IS THE LEASING SECTOR DOOMED?
Jan 24 - 30, 2011
While illegitimate and high profits kept the banks afloat during the global financial crisis of 2007-08, the leasing companies in Pakistan succumbed to the onslaught; the reason being the uneven playing field and sharp reversal of SBP benchmark rate that choked the flow of business funds to the leasing companies.
The leasing sector is in the throes of death and that doesn't sound very decent as we have been so brazenly bragging about the so-called strength of our financial sector, particularly the banking segment.
Leasing sector has played an important role in boosting the country's capital formation, and is still capable of reviving its glorious past if treated at par with the banking sector.
The leasing business in Pakistan, after witnessing an early boom period, has gone into deep recession. The operator base has shrunk drastically and an almost unmanageable liquidity crisis has ensued from the choked flow of new investment funds.
The exceptionally high policy rate regime extending over the last three years has taken a heavy toll on the leasing sector. Capping it all was the 2007-08 global financial crisis that drained the Pakistani banks and the money market of liquidity so vital for the survival of leasing business.
Presently, the leasing sector is struggling as it is threatened by the perennial resource mobilization problem. Unlike banks, it has no access to the low cost customer deposits and has to procure business funds from open market, which, besides charging higher rates, also takes into account the credit rating of a particular leasing company. Acceptance of public deposits through COIs (certificates of investment) is also contingent upon a good credit rating, in the absence of which the SECP suspends the right to accept such deposits. During the falling interest rate era too, the leasing companies could not enjoy a free, sustained flow of low-cost business funds. In the rising rate regime that followed, the problem was compounded. Though the banks never assumed an explicitly competitive posture against the leasing companies, yet the fact remains that in the absence of an even playing field, the leasing companies always find themselves in a state of implicit competition. The floating rate borrowing and lending also pose maturity-mismatch problems for the leasing companies.
With the phasing out of country's high profile development financial institutions (DFIs), the leasing and modaraba sectors stepped in with a mandate to act as financial sector intermediaries. With the advent of leasing sector, the business and industry circles were introduced to a new financial culture with a sharp focus on the country's capital formation needs and a will to act as swiftly as possible. This was in sharp contrast to banks' traditionally slow and over-refined lending procedures.
Blessed with an enormous business network and numerous business options, banks allowed the leasing and modaraba sectors to develop without subjecting them to any serious competition pressures. Some of the modarabas were also allowed to do leasing business, albeit strictly in line with the Shariah-compliant regulations. Driven by the urge to improve profitability and growth, the leasing companies shifted the focus from large-ticket industrial leases to small-size consumer lease financing. Large size industrial leases, besides posing risk concentration threat, entailed foreclosure and disposal problems in case of a default. An erected industrial plant at borrower's site is not only cumbersome and costly to remove but also difficult to dispose off at a price that guarantees 100 per cent loan recovery. On the other hand, the moveable assets like vehicles, equipments, appliances etc. are not only easy to repossess but are most likely to fetch a full-loan-liquidation price.
The changed scenario has not only put a big question mark on leasing sector's survival but has also undermined country's industrial growth. How the global financial crisis and monetary and fiscal policy failures have wreaked havoc with the leasing sector during the last three years, can be understood from the following key financial indicators of a leasing company having an asset base of more than Rs5 billion three years back:
KEY FINANCIAL INDICATORS OF A LEASING COMPANY
(RS '000 YEAREND JUNE)
INDICATOR 2010 2009 2008 2007 2006 2005 Total Assets 2,749,705 3,966,829 5,577,274 5,352,516 4,770,553 3,647,523 Total Liabilities 2,668,937 3,727,834 4,961,129 4,832,031 4,364,808 3,284,847 Net Worth 80,768 238,995 592,369 517,326 390,539 346,670 Shareholders' Fund 438,028 438,027 475,500 513,000 392,000 315,000 Reserves (384,454) (111,728) 244840 42,593 87,440 85,769 Borrowings 1,749,185 2,378,326 2,923,907 3,139,950 2,517,885 2,090,253 COIs - 110,200 562,100 443,448 910,100 598,100 Net Investment in Leases 1,868,785 2,759,686 4,003,830 4,026,373 3,327,281 2,260,342 After-tax Profit (273,954) (357,796) 211,810 40,258 108,021 74,281 Mkt-Price of Rs10 share 2.84 1.98 6.89 10.95 15.40 17.50 (Source: Company's Annual Report 2010)
Leasing companies have felt the pressure of monetary and fiscal policy deficit. On monetary front, the highest bank rate in the region, ups their funds cost to an unmanageable level. Government reliance on SBP and commercial bank borrowings gives our banks a reason to avoid private sector lending on the false pretexts of better risk management and asset quality improvement. In fact, it is a zero-risk lending to the government and its affiliates that leaves the private sector in general and the leasing sector in particular languishing in funds paucity. This situation chains the leasing companies to a vicious circle: liquidity crunch leading to drastically reduced margins; reduced margins leading to weak financials; weak financials leading to poor credit rating; poor credit rating prompting SECP to suspend leasing company's right to raise money through COIs; inability to issue COIs leading to a more severe liquidity crunch.
According to the data released by the erstwhile LAP, the number of operative leasing companies is shrinking continuously due to the closures/mergers. Majority of the leasing companies is being quoted below-par on stock exchange. The shareholders have almost forgotten that the leasing companies used to pay dividends regularly. The paucity of funds syndrome has enveloped the entire leasing sector, which is in need of an immediate bailout. Its basic role of a powerful engine to provide financing steam to the industry, especially the SME sector, needs to be rewritten.
The banks that, by virtue of their various economies, operate at a much lower administrative cost, should not be allowed to compete with leasing and modaraba companies in any form. The existing fund raising instruments namely COIs and TFCs should be retailored to suit the requirement of leasing companies. A level playing field that ensures survival of the leasing sector is the crying need of the moment.