BONDS SERVE AS AN INSTRUMENT FOR FINANCING GROWING PORTFOLIOS
The leasing industry’s growing interest in financing and refinancing its activities by issuing bonds is confirmed by data fr om a survey of companies rated by ACRA and is due to active growth of portfolios (most importantly for retail business), the relatively low level of interest rates for issuers until recently, and investment activity that has increased over the past year and a half in relation to debt securities.
The largest growth in demand for bond funding is observed among small and medium-sized lessors. According to ACRA’s forecasts, the volume of bond funding of these retail players may grow by more than 30% in 2021.
This is largely a consequence of the active expansion of business that is financed, among other things, by bonds, amid the economic recovery. The industry continues to be stimulated by the rapid recovery of wheeled vehicle leasing, deferred customer demand, government programs, expected inflation and interest rate growth, the flow of bank borrowers to the ranks of lessees, national projects, as well as urban development, along with improving services and digitalization of the sector.
The observed rise in interest rates will somewhat lim it industry’s interest in bonds. Nevertheless, ACRA believes that these restrictions are temporary and expects favorable conditions for borrowing to recover during 2022 as inflationary pressures stabilize.
During the survey, the majority of leasing companies rated by ACRA noted that the presence of bonds in the funding structure makes it easier to manage their liquidity and increases the diversification and stability of the resource base. At the same time, the Agency believes that leasing organizations still have a long way to master the debt capital markets — the main constraining factors are the cost and complexity of preparing placements of bond issues.
THE POPULARITY OF BOND FUNDING IS GROWING
In 2019–2021, the leasing industry saw steadily growing interest in financing their activities using bonds, which, according to ACRA’s expectations, will remain in some form over the 12-month horizon. The main drivers of this growth were the decline in the cost of debt, as well as a sharp increase in the interest of local investors in the securities market, which has been observed since last year. While the influence of these factors has weakened somewhat amid the tightening of monetary policy, for companies in the retail segment the active growth of business, which has been observed since H2 2020 and continues to this day, still plays an equally important role. The latter remains the main incentive to issue bonds, which are a convenient tool for financing rapidly growing leasing portfolios.
In 2020, the volume of issues attributable to two leasing companies that mainly work with large business approached its historical peak. Lessors servicing mainly small and medium-sized enterprises (SMEs) have also significantly increased borrowing in the capital market since 2019. It is noteworthy that in the first eight-and-a-half months of 2021, the volume of issues of these companies is 2.3x higher than the indicators for the whole of 2020.
Figure 1. There is a pronounced progressive trend in the volume of bond issues (RUB mln), as well as the number of issues and issuers among leasing companies
* From the start of 2021 until September 17, 2021
In ACRA’s opinion, the growth in the volume of bond issues in the leasing industry and the number of issues among companies servicing SMEs indicates that organizations are able to interest investors using the growing confidence in the Russia’s leasing industry and the current economic environment.
CONTINUING GROWTH OF BUSINESS VOLUME SUPPORTS RETAIL LEASING COMPANIES’ BOND FUNDING NEEDS
The economic recovery (ACRA expects Russia’s GDP to grow by 4.1% in 2021 and 2.7% in 2022) serves as a favorable backdrop for active growth of leasing portfolios, especially for companies that are engaged in the retail business, servicing SMEs. In turn, a successful bond issue, which implies a one-time receipt of a significant amount of borrowed funds, works well for financing rapid business expansion. According to ACRA’s observations, many lessors take this into account when planning their funding structure and making decisions about entering bond markets.
