. AN ASSESSMENT OF THE LEASING INDUSTRY INTHE PHILIPPINES

LEILA CALDERON

L easing is the process by which a firm can avail itself of the use of certain fixed assets for which it must

make a series of contraCtual~ periodic, tax-deductible payments. The lessee is the receiver of the services of the assets under the lease contract, whereas the lessor is the owner of the assets (Gitman 1987).

A lease can be classified under two general types: the operating and financial lease. .

The operating lease is a short-term contract ranging nom one day to twoyears. The contract is cancellable and not a fiill-payout arrangement. Incidental expenses to possession and use is borne by the lessor and the lessee has no purchase option at the end of the lease term. , Financial lease or capital lease or "full payout lease",

as defined in Revenue Regulations No. 1986, is a contract involving payment over an obligatory period (also called primary or basic period), of specified rental amounts for the use of a lessor's property sufficient in total to amortize the capital outlay of the lessor, and to provide for the lessor's borr9wing costs an~ profits. This type of lease is long-term in nature since the contract is non-cancellable and covers a period of not less than seven hundred thirty (730) days or two (2) years until seven (7) years. Main­'tenance, insurance, taxes and other related expenses inci­dental to ownership are...shouldered by the lessee. How­ever, upon condu~ion of the lease contract, the l~ed asset may be purchased by the lessee at its residual or estimated market value.

Here in the Philippines, leasing. as defined under the Rules and Regulations of Republic Act 5980, also known as THE FINANCE COMPANY ACf, shall refer to financial leasing which is a mode of extending credit through a non­cancellable contract under which the lessor (owner of the -assets being leased) purchases or acquires at the ins~ceofthe

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lessee (receiver of the services of the asseIS under the lease contract) heavy equipment, motor vehicles, industrial machinery, appliances, business and office machines; and other movable property, in consideration of the periodic payment by the lessee of a fixed amount of money sufficient to cover at least seventy percent (70%) of the purchase price?r acquisition cost, including any inciden­tal expenses and a margin of profit. The same conditions under the financial lease as mentioned earlier are followed in this country.

LEASE FINANCING ARRANGEMENTS .

DiwaUase

U nderthedirect lease, which is the simplest leaseanangc-ment, the lessor or owner leases the fixed asset to the

lessee. The lessee acquires the use of me asset, along with a contractual obligation to make lease payments to the 1essQr'.

. Under the sale and leaseback, the owner of the asset sells.

it to another party with an arrangement that die buyer will lease it back to 'the furmer owner. The asset is usually sold approximatdyat its market Y.due. The preVious owner may initiate this move if they need additional working capital. Selling the fixed asset would meatl additional cash to the company's coffers, which 'can improve iis working capital. Under this arrangement, the previous owner (now the lessee) still benefits from the economic use of the assdS during the basic lease period. In turn, the lessee is obligared to make periodic lease payments and gives up the tide to rh:e asset.

Consequently, the lessor re:ilizes any residual Y.due the asset

might have at the end of the lease period.

UvuageJ lease The lessor finanCes the purchase of the asset through a

debt-equitymix. The owner of the asset provides only a small portion of the capital from his own funds to purchase equipment fur lease. The equity portion may range from twenty percent to thirty percent (200/o-3Q%). The balance fur

payment of the asset is financed by financial institutions. Usually, theloan is secured bya mortgage on the asset, as well as by the assignment of the lease payments. . In this case, the lessor is the borrower. One adV1lIltage of this amngement is that the lessor need not tie up all his available funds in

. purchasing the asset. Only a small portion of his funds is immediately tied to the asset. The restofhis available funds em be used fOr worlcing c;apitd or irMstment ~ while still mainWning the payment of the loan amortizarion on d~ asset.

Yendor Lease It is a sales tool employ~ by equipment manufacturers

or distributors to offer leasing to their rustomers through a tie up with a leas~ company.

SynJicattd Lease or Lease Packaging · A form of lease arrangement whereby big ticket leases

thatinvolveseveral million pesos are funded btmore than one lessor through direct investment, outright, purdtase oflease receivables or guarantee. This typeoflease is needed to service capital requirements too large for a single lessor to handle. The advantages of this lease arrangement are: the pooling of enougij resources, risk dissipation, and sharing of benefits among the participants.

