A higher RoE translates into improved profitability and enhanced shareholder returns says Bernhard Schneider
All well-run leasing companies are looking for improved performance.
This article takes a brief look at some options open to leasing companies to generate improved return on equity, improved profitability and ultimately enhanced shareholder returns.
Focus on the right geographies, markets, channels and assets
To focus a leasing business’s key resources might require – as a first step – streamlining the portfolio.This could involve exiting all sub-scale and below-profit threshold areas of the business to improve returns.
Streamlining might be achieved by straight divestment. But experience shows that a sale, even at book value, in combination with quite extensive representations and warranties, can be difficult to achieve.
An alternative is to stop all new business, wind down the portfolio in an orderly fashion, resolve legal cases and overdues, before finally liquidating the company. But this can be a lengthy and cumbersome process.
A sale, even at what a business may consider to be an acceptable loss, might be the better long-term choice. Due regard should be given, however, to market reputation.
Sale at a loss might become known in the industry and attract speculation about the stability and health of the remaining business.
Globalisation presents opportunities for enhanced returns. For early market participants they can offer a unique opportunity to participate in a higher margin environment – until the point that the market develops and matures and (often local) competition, rising labour costs, and inflation/devaluation drive real margins down.
Even then, leasing – as an alternative to tightening standard bank credit – may still present customers with a useful alternative funding source, or a powerful refinancing tool.
So, key questions to ask are: Does the organisation…
- Have shareholders and management who can cope with the volatility of any expansion initiative?
- Have a sound, long-term refinancing model?
- Have a good mix of local and international management and specialists skills?
- Have a clear understanding of the competition, legal environment and the future market development?
- Have a clear understanding of the key success factors in the market (ability to repossess assets; speed of customer decisions; asset trends)?
- Have access to a reliable sales network of international asset vendor partners?
If a leasing business can give a clear ‘Yes’ to these questions, then success is more likely.
Management might also develop underserved markets in countries where they operate. This needs to be on the basis of added-value product and service offerings; sustainable market development is seldom achieved through pricing alone.
One recent example of this kind of development is the financing of energy-efficient equipment. Quite aside from any state subsidies or incentives for energy-efficient equipment investment, there is a compelling proposition for leasing solutions that flex the financing period so that energy savings effectively pay for the finance payments over the term.
Fine-tuning to enhance returns
Next, it is necessary to examine a number of areas to fine-tune in the mission to improve profitability and return on equity. These include:
- Better performing vendors;
- More focus on the markets the organisation truly understands;
- Reduction or elimination of distracting sub-optimal activity.
- Increased customer satisfaction and retention;
- Better use of resources;
- Improved credit quality;
- Improved asset quality.
Properly implemented and monitored, this mix should see the profit and loss statement positively impacted by lower overdues, reduced credit hits and slower growing operational expenditure.
Yet the successful implementation of these principles also requires a simple key performance indicator reporting system, aligned to business objectives, based on actively managed, high-quality data, making full use of back testing results, with key stakeholders motivated through a re-engineered incentive system.
The basic thinking is that if everyone in the organisation is aware of what they can personally contribute to improve return on equity performance (and be rewarded for those improvements) then the organisation has passed a key milestone.
Control costs and manage other income
At this point in the argument, it is assumed that any leasing organisation is already:(a) identifying new income sources in the form of lease extensions, service fees and other added-value services such as insurance;(b) remarketing based on e-platforms; and (c) enhancing productivity through smarter processes and enhanced IT automation.
Every one of these is important, but it is critical to recognise that these elements are unlikely to compensate fully for the costs resulting from tougher regulation.
When IT implements the manifold regulatory processes and concomitant extra applications, and staff time has to be devoted to internal audit, compliance and risk management, cost and complexity will rise.
There could also be new caps on bonuses or even a personal liability for managing directors (with a five-year sentence for offenders, in Germany at least). This is simply a bullet that the industry has to bite.
So what should a leasing company do next?
So long as the key principles contained in this article are followed, there is a good chance that the team will develop further strategies that target markets where the organisation’s expertise is deep, potential is high, margin extension is viable, and consequently return on equity and profitability can be enhanced.
Leasing companies adopting this approach are still playing their own instruments, but now to a better tune. So I would like to leave you with my favourite German proverb – "shoemaker stick with your last" – a sentiment that expresses the key principle behind the arguments in this article
Bernhard Schneider is chief financial officer, commercial finance at Siemens Financial Services