In the Agency’s opinion, the desire to expand market presence will remain relevant over the next 12 months, and so retail leasing companies will continue to be interested in issuing debt securities. In addition to the general recovery of the economy and business activity, a combination of the following conditions will support active growth of business:
The continuing demand of SMEs to renew equipment and machinery, especially wheeled transport, which was partially postponed due to the economic downturn. According to ACRA, in particular the need to renovate the fleet of trucks will continue to drive interest in leasing of this product. Even in 2020, this area did not record significant negative dynamics due to the continuous operation of grocery chains and activity in the construction segment, an aspect which is still relevant;
Relatively rapid growth of the taxi and carsharing segments, which began in H2 2020 due to high demand for these services among the population, continues to be a long-term point of growth even despite temporary episodic difficulties associated with the pandemic;
Government subsidies provided to support lessees and other programs are highly significant in terms of supporting demand for various equipment, especially in the area of transport. In the next 12–18 months, it is possible that new additional programs will be launched, involving, among other things, waste collection and recycling equipment, and/or an increase in the limits on existing programs, if demand for relevant equipment begins to weaken;
The high inflationary expectations (represent risks of rising prices for leasing objects) and the trend toward increasing key rate (risk of higher cost of leasing in terms of the financing/lease rate) push SMEs to actively carry out capital investments, supporting demand for leasing in the medium term. Nevertheless, the government subsidies and programs mentioned in the previous paragraph are intended to somewhat mitigate these risks;
The effect of the flow of the client base from banks to leasing companies, which intensified last year amid economic instability, still remains relevant today. Historically, leasing companies’ requirements to lessees and the procedures for issuing leasing products have been and continue to be simpler and more relaxed in comparison with banks’ requirements. This is becoming especially important for clients during periods of growing credit risks in the economy, when the number of refusals to provide financing is growing;
National and infrastructure projects and development of urban economies as an additional factor stimulating the growth of the segment;
The profitability of the retail leasing segment, as before, remains steadily high, fueling the interest of market participants and their willingness to accept risks;
An improving level of service and business digitalization lets companies attract clients and process transactions faster. In addition, the awareness of SMEs about the benefits of leasing is growing, which together expands the client base and strengthens its loyalty to the sector.
Figure 2. Amount of financial leasing agreements (RUB bln): the motor vehicles and other machinery and equipment segments showed strong growth even in the challenging conditions of 2020
* The growth of leasing of ships and water transportation is due to one-off deals in this segment.
Rosstat’s data also confirms ACRA’s observations: growth in the amount of financial leasing agreements for motor vehicles, trailers and semi-trailers amounted to 30% in 2020 (22% and 28% in 2019 and 2018, respectively), while for other machinery and equipment 20% growth was recorded (26% and 14% in 2019 and 2018, respectively). It is noteworthy that growth indicators comparable to 2018–2019 were achieved in these segments in the unpredictable and complex operating environment of 2020 and, are essentially largely a reflection of an active six-month period of portfolio expansion that began in the second half of the year. In other words, in H2 2020, the business growth rates of many retail leasing companies must have been approximately twice as high as compared to 2018–2019.
Nevertheless, the large appetites of retail leasing companies for portfolio expansion — a key driver of bond funding growth in the segment — may have the opposite effect in the future. The Agency does not exclude such a scenario, that the excessively relaxed approaches of lessors to issuing leasing products may turn out to be risky, since there is no complete certainty whether the consequences of the challenges of 2020 will surface as portfolios mature.
GROWING INTEREST RATES SOMEWHAT INCREASE, ALTHOUGH TEMPORARILY, ENTRY BARRIERS TO THE DEBT MARKET FOR LESSORS
Growing interest rates amid the tighter monetary policy of the Bank of Russia observed since March 2021 will have a certain constraining effect on leasing companies’ appetite for corporate bonds in the medium term. Nevertheless, ACRA believes that the restrictions are rather temporary and expects borrowing conditions to be more favorable by the end of 2022.
The opposite trend of the key rate, which was observed until 2021, on the contrary, encouraged the leasing industry to enter the debt capital markets. In particular, the Bank of Russia’s adherence to a soft monetary policy in previous periods, which was especially obvious in the past year, led to a noticeable reduction in the cost of funding for business in general and the leasing sector in particular. These savings on interest costs, in ACRA’s opinion, allowed leasing companies to spend more on organizing bond issues, which is especially important for moderate-sized industry players. The Agency believes that this reason, coupled with rapidly growing demand for bonds amid lower interest rates (including those offered for bank deposits, the real income adjusted for inflation on which has become minimal), encouraged lessors to go to the capital markets to finance their operations.
