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Cover Story

Outlook for the year 2000

Feb 28 - Mar 05, 2000

The year 1998-99 was not very different from previous years. However, post nuclear economic scenario added difficulties for the leasing sector. Imposition of economic sanctions, disruption in flow of funds from multilateral lenders, freezing of foreign currency accounts, political uncertainty and lack of clear-cut policies to overcome the situation resulted in overall economic slow down. The impact would have been worse had the country did not enjoy a very strong and prosperous informal economy. The economic slow down resulted in lower volume of business, declining repayment ability of the borrowers and shrinking of spread for the leasing companies. More than desired number of players, entry of commercial banks and DFIs in leasing business and dearth of quality borrowers resulted in uncalled-for competition.

The pundits of leasing sector say that whatever has happened is history now. The companies which make prudent and conservative decisions were able to maintain their cash flow as well as underwrite new leases— even during the difficult time. The companies which went a little adventurous or became reckless in picking up clients have visible scars. Out of these, the companies which realised their mistake quickly, were able to minimize the adverse impact.

These pundits also say that while a significantly large number of companies will continue to suffer, in the near future. The big ticket companies as well as professionally managed ones will be able to post better results. Since DFIs and commercial banks are not keen in providing medium-term funds, borrowers will be forced to look towards leasing companies to meet their requirement for funds. At the same time, the quantum of funds required by a single borrower often requires syndication. Therefore, such companies will not be competing but complementing activities of each other. The smaller companies if also decide to participate in syndication can benefit. So far the syndication process has worked efficiently simply because the syndicate leader has the largest stake.

A question still bothers the small savers and investors, has the process of economy recovery really started? Though the signs of turnaround are still not very visible, the change in investors' sentiments is very much evident. It is based on some of the actions and measures taken by the new economic managers of the country. For the first time, in over fifty years, investors feel that there has been an effort to break 'status quo'. This was supported by the recovery campaign resulting in collection of over Rs 8 billion in cash and another Rs 3 billion in the form of other securities. This has resulted in higher liquidity in the financial system. At the same time, there are efforts to bring down interest rates. Although, there is no immediate and significant increase in private sector borrowing, one should not forget that the desired results will only be visible after 12 to 18 months.

Leasing companies have also realized the changing trend and are trying to quantify the future borrowings. This is evident from flotation of Term Finance Certificates (TFCs) by a number of leasing companies recently to overcome mismatch of funds and lock their future financial cost. Some of the analysts question the rationale behind flotation of TFCs at relatively higher coupon rate as the interest rates are going down. However, others say that excessive liquidity in the financial system is a temporary phenomena and interest rates are bound to go up even with the year 2000.

The basis of their qualifying remarks is that there has been no BMR in the manufacturing sector during last 3 to 5 years. Now, there is an urgent need for BMR and declining interest rates offer attractive opportunity. Similarly, there was hardly any fresh investment. The total listed paid-up capital at Karachi Stock Exchange was around Rs 200 billion in 1996 and it has remained at, more or less, the same level. Only 5 new companies have been listed since 1997.

It is clear that bulk of the appetite funds, in the near future, has to met by the leasing companies. Commercial banks are not interested in providing medium-term funds, DFIs no longer enjoy low cost credit lines and every company cannot raise funds from capital market. In other words, leasing companies have the enormous potential to expand their business. However, they will continue to face dearth of quality borrowers. Therefore, there is a need to explore the market and also go to small and medium enterprises rather than totally depending on the corporate sector.

One should take a lead from Sigma Leasing. It has created its own niche market. A significant percentage of its business comes from leasing of apparel machinery to small and medium sized units. This sector was grossly ignored by commercial banks and DFIs in the past. Sponsors of Sigma are in the business of selling apparel machinery. The buyers of these machines need softer credit terms and Sigma is able to match their demand. It may not be out of context to say that small borrowers are regular and prompt in discharging their liabilities. It is another issue that they often cannot offer 'too many collateral' other than the machines they want to buy.

The other area being ignored, to a large extent, is consumer leasing. Since this involves a large number of clients and small monthly rentals not too many companies are interested in undertaking this type of business. However, it is evident some of the leasing companies have been able to capitalize this opportunity by underwriting consumer leases to the employees of the corporate sector. A number of corporations, instead of giving soft-term loans to employees, just undertake to deduct the rentals from the salary of the employee and pass it on to the leasing company. While this policy helps the employer to use its own funds in other productive activities, the employee gets the advantage of using the equipment and pay rental over the years.

Sector review

The concept of leasing and hire purchase existed long before the first leasing company, National Development Leasing Corporation Limited was established in 1985. During 1985-1991 period only six companies were established whereas during 1992-97, as many as, 27 leasing companies entered the market. Some of the modaraba companies are involved in leasing as their business. The leasing sector has registered consistent and double digit growth — except for the last few years. However, this was mainly due to recessionary trend of the economy. The volume of leases underwritten over the years has increased mainly due to the fact that leasing companies have become the only source of medium-term financing.

Initially leasing companies could start business with a capital of Rs 50 million. This limit was raised to Rs 100 million in 1992 and further enhanced to Rs 200 million. Companies were required to increase the capital to this level by November 1999. However, a large number of companies failed to meet the deadline. All such companies have requested the SECP to extend the deadline. The SECP was also requested to consider shareholders' equity (capital and reserves) as the capital for meeting this requirement.

At present 32 leasing and 8 modaraba companies are members of Leasing Association of Pakistan. According to the information available from the Karachi Stock Exchange, 29 leasing companies posted profit for the year 1998-99 and 3 posted loss. Out of the profit making companies 9 companies did not declare profit.

