Path of lease resistance

"The lease got approved!"

Money hides a thousand defects, the Chinese proverb suggests, but now is probably not a time to be worrying too much about that. Governments want banks to lend and in China the money is certainly flowing. The latest data suggests Rmb1.62 trillion ($237 billion) in new loans were made in January, almost a third as much as was lent in all of 2008, according to the People’s Bank of China.

The pace of credit expansion in the year so far suggests that government prodding is working. But to focus purely on new loans is to overlook other financing options available. Activity in the financial leasing market, for example, suggests that it is not just the money on offer that we need to look at but also the way that it is being offered out.

China’s financial leasing industry grew aggressively to Rmb114 billion by the end of 2008, an increase of 54% on the previous year alone. After a relaxing of restrictions in 2007, six of China’s larger banks moved into the financing of high capital assets like ships, aircraft and heavy machinery. Customers – keen to avoid the full weight of debt involved in ownership of these big-ticket items – have been choosing to pay rentals on them instead.

This was all part of a China Banking Regulatory Commission (CBRC) plan. Leasing finance levels in China are low by international standards, at 3% of capital equipment investment compared to a global average closer to 17%. Domestic firms complain that this hinders sales growth, as buyers expect vendors to offer access to more sophisticated financing options. Beijing wants to see more Chinese ships (and in the future, aircraft) being sold overseas, so the CBRC resolved to boost the nation’s leasing capability too.

But Beijing also remembers the last period in which the leasing industry gained traction in China. As the economy grew in the 1990s, foreign companies used quasi-leasing firms to bypass some of the restrictions on buying equipment from abroad. Foreign banks lent to China’s new quasi-leasing firms who bought the assets and then leased them on to interested parties.

China’s regulators struggled to control deal flow and by the mid-1990s the bubble was bursting. International lenders took a heavy hit and argued that the government was on the hook for bad debt, as the quasi-leasing firms were state-owned enterprises at root. An embarrassed Beijing moved to close the domestic industry down. The government’s fingers were sufficiently burned to see it bar its own banks from the leasing business for years. And its change of heart is a cautious one. The Economic Observer reports that the banks that have been allowed to set up leasing arms cannot fund them with core capital from the “mother bank”. But the Economic Oberver adds that leading operators have navigated this hurdle by “cross-borrowing” amongst themselves. And this sort of resourceful response is probably the true cause of the industry’s apparent health. Since late 2007, borrowers increasingly switched to lease finance as bank lending dried up.

The Economic Observer agrees that a greater flexibility in getting lease deals approved is at the root of recent industry success. Much else in the arrangements surrounding a transaction looks little different to a vanilla loan. The same state-owned customers are signing contracts with the same state-owned banks. The lease rental sums are often matched almost exactly to an interest rate on an equivalent bank loan.

So will the leasing industry wane as bank financing becomes more plentiful again? Possibly. But the ambitions of the industry remain undaunted. In fact, Reuters reports that China Investment Corp – a sovereign wealth fund – is in talks to buy AIG’s aircraft leasing unit. Reuters says it will bid jointly for the asset – worth $8 billion – with both Bank of China’s and ICBC’s leasing businesses. If successful, that really would mark a jump into the big league.

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