ADVANTAGES AND DISADVANTAGES OF LEASE FINANCING

O ne is the freeing of valuable capital for new profit generation. As mentioned earlier in our discussion

of different leaSe arrangements, leasing allows the lessor or even the lessee some movement in their liquidity position. The lessee can still use the asset and at the same'time free a bigger portion ofits availabl~ resources for other invest­ments and business expansion. The same holds true for the lessor under the leverage lease arrangement.

Another advantage is that lease payments can be used as tax deductible expenses and may also be used to hedge . against inflation. In periods of rapidly rising inflation, equipment is acquired at current prices outoffutureeamings.

Other advantages include:

1) Under both fin~cial and operating leases, the lessee normally records the account as an "off.­balance" sheet transaction or a note to the finan­cial statement. In either caSe, the lease payments aretreated as rent expense tnasmuch as Revel!ue Regulation 1986 requires all lessors to record all rentals received as revenues. The lease payment being an "off-balance" shc;er transaction, the

ASSESSMENT OF LEASING INDUSTRY

lessee is placed at an . advantage in still getting credit from financial institutions.

2) Leasing prevents dilution of ownerhip. The lessee makes use of the capital assets without expanding its capital base. The lessor in tum gets compensated in the form of residual value of leased assets.

3) Leasingprovides protection against obSolesance. The lessee may be given the fte:xibilityto upgrade or add on equipment at any point during the lease term.

However, there are also disadvantages to lease fiDanc­ing~ The lessee may have a problem in totalftexibility in the use, deployment, adaption, rustomization and servicing of the equipment to suit his specific needs since the lessor retains ownership of the leased asset. Also, the lessee loses potential residual value which would otherwise have benefitted him if he fi.Jlly owned the equipment.

The most significant disadvantage is the expense of leasing. The personnd overhead cost ofkasing comPanies to total assets as compared to banks is definitely higher because lessors have to be conversant of both the, credit rating of their clients and their market for each type of equipment they are leasing. Lessors need to inspect the equipment periodically to make sure that it is properlyused and maintained throughout the lease period. These activiti~ tend to raise the cost of leasing transactions compared to unsecured syndicated loan transactions.

At present; the leasing industty in the Philippines is ~ot fully devdoped. Although there are about eighty (80) finance

. companies which offer leasing as one of thejr semces, the leasing industry is practically controlled and dominated by

. only. ten (10) companies. Based on Table 1, the top seven . lease companies accounted for 95% of the industry's total

outstanding po~lio in 1990.

LEASING COMPANY PROALES

M· ost ~f the l~ing companies are sub~idiaries or are . affiltated .. WIth reputable commercIal banks and

business con~rDs.These are BPI Leasing Corporation, Citytrust Finance Corporation, and pa Leasing and Finance, Inc. whiclt· are wholly owned subsidiaries of leading unibanb Bank of the Philippine Islands, Citytrust Corp., and paBank. Of the others, Mercator Finance Corp<;lration is wholly-o~ned by the Zuellig Group of Companies, while the Korea Merchant Banking Corpo­ration and International Finance Corporation joindyown 20% of All-A.s;a Capital and Trust Corporation. These

LEIlA CALDERON

Table 1

TOP TEN LEASING RRMS OUTSTANDING LEASE PORTFOLIO

As of December 31, 1990 (In millions)

1990 % 1989- % 1. BPI Leasing Corporation 898 35 688 33 2. AU Asia Capital 457 18 400 20 3. PCI Leasing & Finance 440 17 401 20 4. Consolidated Orix Leasing . 181· 7 176 9 5. Mercator Finance Corp. 176 7 114 6 6. First Malayan Leasing 144 6 153 7 7. POB Leasing 120 5 - -8. Citytrust Ftnance 63 3 76 4 9. BA Finance Corporation 46 2 21 1 10. FEB Leasing & Finance Corp. 1 - - -

Total P2.526 100 P2.029 100

Source: Philippine A~tion of Finance Companies. Inc.

leasing companies therefore have a prominent advantage over their competitors because they have easy access to cheap funds. a marketing and distribution network, and a wide base of individual and corporate clientele that can readily be tapped. Also, such a set-up is conducive to cross-selling of products and advertising on the institu­tionallevel.

Most of the lease contracts done by these companies involVe motor vehicles (fable 2). In 1990, motor vehicles leasing accounted for 78.6% of total equipment leasing contracts, and this can be attributed to the resurgence of the car manufucturing program by the government. This was a plus factor for the leasing industry despite the natural calami­ties that struck the country in the second half of that year.

