Leasing sector

The non-banking financial institutions (NBFIs) in Pakistan, play a vital role in broadening access to financial services and support the expansion of the financial base; complementary to the banking system. In a two-part series, BR Research presents an overview of the NBFI sector; its evolution and current state in the country. Today's Brief Recordings are the first of this two-part series; and focuses on the leasing segment among NBFIs.
The NBFIs enhance the efficiency of investments and savings and also help to broaden the base of the financial markets. A strong NBFI sector not only offers a diversified range of asset classes to investors; but also provides alternative fund raising opportunities to the participants of the financial system and assists growth of capital and debt markets.
The financial sector in Pakistan is comprised of commercial banks, development finance institutions (DFIs); microfinance banks (MFBs), non-banking finance companies (NBFCs), leasing companies, investment banks, discount houses, housing finance companies, venture capital companies, mutual funds, and modarabas. Under the prevailing legislative structure the supervisory responsibilities in case of banks, DFIs, and MFBs fall within the legal ambit of the State Bank of Pakistan (SBP) while the rest of the financial institutions are monitored by Securities and Exchange Commission of Pakistan (SECP).
The banks are the dominant segment within the financial sector, in Pakistan. This dependence on the banks makes leads to vulnerabilities due to a lack of diversification and also restricts the scope of product innovation. It is imperative to strengthen the financial sector through the promotion of institutions other than banks. This will strengthen the risk management capacities and provide different asset classes to cater specific needs of prospective customers through diversification, product innovation and market penetration.
Leasing: an introduction Leasing is considered the quickest means to obtain equipment finance; without lengthy and time-consuming procedures. It allows conservation of working capital that can be utilized for other productive business purposes. It is a Shariah compliant mode for financing given certain changes in processes and rental payment which may be charged as a tax deductible expenses to the borrower's balance sheet.
Leasing activities in country started as an organized sector in the mid-eighties with the establishment of the first leasing company in 1984. The National Development Leasing Corporation Limited (NDLC) was established as a joint venture between Asian Development Bank (ADB), International Finance Corporation (IFC), National Development Finance Corporation (NDFC) and local sponsors. It was established under the supervision of SBP and enjoyed the status of a DFI.
Since then the sector has witnessed constant growth. The enviable growth of the sector can be judged from the fact that at one time, the number of leasing companies in the country rose to 41. Leasing; while an alternate source of financing for medium- and long-term; is different from conventional lending. As such, it requires specialized knowledge and skills. It is not a simple straight forward lending activity.
Core business areas The core business of most of the leasing companies in the country is machineries, equipment and vehicle leasing while other products have been added to expand the overall business. Today, the products being offered by leasing companies include:
-- Corporate Lease
-- Consumer Auto Lease
-- Operating Lease for various equipment.
-- Commercial Vehicle Lease.
-- Leasing to SME sector.
The leasing sector has remained an essential component of the financial industry and plays a vital role for promotion and development of the industrial sector through capital assets financing. Over the years, the sector has registered progressive growth; both in number of firms and business volumes, until it was hit by the liquidity crisis of 2008-09. Despite of that crisis, some of the leasing companies have improved their performance in terms of profits and generation of business volumes, as compared to losses posted in the preceding years. The year ended June 30, 2014; showed that the total assets of the leasing sector exceeded Rs 36.5 billion and total equity stood at Rs 6.5 billion; while the sector booked a profit of Rs 585 million.
The core activity of leasing company is financing of assets for different sectors. The categories of assets are industrial machinery, equipment, agriculture farming machineries, commercial and private vehicles, etc. According to regulations, 70% of the business should be in the core business ie leasing financing in long- and medium-term. Leasing companies also place funds in other investment conduits such as the equity market and government bonds.
Market composition Currently there are ten leasing companies operating in the country. The total assets of the leasing sector as of June 30, 2014 are Rs 36.57 billion. Total assets of ORIX Leasing Pakistan Limited alone stood at Rs 24.45 billion which represents about 66% of the assets under management of this sector.
Similarly, total equity of the leasing sector was reported at Rs 6.51 billion; of which ORIX Leasing Pakistan Limited's share is roughly 47%. Sindh Leasing constitutes 15.7% of this tally while 14.7% is attributable to Standard Chartered Leasing.
As such, the sector is driven by a few, major companies who have larger assets size. The large assets share is with Orix Leasing due to its wide branch network strong market penetration at country level. If we review the performance of the major companies such as Orix; it is apparent that the individual performance is outstanding. All the key indicators of such companies are very progressive and satisfactory. However, few leasing companies continue to struggle due to liquidity crunch and shortage of capital.
The number of leasing companies has dropped from more than 33 to 13, by the end of 2014. In the late 1990s; the commercial banking sector entered into leasing business activities. Since the banks have access to relatively low-cost funds; particularly from current and savings account deposits; they were able to capture a large portion of the lease financing market. The leasing companies; with their small equity base, could not compete with commercial banks and their performance was gradually diluted.
