BLM71300 - ’Income-into-capital’ schemes and back loaded leases: 'Income-into-capital' schemes: example, part 1 of 5

Example

This example shows more detail of the practical effects of an ‘income-into-capital’ scheme. The following steps are agreed in advance between the parties-a finance lessor which is part of a major banking group (Bank) and a finance lessee (the Borrower):

• Borrower owns a property freehold and grants a 999 years lease to Bank for £70 million. No rent is payable under this lease. That £70 million is the ‘loan’.
• Bank’s funding cost (interest payable by Bank) is £9 million a year.
• Bank leases the property back to Borrower for 30 years in return for rent. The rent is low until the end of year 7 of the lease when it increases so that the rents over the remainder of the lease will repay the ‘loan’ with ‘interest’. The first seven years’ rent amounts to £40 million.
• Bank grants an option to a subsidiary of Borrower called Holder: this is the company that holds the option to buy back the leased asset. The option enables Holder to acquire the 999 years lease from Bank after 7 years for £100 million.

The important point here is that, if the option is exercised, Bank will get its money in two ways; first, as rent under the lease (£40 million) and, second, as proceeds of sale when Holder exercises its option (for £100 million) - this amounts to £140 million in total. In this way, Bank gets back the £70 million spent on acquiring the 999 years lease and £70 million representing ‘interest’.