The World of Leasing
Tax breaks and rules to protect lessors and lessees can help leasing play a big role in the productive sector, says Bangkok Bank
Click here for a report on amendments carried out by Thailand to promote leasing
Prospects for the local leasing business in Thailand have brightened considerably, according to an Article in Bangkok Post, Dec. 9,1998. Based on a study by the Researcg Department of the Bangkok Bank, this articles claims that an important reason has been the sharp curtailment of credit by commercial banks and other financial institutions.Would-be borrowers, particularly small and medium-sized enterprises (SMEs) with relatively lower credit ratings, have thus turned to leasing to obtain needed equipment.
Leasing allows lessees to have the use of goods (particularly capital goods) without having to set aside their own funds to acquire them. These funds, which have become increasingly scarce, can then be put to use for other purposes.
As Harvey Lieberman and James Smith put it: "A more important advantage to leasing is the conservation of working capital. Neither a cash outlay for outright purchase of an asset nor a down-payment is required. Most leases require only a small deposit of the first and last months' payments in cash."
However, leasing in Thailand still has a number of weaknesses. For instance, there are no comprehensive regulations on collateral security. This shortcoming actually benefits SMEs, as they can resort to leasing services that might otherwise be available almost exclusively to large, better-collateralised businesses.
Local leasing companies, however, pay the price by having to shoulder the risks when lessees fail to pay rentals on time or become delinquent.
The authorities can help the industry by correcting these weaknesses, particularly by enacting clear-cut regulations in order to enhance efficiency, and tax incentives to stimulate the industry's expansion.
The percentage share of credit extended by leasing companies has grown more rapidly than that granted by other financial institutions. The percentage share of leasing rose from 0.2% in 1988 to 1.18% in 1995 - a five-fold jump compared with that of credit extended by the Small Industry Finance Corporation, whose increase doubled. Leasing volume soared by an average of 62.7% a year between 1988 and 1995, compared with the average annual increase of 25.6% in credit extended by the four financial institutions during the same period.
Although there are no available statistics on leasing for the past three years, it is reasonable to assume that the growth trend has been similar to that of the previous eight years. This is because the leasing business has been able to augment its role due to the credit squeeze elsewhere.
Of the companies using leasing services, about 40% require five million baht or more. The remaining 60% are SMEs whose leasing requirements are below five million baht. Statistics also show the value of leasing services has been on the uptrend since SMEs are constrained by their lack of collateral security.
Originally, automobiles accounted for nearly 95% of all leasing and hire-purchase services. Other types of leased goods, such as machinery, computers and construction machinery, had tiny shares.
If, in the future, more appropriate regulations are enacted to provide a legal framework for leasing, and tax support is given, the leasing of assets beneficial to production, such as industrial machinery, will likely account for a larger share.
A 'Swot' (Strength, Weakness, Opportunity and Threat) analysis reveals leasing has strong growth potential. However, it is still necessary to remove or reduce the constraints and shortcomings of the industry, so that leasing can become an important tool for developing Thailand's production sector more efficiently.
Strengths
1. Reduction of financial burdens. In resorting to leasing, entrepreneurs can reduce their costs substantially, as they do not have to set aside funds for purchasing machinery. Instead, they incur expenses in the form of rents only. The funds they still have on hand can be used as working capital or for investments with higher returns than those in fixed assets, such as machinery.
2. Convenience. Leasing is more convenient than seeking credit from banks and other financial institutions. In addition, leasing does not require substantial collateral security. It enables businesses to operate more quickly, as leasing requests are normally approved within a shorter period than those for bank credit. Lessors look only at their customers' rent-paying ability, which in turn depends on how successfully lessees make use of the leased property.
3. Technological change. As the technology of many types of equipment changes rapidly, it is not cost-effective to commit funds for purchases, because equipment will have to be replaced within a relatively short period by newer and more efficient models.
4. A rental is regarded as an expense, not a debt, and can thus be used as a tax deduction. This avoids creating debt, and making it possible to seek credit for investment in items other than the ones that are leased. As rentals are not debt, the company's balance sheet appears healthier.
Weaknesses
1. Collateral. There is a lack of clear regulations to protect lessors in cases where lessees fail to pay rentals on time. As it is, there is relatively little collateral security pledged to lessors, who therefore lack an effective means to force payment of rentals by delinquent lessees.
