In the world that existed before the financial crisis,
leasing companies were driven by the desire to grow volumes. They
were assisted by low levels of regulation, short-term interest
rates and banks only too happy to fill the begging bowls of factory
managers.
This was reflected in the fact that
European lease outstandings increased from €587 billion in 2005 to
€780 billion at the end of 2008, a 33 percent growth.
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Furthermore, despite the credit crunch
having started in August 2007, European lessors in 2008 still
managed to grow volumes year-on-year by 4.5 percent. The picture is
similar in the United States where, despite having seen some drops
in monthly new business towards the end of 2008, leasing volumes
overall for the year grew, albeit marginally.
The financial crisis has changed all
this, although it took a while for it to have any major impact.
Last year, leasing continued to grow overall – with the odd
exception of certain sectors, such as Italian real estate leasing –
despite manufacturing entering free fall. Now, however, asset
finance is going the same way as manufacturing.
Lease finance for plant and machinery
in the UK fell by 44 percent during the first quarter of 2009. This
compares with contraction in Britain’s industrial production in
March for the 13th straight month, but only to 12.4 percent lower
than it was the same period the previous year.
The situation is much worse elsewhere,
with Central and Eastern Europe witnessing a virtual collapse in
construction equipment finance during the first months of this
year. In Hu ngary, for instance, it dropped by 82 percent.
Bulgaria, which saw volumes grow year-on-year by 60 percent in the
final quarter of 2008, saw them dip 1.6 percent on the previous
quarter.
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By GlobalDataAsset finance has now hit the bumpers
for several reasons. First, because of the deepening of the crisis
within the manufacturing sector. Second, because the recession has
now affected the medium and long-term loan markets, both of which
lessors operate in. Third, underwriting criteria has become far
stricter as the risk of bad debt rises, meaning lessors are lending
less.
So, what tools are leasing companies
using to steer their way through this economic darkness?
The smart ones are extending lease
contracts in order to avoid the drops in residual values which,
according to recent published statistics, total around £1,000
(€1,132) per piece of equipment.
This matches the requirements of some
lessees which want to hold onto their fleets in the knowledge that
in several months’ time they will be restructured.
It does not work like this for
everyone. Many customers are being forced to downsize and,
therefore, cannot wait to get out of their lease agreements.
Others, even, are in a far worse position and have entered
administration.
The UK’s insolvency service, a
government agency, last month reported that compulsory and
voluntary liquidations rose 56 percent year-on-year during the
first quarter of 2009.
This explains why equipment auction
houses are seeing record levels of sales. This is good news for
those leasing companies which predicted a collapse in the
second-hand sale market with the drop in demand from the troubled
CEE region.
Recent sales figures from Euro
Auctions (UK) Ltd show that there are large numbers of
second-generation North Africans living in Europe who are buying up
a lot of this equipment.
The drops in residual values also
means lessors are now having to find new ways to make profits. As a
result, despite Europe-wide interest rates being at record lows,
margins are as high today as they were a year ago when rates were
set reasonably at around 5 percent.
Meanwhile, European lessors that
specialise in subprime lending have switched some of their focus to
innovative forms of finance aimed at helping struggling companies
through the downturn.
Besides turnaround finance, subprime
lessors are now increasingly offering a package of finance
facilities, including sales finance products such as factoring and
invoice discounting, as well as leases. Turnaround finance is also
growing in popularity.
But it is not just subprime lessors
who are focusing more on these types of facilities; mainstream
lessors are doing so, too. The latter are also increasingly
targeting the sale and leaseback (S&L) sector.
Customers who seek S&L generally
have the same profiles as those who seek turnaround finance.
Woolworths sought this kind of finance in the early days of its
efforts to avoid bankruptcy.
Ultimately, S&L is subprime in
nature. Furthermore, the assets that come on to lessors’ books in a
S&L are second hand. Therefore, while in the short term the
high demand for S&L will help to grow lessors’ books, in the
long term they could lead to yet further writedowns.
Lombard, one of Europe’s largest
leasing companies, stated publicly in recent weeks that it is
targeting investment in S&L. It might well get its fingers
burnt as a result.
Looking at this from a wider
perspective, it is worth noting that a lack of supervisory
regulation had little to do with the cause of the recession. After
all, neither Canada’s central bank nor Australia’s has any
supervisory duties, yet the financial services systems of both
these countries have been almost unaffected by the downturn,
largely because their subprime mortgages never went above 2.5
percent – they reached 14 percent in the United States.
Greenshoots of
recovery
Also, there is the adage that what is
subprime today will be sub-subprime a year from now.
Despite the green shoots of recovery
having begun to appear with a rise in US shares as a revival of the
housing and banking sectors induce investor confidence, the crisis
is far from being over for the financial services sector. Bad debt
levels, currently just over 4 percent in the UK and rising steadily
in safe-as-houses Scandinavia (see country analysis on page 13),
are likely to worsen as unemployment levels rise causing even more
late payments.
Government financial stimulus packages
are unlikely to be as forthcoming as they have been so far, mainly
because of the high levels of public sector debt. Many in the asset
finance industry are cynical of exactly how beneficial they have
been. This also applies to their customers.
“Component makers are screaming as a
lot of the money they need isn’t getting through. Those wanting
finance are still having problems,” noted Professor Peter Cooke of
the University of Buckingham.
Against this background, it does not
come as any great surprise to see evidence of some manufacturers,
frustrated at being unable to get lease finance, now creating their
own captive finance companies using block discounting lines.
Some of these are also relying on
schemes, such as the UK’s Enterprise Finance Guarantee Scheme
(EFGS), but there are limits to how many banks can get access to
this. Also, New Labour scrapped EFGS’ predecessor just when it was
starting to do well. Meanwhile, rental companies, which
traditionally only did short-term loans, are muscling into asset
financiers’ turf by offering longer-term leases.
There is some hope to be drawn from
the fact that manufacturing may pick up in the third quarter as
plants, which have been closed to reduce excess stock, are
reopened. However, the asset and finance sectors have seen years of
over-supply.
“Manufacturers have been force feeding
the market,” said one economist.
Today, the market is seeing the effect
of this in the form of large returns of used and relatively unused
assets. Sources reckon it will be another three years before
leasing companies return to pre-recession volume levels. The
lessors of 2012 will then suffer, as a result, from a shortage of
used assets.
Brendan Malkin
brendan.malkin@vrlfinancialnews.com
