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ANALYSIS OF TRENDS AND SECTOR AND ECONOMIC RISKS OF THE LEASING INDUSTRY

• The transformation of the economy against the backdrop of geopolitical tensions is shortening the forecast horizon of the leasing industry, which is closely related to business activity and foreign trade.

• Data of companies surveyed by ACRA shows that competition is expected to increase in the next 12–18 months. This will be facilitated by the efforts of the majority of respondents to restore the currently reduced volume of business in the face of a difficult operating environment and risks of deterioration of customers’ credit quality.

• Quite often, there are market expectations of a further decrease of the availability of leasing items, which was one of the main obstacles of the past year. The situation is somewhat mitigated by occasional positive sentiment regarding demand for leasing in the next 12–18 months, despite the general reverse trend of last year.

• The absence of deterioration of asset quality and forced deleverage ensured stable financial profiles of the leasing companies rated by ACRA. At the same time, the Agency does not rule out credit risks seasoning over time.

• The cost, availability, and sustainability of the funding base remain under pressure. The exception is large companies that are affiliated with banking groups or have ties with the state.

• The development of certain leasing segments will vary. Recovery of rail transport leasing depends on the pace of reorientation of exports; the aviation segment is in the most vulnerable position due to reduced flight destinations; car leasing may start growing as logistics supply chains and connections stabilize; while the conditions are in place for gradual development of leasing of trucks, as well as special and construction machinery and equipment in 2023.

TRANSFORMATION OF the RUSSIAN ECONOMY AS THE KEY FACTOR OF UNCERTAINTY

Since the end of February 2022, Russian leasing companies have had to operate in a new reality that is mainly characterized by a high degree of uncertainty as the economy undergoes a transformation. The country’s GDP declining by 2.1%¹ last year limited the desire of lessors and lessees to expand their activities.

The existence of negative trends in the development of the industry is confirmed by Bank of Russia data, which allows us to conclude that the volume of leasing portfolios and new business decreased by approximately 15.6% and 9.5%, respectively, during H1 2022. Results varied by the type and area of activity of the companies.

When forming further conclusions and assessments, ACRA also relied on the results of a survey held among leasing companies rated by the Agency. By analyzing of respondents’ answers, it was possible to identify the leasing market’s most acute problems in 2022 that affected the dynamics of its development, as well as industry participants’ main expectations for the next 12–18 months.

Lessors who are not members of banking groups are in a slightly worse position. Such type of companies, that specialize in the automotive industry, have had to stop their once-booming growth, with most posting less than 15% growth over 9M 2022. A similar situation was observed in the leasing segment of industrial, special and construction equipment, where growth rates for the analyzed sample of companies are limited to 5–10% over 9M 2022.

Lessors who are focused on the abovementioned areas of activity and at the same time are affiliated with banks are in a much better position. These companies recorded growth of about 25% over the same period, probably due to relatively higher stability of funding.

Companies that lease larger and more expensive items were also under pressure due to the worsening operating environment. Entities that are somehow involved with the aviation industry were the most susceptible. A more manageable reduction of portfolios was observed in the railway segment.

Despite the fact that the situation in the economy is stabilizing, ACRA expects heightened uncertainty to remain in place over the next 12–18 months, which limits the forecast horizon and thereby restricts the development of industry participants who heavily depend on business activity. The real sector has assumed a wait-and-see stance — according to the Agency’s estimates, investments in fixed assets adjusted for inflation and seasonality have followed a downward trend since March 2022 (for comparison, even during the pandemic this indicator grew).

¹ Statistical data of the Federal State Statistics Service

Figure 1. Fixed capital investment index*: downward trend indicates limited development of the leasing segment

* At fixed prices for Q1 2021, seasonally adjusted.
Source: ACRA’s calculations based on Rosstat data

The volume and nature of foreign trade continues to be another factor of increased uncertainty in the context of the pronounced focus of the leasing industry on freight transport equipment (both automobile and railway). Restrictions imposed by unfriendly countries affect changes in export and import flows and force lessors to adjust their business to new needs for the transportation of raw materials, goods, and services. Often, these additional efforts take a long time, require the diversion of resources, or market participants even have to recognize a decrease in the need for new equipment due to fewer transportation routes.

Uncertainty about the ruble exchange rate, commodity prices and growth opportunities for the economies of friendly countries, primarily China, will also influence the attractiveness and prospects of exports and imports in the next 12–18 months.

Despite the challenges of the previous year, which forced market participants to reduce the size of the lease portfolios or considerably reduce growth rates, the majority of respondents are optimistic and plan to start actively developing business this year (Fig. 2). Representatives of car and truck leasing expressed the most resolute intention to expand, as many of them envisage the possibility of growing their leasing portfolios by 30–60% by the end of the year. Forecasts are more modest in other areas of leasing and overall growth paths of respected entities do not exceed 20–25%.