At that time, the Leasing Association of Pakistan (LAP) raised concerns on behalf of leasing companies. They argued that the banks had been allowed to encroach on their business and suggested that the activities of the commercial banks should be restricted. It was suggested that the banks should be mandated to enter this market, through subsidiaries; not directly. However, this suggestion did not garner approval from the central bank and other key stakeholders and commercial banks remain entrenched in this business segment. Other prominent factors that have led to shrinkage in the leasing sector include:
-- Non-availability of long-term funds at low costs
-- Withdrawal of credit lines by the banks after the financial crisis of 2008
-- Inability of some companies to meet minimum equity requirement
-- High non-performing loans in the sector's cumulative portfolio
-- Slowdown in economic activities and investment opportunities
Each of these reasons has impacted leasing companies in the country; directly or indirectly. Consequently, the sector's profitability, return to shareholders and growth; have been stunted. This has not only diluted the confidence of investors; but also discouraged new entrants from the market.
However, after the gap of several years, a new entity has entered the sector, last year. The Sindh Leasing Company Limited, has emerged with paid-up capital of Rs 1 billion. The company declared net profit within its first year of operations.
Revenue drivers The major contributions to the sector's revenues are from lease financing activities. The rest of the revenues are attributable to income from rental activities of equipment leasing; mainly generator sets. As per published accounts of leasing companies for the period ended June 30, 2014; gross revenue was Rs 5.3 billion. Out of this tally, Rs 3.82 billion was contributed by ORIX Leasing Pakistan Limited which corresponds to 72%. Similarly, the profitability of the sector stood at Rs 584 million; out of which ORIX's share was 88%.
Normally, both borrowing and financing are linked with floating interest rates which are reviewed on quarterly/semi-annual basis. However, few companies offer Certificate of Investment (COIs) on long-term basis. These long-term deposits are hedged through long-term assets, booked on fixed-rate basis.
The declining rate scenario can affect profitability to some extent for such companies that are less leveraged and have booked their financing assets through equity. Within the last six months, the discount rate has been slashed by almost 300 bps. On the other hand, falling interest rates also bring opportunities for credit off-take. According to current statistics, financing in banking sector is gradually picking up due to reduction of finance cost.
There are also chances of potential growth of consumer financing particularly in car financing. However, the sustainability of low interest rates is uncertain and any upswing in rates will deteriorate repayment capacity of borrowers and ultimately lead to higher non-performing loans.
Sustained low interest rates can be a great incentive for the economic uplift of the country through financing of micro and SME sectors. There is a great need for the encouragement of "asset based financing" through the leasing sector.
Key challenges One of the major and oft-repeated complaints of NBFIs is that their ability to mobilize funds is constrained due to lack of investment opportunities beyond debt and equity markets. This challenge is particularly compounded for Shariah compliant companies.
The leasing companies also experience tough competition from commercial banks because of the latter's access to cheaper funds and larger risk-carrying ability given their relative size advantage over leasing companies. This is one reason for the consolidation in leasing industry and the disappearance of smaller players from that industry.
Minimum equity requirements have been raised gradually over the years and this has been a peeve for some participants in the sector. However, the regulator is reportedly in the midst of changing these requirements to facilitate the sector.
Leasing companies have lodged an appeal in court against the levy of Federal Excise Duty (FED). The introduction of a new tax levy on leasing sector ie Alternate Corporate Tax; has also diluted their profitability. Insurance companies and banks were exempted from this tax in the previous budget however it is applied on leasing companies.
Key opportunities In recent years, leasing has re-emerged as a significant financial industry, globally. In Pakistan, the sector has risen in earlier periods. Back in the 1990s, the number of participants in the industry had increased considerably. Now, with interest rates at historical lows and global commodity prices weak; there is a window of opportunity for NBFI including leasing companies, to resurrect their markets.
The sector can take advantage of certain niches such as the financing needs of small and medium enterprises which constitute the vast majority of businesses in the country. Appetite of the consumer segment is also on the rise. As such, vehicle leasing stands to benefit from rising incidence of vehicle ownership.
Regulatory environment The SECP has finalized draft regulations for the sector and relevant notification is expected soon. According to new regulations, NBFCs have been segregated between deposit-taking and non-deposit taking entities. Minimum capital requirement for non-deposit taking entity is expected to be reduced drastically in order to encourage such companies. Leasing sector representatives believe this move will create impetus for the industry's growth.
The NBFI and Modaraba Association of Pakistan, is a representative forum of leasing and modaraba companies in the country. It functions as a platform interaction between industry participants; undertakes research, participates in national and international conferences and provides training to the human resource of member companies. This association also engages with SECP, on behalf of its member companies.