Figure 3. Consistent decline in effective and nominal rates determined basic prerequisites for enhanced appetite for bond funding
* ACRA’s forecast for 2021–2022.
Sources: Bank of Russia’s statistics, ACRA
These were important incentives and steps that enabled both leasing companies and investors to probe the debt market. Further steps, in ACRA’s opinion, will be easier to take, regardless of the growing rates. In particular, the risk premium for companies in the retail leasing segment took shape when monetary conditions were loose. Subsequent issuers and investors should find it easier to navigate bond prices and yields relying on earlier similar issues as a comparative base.
As a result, the Agency believes that the new economic conditions, although they somewhat cool the debt borrowing market, will not be able to completely neutralize the leasing industry’s appetite for bond funding: the need to finance business amid economic growth will remain in 2021–2022. In addition, ACRA assumes that by the end of 2022 and beyond, inflation may return to manageable levels, which will allow the key rate to be slightly reduced, thus bringing borrowing conditions closer to those observed in 2020. Until this happens, the Agency takes into account the following additional mitigating factors for the period of constraining monetary policy:
The tightening of monetary policy is observed against a backdrop of a noticeable inflationary pressure, which reasonable issuers are inclined to take into account in their bond issuance plans. Thus, in ACRA’s opinion, real rates adjusted for inflation will not demonstrate similar to nominal rates progressive dynamics, remaining at a level acceptable for leasing issuers in the next 12 months (Fig. 3);
Leasing bonds are usually issued for a period significantly exceeding one year (Fig. 6), which makes them less sensitive to changes in the key rate. The latter, being primarily a benchmark for short-term interbank placements, has a much stronger effect on rates in the economy with maturities up to a year. Long-term interest rates are much more influenced by other factors, including, but not limited to, the opinions of lenders and investors on the level of credit risks in the economy, as well as the effectiveness of current monetary policy (in other words, future inflation rates);
Figure 4. Zero-coupon yield curve on government bonds: influence of monetary policy still mostly translates into short-term rates
Sources: Bank of Russia, Moscow Exchange
- The profitability of many leasing companies, especially in the retail segment, is high enough to absorb some additional losses like growing interest expenses on bonds.
significant potential for an increase in the number of issuers among small and medium lessors
In ACRA’s opinion, small and medium-sized lessors doing business with SMEs turned out to be more flexible in taking advantage of the favorable capital market conditions, when entry barriers were minimal for leasing companies. According to ACRA's forecast, annual growth in the volume of bonds issued by such retail lessors may exceed 30% in 2021 (for comparison: the growth in the segment of companies serving mainly large infrastructure businesses may amount to about 15–25%, which is generally in line with the Agency’s expectations for growth of the total leasing portfolio of the entire industry). Small and medium-sized leasing companies, having made their debut placements of debt securities, remain on the stock market, and bond issuance is becoming a common practice for raising funds by them, along with bank loans. In addition, the cautious attitude of the banking sector towards some small and medium-sized leasing companies remaining since the last year is also forcing lessors to resort to alternative funding sources such as corporate bonds.
The number of leasing companies offering bonds were limited, for a fairly long time, to a small pool of large players and remained almost unchanged. Since 2018, when the decline in real interest rates in the economy began, this trend has changed: the number of issuers in the industry has almost doubled and continues to grow from year to year. This trend, as noted above, is supported by rather high appetites for growth demonstrated by retail leasing companies.
Figure 5. The number of issuers of new debt securities in the leasing industry has been growing mostly due to small companies doing business with SMEs
* From the start of 2021 to September 17, 2021.
why are bonds attractive for leasing companies?
Most of the surveyed leasing companies rated by ACRA expressed an interest in issuing debt securities; the greatest rise in interest was observed from small and medium-sized companies. In addition, besides lower funding costs and growing demand from local investors, leasing companies are finding more and more reasons to issue bonds. In particular, the availability of debt securities in the funding structure increases the flexibility and agility of a leasing company in managing assets and liabilities, and also makes the resource base more stable:
Raising funds through bond issues generally does not require collateral, which makes it a more convenient alternative to bank loans. In addition, according to the survey, some small and medium-sized leasing companies find it increasingly difficult to discuss collateral with banks.