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TABLE 2

CLASSIFICATION OF LEASE CONTRACTS BY TYPE OF EQUIPMENT

. As of December 31,1990

TYPE OF EQUIPMENT

Motor Vehicles Heavy Equipment Office Machines Industrial Machinery Others

Total

Percentage

78.6% 9.5 6.2 2.4 3.3

100.0%

Source: Phinppine Association of Ftnance Companies, Inc.

Asw:as mentionedeadier. the leasing indusny is notyct

fully developed. It still has to evolve beyond its adolescent st3ge. The indusny em improve if a sound business and invatmcnt climare wiD occur. As for the oontribution of leasing to capital fonnarion. leasing aa:ounted for a measly 1.2% of toC3l gross domestic capial formation in durable equipment in 1990. cnmpan:d to 1.5% in 1988. and 1.9% in 1989. The slowdown w:as due to the natural alamities, and the attempted mop during the Iattez part of 1989.

LEASING INDUSTRY ANALYSIS

A SWOT Analysis done on the leasing industry is presented. H~ted as the industry's strengths

are: its access to large and cheap long-term funds; econo-mies of scale; wide distribution network; stability and wholesome reputation. These strengths are present ~ cause of the affiliation of most of these leasing oompanies to reputable commercial banlcs and business concerns.

Identified weaknesses are: hear dependence on one major madcer. particulary auto financing for business in­rome; high operating oosts; limited number of business oudets; and relatively high oost of funds. The Iattez two

weaknesses are applicable to leasing oompanies not afIiIiared with the top banks and business concerns.

An economic stabilization is ecpected due to the peaceful and orderly transfer of political powClS last June. With this, the enny of foreign capial is anticipated. New invesnnents in heavy industries will require big-ticket financ-

ASSESSMENT OF lEASING INDUSTRY

ingand thiswiD, begoodfortheleasiogcompanies. Waththis occutrena; leasing may gain wider aa:cptance.

The government den:gularion on import Icvy and the setdement of the 10% Value Added T u (V Al1 issue wiD open doors for the leasing industry. Govanment deregu1a­tion on import levy would mean an inaase in the asset

3aJuisitiondforts of the industrialsectorandcapial iIm:sroIs which theleasiogoompanic:semcapitalize00. Ako.ifIeasing companies are ex~ from the 10% wliae added ra, the true benefits and adwnt:lgeS of Icasiog &I a1rc:rnarift to uadirionalfinancing schemes wiD be highlighted.

With an anticipation that the impending cc:onomic recovery~ be consumer-driw:n. then: wiD be new require­ments for capital equipment and machinc::ryused to produce consumergoods. Thus, financing &cilities will be needed in both the heavy industries and consumer madcet.

lbeassetprivatizarion programofthegovernmcntalso spdls opportunities for the industry since the noo-pc:rform­ihg assets will be sold through biddings and ncgotiarcd saIes.. Most of these assets are big-ticket items that will ""luire syndicated financing which leasing companies em join in.

Since most of the oonsumer goods are made up of materials and oompooents imported.abroad. most manufav turingoompanies would have placed their orders lWOorrhnle

months earlier. However, the ream move of the IIlOIlCtaIy

board to have a foreign exchange liberalization and the adoption of the Philippine Dealing S~ in fun:ign ex­change trading could have resulted in the present peso-doIIar exchange rare ofP 23: $ I, thus spelling some,losses for these

TABLE 3

CONTRIBUTION OF LEASING TO CAPITAL FORMATION As of December 31, 1990

(In miUion pesos)

1988 1989 1990 Gross Domestic Capital Formation

Total P 110,394 153,887 158.208 In Durable Equipment 56,730 65,760 75,238

Total Leasing VoIwne Leasing % of Total GOCF % of GOCF in Dlr.lbIe Equipment

871 0.79% 1.50%

Source: Economic and Social Statistics OffICe National Statistical Coordnation Board

1,245 0.81% 1.90%

914 0.58% 1.20%

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LFlIA CALDERON

manufacturing companies which have placed orders at an exchangerareofp 26: $ 1 oreven more. With theseprojeaed ·losses. manuf.acturing firms will 'be forced to pass on the additional costs to the consumers. thus a slowdown in the demand in the consumer market may occur. Requirements

- fur additional equipment may not be needed. thus affeCting the activi~es of the leasing indusny.

