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SFIG: Tax reform would hurt auto, equipment lease securitization

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The tax reform package making its way to President Trump’s desk would make it uneconomical for auto and equipment rental companies to tap the securitization market for funding, the industry trade group warned this week.

In a Dec. 11 letter to the Senate and House tax reform conferees, the Structured Finance Industry Group said depriving auto and equipment leasing companies of an efficient cost of funds via securitizations would lead to more expensive leases for consumers and businesses.

The letter, which was distributed to the news media Thursday, noted that both the House and the Senate tax reform proposals limit the deductibility of interest to a percentage of the taxpayer's earnings. Lawmakers reached agreement Wednesday on a merged version of the House and Senate tax plan that is expected to be unveiled Friday.

In a securitization, assets such as loans or leases are sold by the lender or aggregator to a bankruptcy remote, special purpose vehicle; this securitization trust issues bonds that are backed by the loans or leases. Interest and principal payments on the assets are used to pay interest and repay principal on the bonds.

This financing method allows some lenders and lessors to access financing more cheaply than they could be issuing general obligation bonds.

Here’s why limiting interest deductibility creates a problem for bonds backed by auto and equipment leases – and not bonds backed by many other kinds of assets such as consumer loans, according to SFIG,
“In most securitizations , the amount of interest income (from, for example, a pool of mortgage loans) is closely aligned with the amount of interest expense on the securitization debt,” the letter states. “In these cases, there would be little impact from the proposed limits on interest deductibility.

“In certain types of securitizations, however, the income is not treated as interest but instead is treated as lease payments. Securitizations of auto leases and equipment leases fall into this group. The inability in a lease securitization for the issuer to offset lease income with interest expense would make such securitizations uneconomical.”

The letter provided the following example:

Suppose an equipment manufacturing company securitized leases on construction equipment which produced $100,000 in equipment-leasing income in year one (and the company had no other net income) and the company issued a single class of debt (backed by these equipment leases) which paid $80,000 in interest in year. Under the current proposal, the company's business interest deduction would be limited to the sum of (A) the business interest income of the company (here they have none), plus (B) 30% of the adjusted taxable income of the company (here, 30% of $100,000 = $30,000). As such, despite paying $80,000 in interest on the debt in year, the company would only be permitted to deduct only $30,000 of the interest. As a result, the company would owe tax on $70,000 of income ($100,000 minus $30,000) but only have $20,000 in net funds ($100,000 minus $80,000).

Reducing interest deductibility isn’t the only proposed reform that would hurt auto and equipment securitization, however. The legislation would restrict like-kind exchanges to real estate assets.

Under current law, a like-kind exchange can be used to defer gain from the disposition of tangible property (real or personal) used in a business. Many auto and farm equipment manufacturers as well as other companies that lease assets to consumers use a like-kind exchange program to defer gain on the disposition of property returned at the end of a lease. “By eliminating the ability to use like-kind exchanges for non-real estate assets, the provision can be expected to impact the securitization of these asset classes,” SFIG stated in the letter.

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