Bond funding usually implies greater freedom in applying borrowed funds in comparison with bank loans.
In most cases, bond funding is characterized by significantly longer durations in comparison with bank loans (this is particularly relevant for companies associated with the state and collaborating with large businesses). This gives lessors a clear advantage in terms of funding base sustainability and managing assets and liabilities by their maturity, reducing the need to synchronize lease payments with debt repayments.
Figure 6. Bond maturities (years) in the leasing industry have been decreasing over the past several years
* From the start of 2021 to September 17, 2021.
- Being an additional funding source, bond funding usually increases the diversification of the resource base and reduces dependence on individual lenders.
Figure 7. Funding structure of leasing companies rated by ACRA: the share of bonds is growing
Sources: ACRA, corporate reports
According to ACRA’s observations, a number of small and medium-sized leasing companies experience difficulties in attracting loans and increasing limits from banks; in such cases bond issues may become an alternative. The problem becomes especially urgent for companies planning a rapid portfolio growth, which is often observed by the Agency among retail lessors.
Bond funding usually helps to increase transparency and strengthens an issuer’s image as a reliable borrower.
entering the public debt market is not so easy
The main factors preventing companies from entering the public debt market are costs, especially against the backdrop of a constraining monetary policy, and complex procedures required to issue a bond. Certain qualified professionals are needed to place an issue, put together a set of required documents, and work with organizers and investors. Moreover, the placement of an issue by a company that is small or is entering the market for the first time may turn out to be a lengthy procedure, which may prevent the issuer from receiving and allocating the proceeds from an issue on time.
In addition, after a bond is placed, a significant amount of proceeds is debited to the issuer’s balance sheet prior to their actual use in transactions. In the current Russian reality, this, as a rule, causes a negative or near-zero interest margin during the initial period of using the proceeds, since the company incurs debt financing costs but does not yet receive income from investments in core business.
For many small and medium-sized leasing companies, the cost of borrowing in the capital markets remains high, especially if compared to bank loans. This is most important for companies that are entering the market for the first time and are yet unknown to a wide range of investors.
Moreover, when entering the stock market, a company must demonstrate its transparency by disclosing detailed reports and data on its leasing portfolio, and this requirement is far from welcome by the entire leasing community. Financial performance, quality of corporate governance and risk management, as well as reputation and position in the industry are becoming more and more relevant, as this information is the priority for potential investors. At the same time, not all companies prepare their reports in accordance with international standards and only a few engage auditors with a recognized reputation. The preparation of reports in itself requires additional costs. Among those companies in the leasing industry that dare publish their performance indicators, information disclosed within a reporting period often does not allow for high quality monitoring of their financial condition.
The Agency is of the opinion that the upcoming reform of the leasing industry should make it simpler for potential investors to assess issuers. It is expected that one of the most important stages of the reform will be the unification of reporting and the supervision of the companies’ compliance with financial sustainability requirements.
As noted above, bond market growth in 2020–2021 was facilitated by the entry of multiple private investors into the market. At the moment, this factor tends to weaken, firstly, due to the growing likelihood that a part of investors’ capital will turn back to banking instruments as the interest rate offered on the most popular among them, banking deposit, rises to psychologically acceptable levels against the backdrop of tightening monetary policy. The second reason is a smaller expected audience of potential investors due to the introduction of the new Base Standard for the Protection of the Rights and Interests of Brokers’ Clients1, which requires unqualified investors to pass a test that checks their eligibility to purchase bonds issued by companies without ratings or with ratings below the level set by the Bank of Russia. This segment includes the vast majority of retail leasing companies serving the SME sector.
1 Base Standard for Protection of the Rights and Interests of Individual and Corporate Recipients of Financial Services Offered by Self-Regulated Broker Associations (as amended); approved by the Bank of Russia (Minutes No. KFNP-28 dd. August 19, 2021).