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Leasing companies limping back to business

November 11, 2013

THE outlook for the leasing business is apparently improving. Some top companies are focusing on agricultural leasing, while others are moving from long-term, low-risk finance leasing to short-term, high-risk operating leases.

And most of them are hoping to gain from business expansion plans and some increase in overall economic activity.

Leasing is asset based financing and is acceptable under Shariah laws. Some leasing companies, including ORIX, NBP Leasing and others, have been providing financial lease facilities to farmers for purchasing tractors and other machinery.

Lately, they have also gotten involved in operating lease of solar power projects of individual companies and solar tube-wells owned by rural communities.

The cumulative after-tax profit of all leasing companies stood at Rs610 million in FY08. But over the next two fiscal years, the profits evaporated, with the sector recording after-tax losses of Rs1.52 billion and Rs579 billion respectively, as banks’ financing to the private sector almost dried up.

The situation improved in FY11, with a cumulative after-tax profit of Rs337 million. But FY12 saw them again record an after-tax loss of Rs388 million.

“Lease financing fell out of fashion as economic growth slowed down. And leasing companies were also not getting funds from banks,” explains the chief financial officer of a local leasing company.

Finance leases generally form the core of profitability of leasing companies. “Income from this source began falling from 2008, and that made things bad for us,” he admits.

The cumulative finance lease income of all leasing companies fell from Rs4.895 billion in FY08 to Rs4.668 billion in FY09, before nose-diving to Rs2.971 billion in FY10, as funding issues started pinching them. In FY11 and FY12, finance lease income remained more or less static at Rs2.834 billion and Rs2.775 billion respectively.

Regardless of how fast finance lease income would recover, the key issue is when will our leasing companies be able to increase the share of operating lease in their overall income pie?

Historically, over 60 per cent income of the leasing industry originates from finance leases, with operating leases, investment and all other sources constituting less than 40 per cent.

Finance leasing involves purchasing an asset for a client and allowing him to use it on the condition that he would pay periodic installments of agreed rental during the term of the lease. At the end of the lease period, the client gets the ownership of the asset by making a marginal ‘pepper-corn’ conclusive payment.

Leasing companies prefer this for two reasons. First, in a finance lease, the company generally recovers the entire cost of the leased asset, and all the risks and benefits remain centred on the client.

Unlike this, in an operating lease, the leasing company recovers only a substantial part of the cost of the asset, and it also has to carry a substantial part of the risks associated with the economic life of the leased asset.

So, we can say that like other entities in the financial sector, leasing companies had also chosen an easier way of earning income. “And that was understandable under a given environment. But in unusual circumstances, the hollowness of an easygoing approach is bound to be exposed,” says a central banker who tracks the performance of non-banking financial institutions (NBFIs).

Executives of leasing companies say that key financials of these companies improved in FY13 — first, due to thicker cash flows of such important corporate sectors as food and textiles, and secondly because of increased activity in power generation and the construction industry.

“Our experience shows that larger cash flow encourages companies to acquire new assets on lease rather than through direct purchases simply because it emboldens them to undertake expansion projects, along with creating financial space for them to make regular rental payments,” says an executive of ORIX Leasing.

His company had signed a deal in mid-2011 with Engro Foods to provide lease finance to the Engro Milk Automation Network in Multan.

ORIX is an example of how fast an efficient company gets out of trouble during unfavourable circumstances. Like many other leasing companies, it also reported a pre-tax loss (of 12 per cent) in FY09, but recovered from it immediately afterwards. It’s pre-tax profit grew 3.3 per cent in FY10, and from then on, the trend only solidified with even higher growth rates of profit — 7.1 per cent in FY11, 8.2 per cent in FY12 and 11.6 per cent in FY13.

While up-to-date financial results of all leasing companies are not available, the published accounts of some of them indicate they did a bit better in FY13 than in FY12.

Saudi Pak Leasing Company, for example, came out of the perpetual losses it had been making since FY09 and posted a small pre-tax profit of Rs133 million. But the company’s income from operating and finance leases almost halved to Rs33 million in FY13 from Rs63 million in FY12, and its profit originated mainly from investment and other sources.

“That really is the issue,” says a central banker. “We know that in FY13, banks’ lending to NBFIs, including leasing companies, was very high. If some NBFIs reemployed banks’ money in stocks or somewhere else and made money out of it, that makes sense. But ideally, if the bulk of their income doesn’t originate from the leasing business, then just making some profit isn’t sustainable in the long run.”

The Standard Chartered Leasing Company also managed to get out of financial losses it had accrued in FY08 and FY09, and managed to increase profits over the next four years. It had earned a small after-tax profit of Rs43 million in FY10, which grew to Rs76 million in FY11 and to Rs98 million in FY12.

In FY13, the company made Rs106 million in after-tax profit, as its income from finance leases increased 13 per cent to Rs508 million.