ACRA, however, is much less optimistic, given the operational environment risks that have materialized, as well as the fact that economic restructuring may go on for most of 2023, therefore, influencing leasing customers to postpone plans to update fixed assets.

Growing ACTIVITY OF LEASING COMPANIES would face TOUGHER COMPETITION

As noted above, despite the difficult business conditions, survey participants plan to intensify their activities and are ready to take certain risks for the sake of this. Most of the companies surveyed expect to maintain their current customer base, and absolutely all of them predict that the availability of qualified personnel for the industry will not change.

However, respondents recognize that the implementation of business development plans in the current environment also implies an increase of competition.

Figure 2. Survey results in the form of indices* reflecting the responding companies’ expectations over the next 12 to 18 months

* Set in the range [-1;1]; the closer the values are to extremes, the more respondents expect decline or growth, respectively.
Source: survey of leasing companies rated by ACRA

In addition, companies’ intentions to resume active expansion of business may come up against limited potential for growth of demand for leasing services. Many respondents acknowledge that a decline of demand among current and potential customers was noticeable and narrowed business prospects last year. Companies that are engaged in leasing industrial and food equipment, as well as agricultural machinery, are mainly confident that this indicator will be positive over the next 12–18 months. For comparison, over the past 12 months, the smallest drop in demand was observed in the segments of special and construction equipment, as well as industrial equipment. ACRA expects the relatively high sustainability of these areas to be maintained in 2023.

The respondents’ answers concerning other development parameters of the industry were less homogeneous. However, they point to a number of issues that are reducing the likelihood of leasing companies achieving their desired level of business activity. Given the growing competition, the materialization of these problems may lead to a deterioration of business efficiency and the ability of leasing companies to generate capital to finance further growth.

In particular, a common opinion was that the availability of leasing items might continue to decline over the next 12–18 months. In 2022, representatives of the aviation segment and companies involved in leasing motor vehicles mainly faced shortages of leasing equipment. Among the latter, small companies suffered less from this (here, the scale effect is significant as it is probably easier for small companies to obtain equipment by establishing new supply chains).

Figure 3. Respondents’ positive expectations regarding growth of demand for leasing are somewhat balanced by negative sentiments regarding the availability of leasing items in the next 12–18 months

Source: survey of leasing companies rated by ACRA

The shortage of equipment provoked an increase of the prices of supply contracts (according to 100% of respondents) and insurance of leasing objects (according to about half of the respondents, mainly companies involved in leasing cars and trucks). All survey participants agree that delivery times also remain elevated, which limits business opportunities.

The survey reveals that in practice some companies faced the seizure of property in connection with mobilization, as well as breaks or bans on the seizure of property from problem lessees. Respondents who are engaged in leasing vehicles were most concerned about this.

A number of issues covered by the survey were about the relationship between sector participants and the state. Most respondents do not expect regulation to be tightened, however, an opinion was voiced that this factor will play a certain role over the next 12–18 months. ACRA does not expect any major changes in this area over the aforementioned period. There is a new reason for delaying leasing industry reform as tightening of regulation may seem untimely against the backdrop of the complexities of the external environment. Discussions among the participants of this process, including various government departments, are ongoing.

At the same time, the survey’s respondents do not expect state support measures, which could be a serious incentive to revive the leasing industry, to be broadened either. In ACRA’s opinion, demand is present for such measures, and it will increase if economic and geopolitical uncertainty remains. Taking this into account and the import substation policy, which may lead to higher public investment, the state’s role as a significant investor in the development of leasing in Russia will probably strengthen.

ASSET QUALITY IS STABLE, BUT RISKS OF DETERIORATION REMAIN; STRICTER STANDARDS FOR lease ISSUANCE IN RESPONSE TO EXTERNAL ENVIRONMENT CHALLENGES

ACRA’s analysis shows that there was no pronounced deterioration of asset quality in the industry over the past 12 months. According to the Agency’s assessment, which takes into account both overdue debt and potential problem clients in the portfolios of rated leasing companies, the share of total non-performing claims is generally stable and varies within 11% of the portfolio.

ACRA assumes that the stability of portfolio quality was maintained over the past 12 months thanks to the following factors:

• Reduced appetite for credit risk among most leasing companies, and, consequently, stricter requirements for issuance led to attention shifting from portfolio volume to its quality;

• A shortage of leasing items and a significant increase of prices for those that were available supported the payment discipline of lessees who sought to avoid returning property to lessors (this factor, according to ACRA and market participants, is likely to remain relevant in 2023);

• Growth of demand for used equipment (especially the brands that ceased selling in Russia or became much harder to acquire) facilitated more rapid recovery of leasing items from problem clients for the purpose of subsequent sale, which could prevent the accumulation of arrears in portfolios.

