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December 8, 2016updated 15 Aug 2022 12:56pm

UK leasing – a positive outlook for 2017

The UK leasing sector has been a strong performer in recent years and is expected to shake off the economic uncertainty set to persist as we prepare for a post-Brexit landscape, whatever it will look like. Peter Galka, partner at EY, discusses the transaction themes for the upcoming year

By Verdict Staff

The UK leasing sector has been a strong performer in recent years and is expected to shake off the economic uncertainty set to persist as we prepare for a post-Brexit landscape, whatever it will look like. Peter Galka, partner at EY, discusses the transaction themes for the upcoming year

Leasing is a major source of financing for UK businesses, and the number and size of leasing providers has increased since the financial crisis.

This has occurred as good performance has generated consistent profits for reinvestment into increased lending, and attracted providers of new debt and equity capital to grow leasing books.

Despite the market uncertainty caused by Brexit, we believe there is good reason for confidence in leasing, which is continuing to play an important part in fuelling the UK economy.

A key determinant of the future growth of the leasing sector will be transaction activity, from both a debt and equity perspective, where we see positive dynamics continuing.

Stable asset performance

We expect the overall performance of the leasing sector to be stable, and in line with expectations that the UK economy will see lower growth over the next few years, but avoid recession.

The EY ITEM Club currently forecasts GDP growth of 0.8% in 2017, going up to 1.4% in 2018, 1.6% in 2019 and 1.8% in 2020.

We could see an increase in residual values of passenger, light commercial and heavy commercial vehicles, through a combination of higher demand for and reduced supply of used vehicles.

On the other hand, demand for leasing of construction equipment and aircraft could fall following the significant depreciation of sterling against the US dollar and euro since the referendum.

Overall demand for leasing, however, continues to grow, and the Finance & Leasing Association reported 8% growth in new business for the 12 months ending August 2016, to over £30.5bn.

If macroeconomic uncertainty leads banks to tighten terms for unsecured corporate lending then we could see more corporates, especially SMEs, switching to asset finance. We believe this will maintain the strong risk-adjusted returns that have attracted capital to the leasing sector to date.

Funding markets open for business

When it comes to debt capital, there is something of a three-way split in the leasing market. The largest leasing businesses are funded through the retail deposits of their parent banks, whereas medium-sized leasing books are funded through wholesale bank lines, and small leasing books are funded through one or more block discounting lines.

While retail deposits provide a low-interest source of financing, the scale required for efficiency makes this a feasible option for only the handful of commercial banks that also provide asset finance.

We are seeing banks focus more and more on managing profitability, which means the credit risk improvement from the tangible security for asset finance compared to unsecured SME lending should support the availability of asset finance in the high-volume segment of the market served by these institutions.

We are also seeing increasing availability of wholesale financing structures for smaller leasing companies serving particular niches of the market.

Liquidity appears to have even improved since the summer with lenders attracted by the underlying tangible asset security. Wholesale financing is generally more efficient and flexible than block discounting, making it a scalable funding option for growth.

Moreover, government initiatives such as the British Business Bank’s Enable programme have further improved the availability of wholesale financing for leasing companies looking to grow.

We therefore expect debt transactions for small and medium-sized leasing businesses to continue, supporting organic growth and acquisitions of leasing books.

With the underlying drivers of M&A activity around asset performance and availability of funding expected to remain in place, we believe M&A transactions in the leasing sector will continue around three main themes: consolidation among leasing companies, private equity interest, and challenger bank growth.

Consolidation among leasing companies can improve access to capital and provide diversification in the underlying asset base.

For example, 1pm’s acquisition of Bradgate Business Finance earlier this year enabled 1pm to add ‘hard’ assets to its existing ‘soft’ assets leasing business, and provide capital for Bradgate Business Finance to grow its book more quickly. We may also see consolidation to improve financing efficiency.

A number of the recent leasing companies that have come to market attracted interest from private equity, and we are aware of several investors that are active or looking to invest in the sector.

The key challenge we have seen to date is around valuation, where private equity has been unable to compete with trade buyers, though we believe more geared leasing businesses could be a good fit for private equity.

Trade buyers, notably challenger banks, have significant resources for acquisition and low cost financing through retail deposits, which means they have recently been able to pay high multiples to acquire leasing businesses.

There are several challenger banks that have a stated strategy to grow UK leasing and do not currently have a leasing offering, which we expect to generate M&A activity as these banks look to buy a strategic platform or enter into joint ventures.

More activity to come

While the leasing sector cannot be immune to the uncertainty surrounding Brexit, we believe it is currently in robust shape, with positive dynamics around asset performance and access to capital.

Over the coming months we expect to see further M&A activity from both private equity investors and trade buyers. Coupled with liquidity in the debt finance market for non-bank leasing companies, the foundations are in place for the leasing market to come out of this period of Brexit-related uncertainty as an even more significant enabler of economic growth.

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