Credit Risk: Contract Characteristics for Success
Executive Summary
The purpose of this research study is to investigate differences in the characteristics of successful (completed) lease transactions and failed (defaulted) transactions based on the PayNet data. Identifying measurable and persistent differences between successful and failed leasing contracts broadens the understanding of critical factors used in making leasing decisions. Data was provided through a cooperative agreement between the Equipment Leasing and Finance Foundation (ELFF) and PayNet. The study was supported in part by funding from ELFF. The findings indicate that contract characteristics, industry factors, and economic factors each influence default rates. The results support the use of higher risk premiums in specific industries and asset types. Insights from this study may be used to develop more effective risk management models.
- Sample included twelve quarterly data files covering the period April 2001 through January 2004.
- Average number of contracts studied per quarter = 85,487
- Average number of failed contracts per quarter = 9,513 (11.1%)
- Industry classification
- More than half of the contracts are in four broad industry classifications: services (SIC 7000-8999), manufacturing (SIC 2000-3999), transportation/public utilities (SIC 4000-4999), and construction (SIC 1500-1799).
- The greatest portion of failed leases occurred in transportation/public utilities, services and manufacturing.
- Finance/insurance/real estate had the smallest incidence of failed leases in the sample.
- Results provide evidence of industry-level risk factors across the twelve quarters studied.
- Greater industry risk may lead to higher risk premiums in specific industries and place greater emphasis on effective risk models in these industries.
- Contract term
- The majority of contracts studied had original terms between 25 and 60 months.
- Default rates increase with contract term, with nearly 17% of the longest contracts failing.
- Contract types
- The data files include results for a variety of contract types. However, "true leases" represent nearly 70% of the overall sample.
- For the true leases, the average default rate was 12%.
- Revolvers had the lowest default rate at 6.5%.
- Asset type
- Twenty-two distinct contract asset codes are represented in the study ranging from agricultural equipment to waste/refuse handling.
- Over seventy percent of the contracts are found in four asset categories: copiers (36%), trucks (12%), computer equipment (12%) and construction/mining (11%).
- Default rates vary widely among the different asset codes. This high variation supports the use of higher risk premiums for riskier asset classes.
- Contract guarantee
- The majority of the contracts studied did not include a definitive guarantor code.
- Within this sample, guarantor code provided very little additional insight into the development of effective risk management models.
- Characteristics of failed contracts
- On average, failed contracts had higher original receivable amounts and larger reported loss amounts.
- Failed contracts had lower average balances outstanding, possibly indicating an older subset of contracts.
- Failed contracts had a greater number of times past due in all aging categories. The average number of days past due is significantly greater and the average dollar amounts are greater in all aging categories.