2. The burden of taking out insurance on leased properties falls on lessees, adding to their operating costs.
3. A lack of rights to improve assets. When lessees want to improve the equipment and machinery under lease, they must first obtain approval from lessors, causing delays and inconvenience.
Opportunities
1. Technological change. The technology of capital goods changes rapidly. This prompts entrepreneurs to lease more, passing on the risks of having to replace these assets often.
2. The recession reduces the ability of financial institutions to extend credit. In consequence, companies lack sufficient funds to purchase machinery and production equipment.
3. The weakening of the baht has pushed up prices of imported machinery.
Threats
1. Bearish financial conditions have resulted in lessors having fewer funds for operations. The situation also increases risks involved in leasing operations.
2. Regulations. There is still a lack of clear and comprehensive regulations to protect both lessors and lessees. This hinders the growth of the leasing business.
3. Government promotion. The authorities have not promoted the leasing industry effectively to enable it to play a commensurate role in economic development, particularly in the production sector. These measures (yet to be implemented) include tax reductions and tax credits to both lessors and lessees.
1. Economic conditions have an impact on the production, financial and investment sectors, as well as the public's purchasing power and investor confidence. The current slowdown prompts entrepreneurs to delay decisions to obtain leases. At the same time, leasing companies have become more strict in screening requests.
2. Interest-rate volatility affects operating costs, expenses and profits of a leasing company, as it uses a fixed interest rate in calculating the lessee's rental payment. A leasing company must therefore try to cope with fluctuating rates by seeking long-term sources of funds, and obtain low or fixed interest-rate credit.
3. Risks of a lease going sour: Effective management policy must spell out clearly the leasing process, including approval, recovery of unpaid rentals and reserves set aside for delinquent leases. This is necessary to reduce risks from the erosion of security of the company in future, particularly in a recession.
4. Exchange-rate risks occur when a company enters a re-leasing agreement with a foreign company. The leasing company also faces an asset burden when it acquires capital goods that are not leased.
From an analysis of the funding structure of three leasing companies listed on the Stock Exchange of Thailand, it was found that sources of funds were quite similar:
Current liabilities, such as overdrafts, call loans, short-term loans and bills of exchange, together account for about 40% of total funds. The bulk of these, about 70%, are sourced domestically.
Long-term liabilities used to account for a smaller share. However, due to the characteristics of this business, which commits funds for acquiring properties to be leased out over the long term (two to three years), leasing companies have attempted to increase the share of long-term loans in their funding structure.
Equity accounts for 10% to 30% of total funds in the industry. The majority of leasing companies have financial institutions as shareholders, as they require funding support. Many have been established as in-house units to provide support to producers: for instance, Toyota Leasing, IBM Leasing and GE Capital.
By and large, leasing companies that enjoy close business relationships with, or form part of a network of financial institutions, will have an edge over rivals that lack these advantages. In fact, if producers of goods can find financial institutions as business allies, they will have a greater competitive edge.
During 1995 and 1996, competition within the automobile leasing sector was very strong, with numerous companies. At the same time, competition in leasing industrial machinery, computers and other equipment was weak because few companies were involved. This was due partly to a lack of public-sector support, as well as the fact that car leasing was much more lucrative.
Leasing operations require a relatively low level of funds. This has led to an increase in interest by financial institutions and producers to set up leasing firms, in order to take advantage of a growing market.
At present, 42 companies are members of the Thailand Leasing Association. All are finding long-term sources of funds.
They have also slowed their investment, as the bulk of funds they have obtained are short-term loans from commercial banks and finance companies, which are themselves facing liquidity problems. Leasing companies are also experiencing problems: rental collections have fallen about 50% since the onset of the economic crisis.
In the meantime, leasing companies continue to carry a financial burden as contracts are long-term. As a consequence, operational expenses cannot be reduced right away.
The leasing industry is worthy of attention as leasing services can help SMEs reduce their requirements for investment funds in their efforts to continue production.
However, for leasing to develop properly, government promotion, particularly tax incentives, is necessary. Moreover, financial costs are high and the risks involved in undertaking leasing activity are on the rise.
It is therefore necessary to promote active cooperation among government agencies, including the Commerce Ministry which supervises leasing, the Finance Ministry which has the authority to grant tax incentives, and the Industry Ministry, which provides support to SMEs.
As for leasing companies themselves, they must try to adapt by seeking allies, for instance by forming links with financial institutions, producers, and companies with expertise in the assets to be leased.