Leasing companies feeling heat of competition

Leasing companies have a problem or two on their hands. In about the last three years, commercial banks have entered the arena and are wrestling away market share from the leasing sector.

There is doubtless, nothing illegal about that, but leasing companies complain that banks are not bringing in fresh new business but because of the financial muscle that they enjoy, banks are 'poaching' from that share of the 'critical mass' which leasing companies had laboriously built up over the last 14 years.

The leasing concept was unheard of in the country until 1984, when the first such concern-the National Development Leasing Corporation (NDLC)- appeared on the scene with the financial support of IFC and the ADB. The sector has since grown and on December 31, 2002, total number of companies in the leasing sector stood at 23 with another 8 modarabas also in the leasing business.

The industry now reports equity base of Rs15 billion; assets of 64 billion and borrowings of 51 billion. In the last six month ended December 31, 2002, leasing sector made aggregate net profit of Rs651 million, which compares well with profit of Rs721 million earned in all of last year.

So is the growth likely to cease with companies facing competition from banks. Javed A.Callea, chairman Leasing Association of Pakistan, who also heads the Crescent Leasing Corporation, is concerned but not worried. He expects industry to continue to post improved earnings. It is difficult to conceal financial numbers for leasing is the only sector, where every single company is listed on the stock exchanges and therefore their audited accounts are exposed to the public view.

The chairman LAP, however, admits that companies are feeling the heat as margins are shrinking, following competition with banks. But Callea argues that it is a competition between unequals. “How can a single product company (leasing) compete with banks that are wallowing in liquidity and undertake a wide range of activities”, he queries.

There never was a bar on banks to enter the leasing business. But it caught the banks' fancy only when other more profitable avenues started drying up. With a plunge in interest rates on Treasury bills and advances, banks began moving into leasing where they can earn a high double digit spread along with the benefit of asset backing.

Since banks are paying no more than 6- 7 per cent on customer deposits, leasing is immensely profitable for them. On the other hand, margins for leasing companies have shrunk. They need to pay 10 per cent on funds and can seek 14 per cent from lessee.

Before the advent of banks in the sector, the spread for them was almost twice, at 8 per cent, with borrowing cost at 12 per cent and recovery from lessee at 20 per cent. In the environment of open and free competition, it is inconceivable that banks would be asked to leave alone the leasing for the leasing companies. And that is exactly what the Governor, SBP, Dr.Ishrat Husain, had told a delegation of LAP who had earlier gone to him to air their grievances.

Basheer A.Chowdhry, Vice Chairman, LAP and CEO Al-Zamin Leasing Modaraba, says that leasing companies are not asking for ban on banks to enter leasing. He says that all they are asking is that there ought to be a 'level-playing field'. “If banks want to enter leasing, they should do it by setting up subsidiary companies”, argues Javed Callea, adding that such subsidiaries should be governed by the same rules and regulations as are applied to the leasing companies.

The LAP officials say that there are instances of banks that have formed subsidiary leasing companies, such as those of Grindlays, Union, Habib and Saudi Pak. “But the best example of such bifurcation is the Small and Medium Enterprises (SME), where the government has separated banking from leasing-SME Bank and SME Leasing”, says Javed Callea.

The major asset side concentration of leasing in Pakistan is on plant and machinery, which accounted for 54 per cent of lease disbursement in the financial year 2001-02. A major demand of leasing sector in their budget proposals for 2003-04 is about the restoration of initial depreciation on second hand/used machinery.

The industry contends that initial depreciation had always been allowed on second hand/used machinery whether imported or purchased locally as was provided in the Income Tax Ordinance, 1979. In the adoption of Income Tax Ordinance, 2001, the allowance was left out.

The leasing sector has represented to the government that the restoration of initial depreciation allowance was justified for small and medium sized companies, which largely depend on second hand machinery for their expansion. “Restoration of this allowance also does not incur any loss of revenue since it is only given to the first time users”, the industry has said in its budget proposals.

It contends that the uncertainty prevailing on the availability of initial depreciation on second hand/reconditioned imported machinery is hampering investment climate for the SMEs which rely heavily on reconditioned machinery both imported and purchased second hand locally. “Allowing initial depreciation to only first time user of equipment is a major source of capital formation in the SME sector”, the industry has said in its proposals for the forthcoming budget.

But there are detractors who argue that initial depreciation was not considered healthy. India had discontinued initial depreciation 15 years ago and even Bangladesh had discontinued the allowance since 1998. Such detractors say that by offering a high first year allowance followed by a slow write-off over time, the system encourages companies to over-capitalise themselves and it also builds a heavy deferred tax liability on the balance sheet. That possibly applies more for new machinery.

But for all its grievances-genuine or otherwise- the leasing sector would have to ride out the challenges. In recent times, there have been spate of mergers and acquisitions (M&A) in the leasing sector, which has as much to do with the raising of minimum capital requirement to the mandatory level of Rs 200 million, as to grow tall and strong so as to face fierce fresh competition from commercial banks. Already half a dozen successful tie-ups between leasing companies have happened in the last two years and twice as many are expected to take place in the next two years.

Things remaining pretty much the same, it looks like leasing companies would have to swim harder to remain afloat in a sea of competition. Those with larger equity base and stronger asset portfolio would be able to obtain funds at attractive rates and perhaps make decent profits.

On the stock exchange leasing companies still do not cut a pretty picture. Around 10 of the 29 companies had declared dividends in 2002 and even in the current bull market, just about eight companies have managed to push their stock prices above their par values.