Figure 4. Changes in the conditions of lease agreements and risk management as per the surveyed companies

Source: survey of leasing companies rated by ACRA

Despite the absence of negative dynamics for the asset quality of ACRA-rated companies in 2022, the likelihood of credit risks materializing in the next 12–18 months remains. As practice shows, including observations of the banking industry, credit risks often appear with a time lag after the acute phase of crises.

Consequently, the business revitalization planned by industry participants in the next 12–18 months in a rapidly changing external environment and amid an expected increase of competition may lead to a more noticeable impact of the risks of deterioration of the financial condition of customers on leasing companies’ results. The validity of these concerns is supported by Bank of Russia statistics, which show the leasing companies’ receivables overdue by more than 90 days grew the first six months of 2022.

Survey participants agree that the credit quality of lessees is unlikely to improve. Moreover, regardless of specialization, many companies in the sample recognized that this fact might limit opportunities for healthy growth.

CAPITALIZATION ALLOWS FOR RENEWED BUSINESS GROWTH

The conservative attitude of all industry participants, both lessors and lessees, to business expansion and credit risks had a positive impact on the equity to assets ratio of leasing companies. This effect is most noticeable in the automobile leasing segment.

Leasing companies can use accumulated capital buffers to implement their business expansion plans in 2023. However, ACRA expects the growing competition, coupled with the abovementioned challenges and risks of the external environment, to limit the expansion of lease portfolios, due to which the capitalization reduction process will be manageable.

The improvement of capital positions of the lessors in the analyzed sample of companies² in 2022 was also driven by maintaining profitability despite the unstable operating environment. For example, the return on assets of lessors focused on more liquid leasing objects³ for the first nine months of last year averaged 4–5% in annual terms (excluding  the most extreme values), which is still quite a comfortable level. The majority of respondents are optimistic about maintaining profitability at current levels in 2023.

In ACRA’s opinion, these forecasts are entirely reasonable, but the likelihood of unforeseen credit losses will remain the key difficult-to-predict risk for profits and capital in the next 12–18 months.

The industry as a whole coped with the sharp increase of the funding costs in H1 2022, having suspended business development and refused to borrow expensive money from banks. Another factor that curbed the interest rate risk was an increase of the lease payments ticket in cases where the contract terms allowed for such amendments (Fig. 4). Some leasing companies began to include floating interest rate clauses more frequently in their new contracts. On the one hand, this practice protects lessors from interest rate risk in the event of a change to the Bank of Russia’s monetary policy, but on the other hand, it can exacerbate credit risks due to an increase of the debt burden of lessees.

² Leasing companies rated by ACRA, as well as publicly available information on some industry leaders not rated by ACRA.
³ Retail leasing where more liquid leased objects include cars, trucks, special-purpose vehicles, equipment, etc. Less liquid leased assets include, for example, planes, railcars, sea vessels, etc.

SMALL COMPANIES EXPERIENCED A SHORTAGE OF FUNDS, WHICH MAY IMPAIR BUSINESS GROWTH 

One of the key factors constraining the growth of leasing companies that are not part of banking groups was the availability of financing and resource base sustainability. Despite the fact that the peak of difficulties associated with these factors can be considered passed and an improvement in the situation has been observed since H2 2022, both banks and potential debt securities investors continue to restrict limits for the industry, so the cost of funding remains elevated.

The participants of ACRA’s survey expect that funding availability will not worsen in 2023. The Agency, in turn, assumes that the implementation of plans for active business growth will not be smooth unless the sentiment of potential investors and lenders improves.

It is natural that none of the large companies affiliated with banking groups or the state have faced a drastic deterioration of funding conditions shown in Fig. 5. This advantage will continue to strengthen the market positions of these companies in 2023. The largest lessors will also be in a slightly better position, as they will probably be able to take advantage of raising funds from Russia’s National Welfare Fund (NWF) since the relevant projects are being actively drawn up and undergoing approval procedures. It is not yet clear whether such initiatives will be available to a wide range of leasing companies.

Figure 5. Most common funding obstacles according to survey respondents

Source: survey of leasing companies rated by ACRA

Almost all respondents agree that bank loans will remain the priority source of funding in the next 12–18 months. In addition to reducing general uncertainty, a reduction in the cost of bonds to 10–13% may contribute to entering the public debt markets.

