Adam Daniels, managing director and global head of specialist finance and intermediaries at Lloyds Bank, highlights the shifts that have taken place in the leasing market during the past 12 months
The leasing market has witnessed a period of significant structural change during the last 12 months. Traditionally viewed as the ‘quieter backwater’ of the finance world, the dynamics of the market have been shaken by the withdrawal of traditional lenders, the emergence of new challengers and an influx of capital from new investors.
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The decision earlier this year by General Electric to sell its banking and finance arm GE Capital caught the market by surprise. The sale marked a shift in strategy by the parent company designed to return the group to its industrial roots.
Some commentators predicted GE’s withdrawal could lead to a shortage of funding in the market. However, almost six months on from GE’s announcement, there are few signs to suggest this is the case. GE has moved swiftly to sell large portions of its book to established firms and those looking to build a dominant position in a particular market. The buyers will no doubt be key market players in the future.
Following on from the M&A theme, the sector has also benefited from an influx of private equity capital. The buyout houses are looking to diversify their investment portfolios and are finding success in the leasing sector.
The SME leasing market in particular has seen an increasing number of private equity firms entering the sector after identifying growth opportunities. Private equity-backed deals in this area include Cabot Square Capital’s acquisition of Leasedirect Finance and Star Capital’s acquisition of Kennet Equipment Leasing. The rumour mill suggests there will be more sale announcements in the coming months.
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By GlobalDataA variety of factors are behind the increase in private equity investments into the sector. Buyout houses are attracted to the regular and predictable flow of profits generated from leasing businesses and regard these investments as relatively low risk.
Presently, there’s a shortage of quality assets and a surplus of private equity funds looking to deploy capital. A sector that offers stable returns and capital growth over a defined period is highly attractive to equity investors.
In addition, the UK’s asset finance and leasing sector often operates in a less onerous regulatory environment than other financial services providers. Given private equity’s preference for making investments in less regulated sectors, this is an advantage.
A favoured tactic of private equity houses is either to acquire lending businesses or buy brokers with distribution capability and use this base to build a lending business. This was driven mainly by the lack of available balance sheet businesses.
In the UK mortgage industry we have seen an increase in capital inflows from institutional investors such as pension funds, insurance companies and hedge funds.
They have really made an impact in the mortgage space and these institutions are attracted to the leasing sector because it provides an opportunity to deploy a large amount of capital efficiently and offers the prospect of a reasonable return on their investment.
Clearly, acquiring a lender is the first challenge. The second critical aspect is funding the book. Securitisation has become a theme in the market recently. Investec initially tapped the market with a highly successful financing of its UK asset finance book that was very well received by investors.
In a prolonged low interest rate environment attractive yields are hard to find. Investors are looking for hard assets with good returns. We anticipate more institutions will continue to take an interest in acquiring lease-backed securitisation paper.
Smaller, growing leasing companies who may struggle to attract large institutional investment because of their scale, will welcome the British Business Bank’s new ENABLE programme.
The programme will ‘warehouse’ newly-originated asset finance receivables from different originators – bringing them together into a new structure. Once the structure is big enough, it will seek to refinance a portion of its funding through securitisation techniques, thereby enabling these smaller finance providers to access institutional capital in an efficient and cost-effective fashion. There are also structures in place from various European authorities which Kennet recently aligned with.
Despite increased levels of investment into the sector, securing funding from traditional and non-traditional lenders should not be taken for granted. There are a number of steps that leasing companies need to take to improve their chances of receiving equity or debt funding.
Leadership
The quality of the management team is arguably the most important consideration. Financiers will look for leadership teams to articulate their position in the market effectively and provide confidence that their business model is defensible. They also need to be prepared to undergo a thorough due diligence process, which will question their operational position and financial forecasts. A demonstrable record of successfully managing a lending business is key.
A clearly defined growth strategy is at the heart of any investment or proposal. Banks, institutional investors and private equity backers will want to see the future of businesses mapped out. Being able to point to strong market growth dynamics and emerging opportunities, as well as potential challenges, will help attract the right interest.
When assessing funding applications, financial backers will also examine lessors’ internal infrastructure and scrutinise how robust their IT systems, fraud detection and compliance procedures are.
Robust fraud prevention and detection systems and a clean underwriting book with a small margin of losses are critical, particularly for small leasing companies and challenger banks, who lack the scale and funding diversification to absorb significant losses.
Conduct is also an important consideration. Lessors will need to demonstrate that their dealings with customers are fair and transparent. Failure to do so can incur severe regulatory costs and risks alienating potential investors.
In summary, the so-called backwater of asset finance has and will continue to be an interesting and evolving market over the next 12 months or more. Expect more acquisitions and a gradual move away from traditional debt funding structures to more capital market type solutions. n
