being in flux
Recent events in global markets have raised many questions about
how the US sub-prime problem has led to concerns about world-wide
financial stability. The speed and breadth of the crisis have taken
many authorities and analysts by surprise.
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As the turmoil spread, increased risk aversion, reduced
liquidity, uncertainty about the soundness of major financial
institutions, question marks over structured finance products and
economic uncertainty have been feeding off one another and
compounding the overall negative situation.
Mixed fortunes
The asset finance industry is going through a period of mixed
fortunes, not all I may say of its own making. We continue to see
the underperformers amongst the banking sector being exposed and,
as a result, can expect to see more leasing and asset finance
subsidiaries being sold or closed down. It is a tragedy that the
sufferers may well not be the culprits. On an upbeat note, others
are successfully weathering the storm, achieving above-average
industry growth and actively planning to expand, be this
domestically or internationally.
Innovation should be high on the asset finance industry’s agenda
as it strives to rise to the challenge of creating value. Just
under five years ago – when Leasing Life reviewed a decade
of asset finance as part of the magazine’s celebration of its first
10 years – I was quoted as saying the following: “There is a
distinct lack of visibility of anything new from UK lessors. As a
product leasing has been absorbed by the banks. There is a danger
that creativity will be stifled and even that some banks will
question the justification of leasing.” Regrettably, I have similar
concerns today.
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By GlobalDataLosses at major financial institutions have spread to a range of
products, and credit discipline deficiencies are emerging in
worsening economic conditions. Institutions with weakened balance
sheets that need to raise more capital and to ensure their ability
to fund are finding it more expensive to do so. Many have been
exposed as insufficiently prepared for a period of intense
liquidity strain. Normally well-functioning funding markets have
dried up and the use of securitised products has slowed
markedly.
Dramatic falls
Shares in banks have fallen dramatically and may well fall
further. Moreover, the probability of multiple defaults has
increased, meaning that if one bank fails it would not be
surprising if others did too.
Off-balance sheet items are being transferred on to balance
sheets and there is a preference for short-term assets. It may be
the case that the scale of write-downs will be greater than
expected; much depends on confidence levels.
Banks will be weighing up the conservation of capital and
liquidity to support legacy portfolios versus the use of capital
and liquidity to write new business. If they opt to curb lending,
this could be selfdefeating should it result in a further
tightening of credit conditions, contribute to adverse economic
implications and cause further losses. If, however, as seems to be
happening, lending does become tighter and, perhaps, more
expensive, the switch in market conditions from abundant lending to
caution will have been a swift turnaround.This has serious
consequences for the customers; it is not just “I have to pay
more”, it is “Can I get my lease at any price”?
Fresh capital
As we have seen there is some reluctance amongst the banks to
raise fresh capital except where it is clear that this is
necessary. This may well be because institutions want to avoid
being the subject of rumours that they are becoming illiquid. A
collective strengthening of capital positions would engender
confidence in balance sheets and in asset markets.
A further tightening of liquidity conditions could also lead to
a long-term tightening of lending standards.A more careful approach
to risk assessment and management is a prerequisite for an
improvement in the quality of balance sheets and restoration of
confidence. On the leasing front expect to see more attention paid
to asset management and the setting of residuals.
Moreover, the authorities’ reaction to the turmoil may result in
more stringent controls and standards. Institutions also need to
pay close attention to managing their capital and maintaining an
appropriate mix to ensure that they meet regulatory capital
requirements. It is unfortunate that it is often the leasing arms
of the banks that suffer during this process.
Sub-prime
In recapitalising balance sheets of banks that have suffered
from the sub-prime and other losses, other relatively healthier
financial institutions may come to the rescue.The crisis may,
therefore, provide opportunities for further M&A and a way to
strengthen banks’ balance sheets for the longer term. Conversely,
funding problems and the nervousness of potential targets that they
will be the losers in a deal that may only be achievable on
give-away terms may be a reason for ‘second thoughts’.
In the Bank of England Credit Conditions Survey Q2 2008, lenders
reported that corporate credit availability had been tightened over
the three months to mid-June, in line with their expectations in
the Q1 survey. A small further reduction was anticipated over the
next three months. Lenders reported that they had implemented the
tightening in part through a reduction in maximum credit lines,
stricter loan covenants and increased collateral requirements. This
had been driven by concerns about the economic outlook, changing
sector-specific risks and a reduction in their appetite for
risk.
Credit demand
While demand for credit by medium-sized businesses had fallen in
line with lenders’ expectations, there was a larger than expected
decline in demand by large businesses. However, there was an
increase in draw-downs on pre-arranged committed lines of
credit.
Lenders reported unexpectedly large falls in demand for credit
for M&A activity and capital investment. These factors were
expected to contribute to a further weakening of demand.
This paints a gloomy picture so now is the time for the asset
finance industry to hold on to its collective knowledge, expand its
research into new products and maximise the opportunities that
arise from adversity.
Derek Soper
The chairman of The Alta Group, ‘Advisors to the Asset Finance
Industry’