As such leasing companies can be divided into three categories, large ticket, medium ticket and small ticket companies. While the five large size companies manage to get the largest share of the business, some of medium and small size companies have established their own niche market. Such companies, despite being small post modest return on equity.

While the sector continues to operate under intense competition the new interpretation of old laws, particularly with regard to taxation, has become a serious concern for the companies. It is true that the country needs additional revenues to minimize budget deficit, but tax collectors must refrain from issuing unrealistic demand notices. In this connection the tax regime must read the explanatory note, regarding taxation, in the latest annual report of Orix Leasing Pakistan.

National Development Leasing Corporation was established in 1984 as a joint venture between Asian Development Bank, International Finance Corporation, National Development Finance Corporation and local sponsors with a paid-up capital of Rs 20 million. As at June 30, 1999 shareholders' equity was over Rs 1.2 billion.

Orix Leasing Pakistan is a subsidiary of Orix Corporation — Japan's largest leasing company. It commenced business in January 1987. Orix Leasing Pakistan serves as the regional base for the Orix Group's operations in the Middle East. It has strategic investment in and manages joint venture leasing companies in Oman and Egypt. Orix Investment Bank Pakistan also has strategic investment from Orix Leasing Pakistan.

First Habib Modaraba was floated in 1985 as a multipurpose and perpetual modaraba. It is involved in leasing as core business. Ever since its inception, it has been regularly paying dividend to its certificate holders. It paid the second-highest dividend for the year 1998-99 among the 52 listed modarabas.

Security Leasing Corporation commenced its operations in May 1995 and has a paid-up capital of Rs 100 million. Foreign institutional investors are the majority shareholders in the Company. In addition to the leasing operations, the Company's activities include money market/short-term lending, capital market operations and project financing.

Sigma Leasing Corporation commenced its business in January 1997. It has been sponsored mainly by Almurtaza Machinery Company — the leading supplier of apparel and textile made-up machinery for the last 26 years. The main focus of the Company is to provide lease financing to small and medium enterprises.


Almost nine months of the current fiscal year have passed by. There are clear indications that the volume of business has increased. But more importantly, the spread has improved with the declining interest rates and higher liquidity in the financial system. Some of the leasing companies have floated TFCs which also indicates that the companies expect larger business in the coming days and that they have overcome the problem of mismatch of funds as well as locked their financial cost for a specified period.

The direction of economic growth cannot be predicted with certainty. Some of the analysts, having optimistic view, say that across the board recovery may not be there as most of the sectors continue to suffer from over supply situation. However, signs of sporadic investment in BMR as well as fresh investment are very much there. Dewan Salman has already commenced commercial production of acrylic plant which will provide impetus for the broad-based of textile sector. Ibrahim Fibres is in the process of expanding its production capacity from 70,000 tonnes to 200,000 tonnes per annum. The expansion programme of Nishat Mills, estimated at Rs 1.5 billion is at a very advanced stage. Dewan Faroque Motors is expected to make public offer of its shares shortly. Even some of the textile mills, enjoying strong cash flow and producing superior quality products, have started BMR programmes.

The movement of KSE-100 index also indicates revival of investors' confidence in the capital market. Purchase of 2.5 million shares, involving a sum of US$ 17 million, of Shell Pakistan by the parent company also exhibits renewed interest of foreign investors in Pakistan. However, this interest will be confined to less than a dozen listed companies.

The analysts, having pessimistic view, still believe that current euphoria is not supported by economic fundamentals. The country still suffers from adverse balance of payments, tax collection is inadequate to support development programme and exchange rate has been maintained mainly through capital controls. The other point is that unrealistic exchange rates and import tariff makes imports cheaper which encourages spending. Though the country continues to suffer from precarious forex reserves, no effort has been made to curb import of unnecessary items — either by imposing quantitative restrictions or complete ban on the import of such items. Inflation rate is expected to go up once again due to cost-pushed phenomena and interest rates are also expected to surge upwards. The increase in POL prices seems unavoidable which will also result in increase in electricity and gas tariff.

A large number of leasing companies have failed to increase their paid-up capital as per instructions of the Securities and Exchange Commission of Pakistan. Now, two options are available, either the deadline is extended for another 2-3 years or these companies opt for mergers and acquisitions. Apparently, the first option is more practical due to existing laws governing mergers and acquisitions. However, the players have to decide themselves the ways to reduce the number of companies to weed out unhealthy competition.

Financial highlights leasing companies

(Figures are in Rs. million)

1995 1996 1997 1998 1999

No. of companies 27 30 33 33 32

Paid up capital 2,766 3,898 4,234 4,352 4,566

Retained Earnings 1,904 2,746 3,234 3,359 3,305

Investment in Lease Finance 15,316 20,363 25,559 29,164 27,666

Revenues 2,522 4,090 5,046 5,315 5,528

Net Profit 517 922 906 610 451

Financial Charges 1,058 2,758 3,006 3,293 3,634

Financial highlights Modaraba companies

(Figures are in Rs. million)

1995 1996 1997 1998 1999

No. of companies 8 8 8 8 8

Paid up capital 1,959 1,959 1,959 2,639 2,266

Retained Earnings 362 448 529 653 743

Investment in Lease Finance 3,072 3,834 4,146 4,955 5,331

Revenues 1,586 1,706 1,801 2,008 2,297

Net Profit 127 193 244 306 423

Financial Charges 582 1,159 1,127 1,219 381

Source: Leasing Association of Pakistan