_ . Aside from the peso-dollar exchange rate. the indusny has to lmce itself against rising inBation. In 1991, the ·inflation rate was at 17%. Even if there is an optimistic economic furecast fur this year; the indusny still has to work with a projeaed inflation rate of 12%. Consequendy, high inflation ~es translate to high interest rates which will result in a slowdown in economic activity.

Otherthreus identifiedare: theIo.vawarenessoftheleasing <XlfKllX among aedit users; lade ofleasing opportunitic:s; and the mueon thewIueadde;d taX. Atpn:sent, theleasingindusay isstill fur from marurityand its full aa:q>tma:amongaedit users cannot .be brought about easily. Th~ fi a need for sustained and aggressive ~ dfurts to sdl the oonc.epc of leasing ta businesses befOre they come up with an offur.

Companies mayspend heavily on equipment onlyona:or onceeveryfiveyears. l.easingmay beconsidennas aon~otdeal. ,Ona: the lease company misses its opportunity, it may wait for . quite a time befOre dealing anew with that company.

The sales ofleased assets are slapped with a 1 0% Value Added Tax (VA 1) which in tum is passed on to the lessee. With this additional cost, tht lessee may have second thoughts in leasing the asset and may just purchase the asset.

CONCLUSION

. W.· hat has been presented is the current state of the leasing industry in the Philippines. As mentioned earlier, it has

yet to evolve from its · adolescent stage. The political and economic stability of the country would greatly influence the future of this indusny. which can be tapped as an alternative financing schemefot those so-called traditional financing schemes. Leasing qn contribute a lot to capital formation smce this is needed in the production of consumer goods and operations of heavy industries, thus acting as a catalyst in our

. economic devdopment. . l.easing can be considered an alternative financing scheme

because of its salient fuarures (such as low downpayment and less stringmta>llateral) to the high-growth ·eamomic segments and small and medium ente!pOscs (SM&): These SMEs may use leasingtosecureexpansionandgrowthfundingwhichtheycannot avail of from traditional financing schemes. , There is ·a need for the leasing industry to lobby with

congreSs and the senate on how to improve its current state. To make leasing reach its maturity, the government should

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set a framework on what it can and cannot do. Also. it has to

seede the 10% VAT imposed on the sales and leaseback arrangement. If possible, it should exempt the leasing companies from the 10% VAT. In this way. both the lessor and lessee will be benefitted sina: the lessee will inaease her working capital under the sale and leasebaCk arrangement. Also, without the 10% VAT. lease rental would besubstan­tially lowered. As for the lesSor. this may mean an inaease in his business of leased ~.

Perhaps it is best to explore the possibility of turning a leasecontraa into an instrument in the capital market.' Given the proper government agencies where lease contracts can be registered and sold at a discount to the investing public, this could mean opening a new dimension to our capital market and devdoping both the leasing indusny and capital market.

As a whole, the future of the leasing industrywill ~y on changes the government will initiate that will affect them. Also. political and economicstabilitywi1l inBuenceits growth. There is still a need for the indusny to dearly sell its concept to industries dependent on capital assets. A sustained and aggressive marketing of its services.. is needed particularly fur the non-affiliated leasing companies. As fur those affiliated with the top unibanks. acona:rted effort ofboth the unibank or holding companies and the leasing company is required to assure success of the leasing companies. In the future. it is hoped that leasing will finally come out of its cocoon and be recognized by those heavily dependent on capital assets as an alternative to what we have known as traditional financing.

REFERENCES

Asian Devdopment Bank. 1987. UasinginDaI~lopingAsia. Manila: 128-156.

"Business uasing: Another Gamble. " 1989. Manila StanJarJ (March 28).

"Financing Firms Rrport 499% RUe in CombinuJ Profits in .'91. "1992. Tk Philippine Star (March 26).

Gitman. Lawrence. 1987. Basic Managn-itJ Financ~. USA;Harper and Row. Publishers. Inc.

"Leasing Industry Hamstrung by lAck of Government Sup­port. "1990. Manila Times (February 23) .

"LtasinglnaustryPostsHighGrowth. "1989. ManilaBulletin. (May 5).

Lirio. RP. 1988. "Leasing in the Phiiippines: Golltmmml Pmp«tiv4 »Cmtra/ Bank Reuiew39 (Decanber): 14-17.

Scott. David. et al. 1988. Basic Financial Managemmt USA:Prentice-Hall International .. Inc.

uila Cakkron is a faculty mnnbn- of th~ Financial Manag~m"'t D~partmmt of th~ Colleg~ of Business ana Economics.