

If done independently, this often requires focus from the organization, and particularly from the finance director, for a considerable period of time – six months being a reasonable estimate.

As many organizations cannot afford the luxury of distracting these resources for such a long time and may still be concerned of doing things right, instructing a corporate finance advisor with specific skills in this sector is often a wise choice.

Granular Investments is a London-based corporate finance advisor specialized in asset-backed financing and securitization.