THE creditworthiness of most leasing companies rated by acra has remained stable

The Agency currently maintains ratings of 17 leasing companies that represent a variety of business models from various retail and large business segments. A number of companies occupy leading positions in the industry, which adds representativeness to ACRA’s portfolio of ratings when assessing market trends and conditions.

* Upgrade of credit rating or credit rating outlook
** Downgrade of credit rating or credit rating outlook
*** Standalone creditworthiness assessment
Source: ACRA

GROWTH AND RECOVERY DRIVERS VARY BY SEGMENT

Regardless of the fact that the issues mentioned above are common to the entire leasing industry, their impact on the main segments is diverse. Growth drivers also vary by business segments, which, taken together, leads to differences in the rates of their recovery and development.

railway transport leasing

Since last year, the railway industry, which is largely influenced by the situation in the economy, has also been undergoing a transformation. In addition to observing some rated companies, ACRA judges the contraction of business by the 3.3% decrease of the shipments in the railway network of JSCo “RZD” last year. The negative impact of external shocks is assessed by the Agency as modest, and the reduction of transportation volumes and, accordingly, leasing portfolios is relatively manageable.

The development of the segment will depend on many factors. ACRA expects that during the economic transformation, exports (including exports of coal, a key commodity transported by rail) will be reoriented towards friendly destinations, primarily Asia-Pacific markets, instead of European ones. It is a complex process that includes the elaboration and development of logistics links, the laying of additional routes and export channels. The implementation of these initiatives will take time, which greatly increases uncertainty. It is also still unclear whether, and if so, how soon, friendly countries will be able to cover the shortfall in the Russian exports that previously were intended for western countries.

Figure 7. Shipments by JSCo “JZD”, mln t

Source: JSCo “RZD”

A notable positive factor contributing to the stability and capacity of export markets can be considered the recent trend in China to lift COVID restrictions that previously weakened economic growth (the potential of this trend can be estimated by the results of 2022, when coal exports from Russia to China and the total trade turnover between the countries increased by 31%⁴ and 29%⁵, respectively). It is possible that this factor will be able to partially offset global restrictions on prices and volumes of oil, petroleum products and coal purchased from Russia.

Additionally, it should be kept in mind that the processes described above will unfold under the pressure of limited opportunities to increase the capacity of railways in eastern directions that have increased in importance, which, together with the expected price correction in the coal market (as logistics around the world are optimized), may restrain growth of transportation and, as a result, railcar leasing. In addition, the rate of growth or decline of shipments may be affected by fluctuations in the national currency (the weaker the ruble, the stronger the market positions of exporters), along with significant changes in the terms of export contracts, including the duration and volume of price discounts.

Given the above prerequisites, which have a multidirectional impact on the industry and cause a large number of possible scenarios, ACRA assumes as rather neutral dynamics of business indicators for the segment companies the base case projection.

Government initiatives and projects, including those that can be financed using the NWF, are likely to influence the railway leasing segment. If the economic recovery drags, the opportunity to participate in these systemically important projects, in ACRA’s opinion, will be a major competitive advantage.

⁴ According to the Energy Industry Development Center.
⁵ According to the Head Customs Office of the People’s Republic of China.

aircraft leasing

The aircraft leasing segment was negatively affected most heavily, as in the pandemic year of 2020. This time, the main hurdle was the ban on flights to unfriendly countries. In the somewhat longer term, the role of another restriction may begin to grow — the ban on the purchase and use of airliners of those brands that currently make up the bulk of the fleet, as well as the termination of their authorized maintenance.

The Agency does not expect the aviation segment and, accordingly, aircraft leasing to recover in 2023 (see ACRA’s commentary Where is Russian aviation flying to? from February 8, 2023). The need to replenish the fleet with new aircraft has lost its relevance because the current fleet far exceeds the needs of air carriers, since the number of flight destinations has shrunk and it will probably not increase significantly in the next 12–18 months.

An ambitious import substitution program is possible in the long term; corresponding plans are being developed by respective top-tier authorities. However, in ACRA’s opinion, full-scale production of domestic aircraft is probable only beyond the next 12–18 months.

On the back of passenger traffic volatility, the financial stability of lessees is supported, as in the pandemic period, by regular cash injections from the government, which will remain the cornerstone for the stability of the aviation industry and leasing companies that are dependent on it. The importance of such support for lessors is increasing as the liquidity of leased assets declines (domestic demand is limited, while it has become much more difficult to sell aircraft that have been seized in Russia outside the country).

car and truck leasing

The passenger vehicle leasing segment has experienced a noticeable negative impact from the withdrawal of a number of foreign car manufacturers from Russia.

In the Agency’s opinion, the abovementioned optimistic expectations of the surveyed industry players for rapid growth in 2023 seem overambitious in the context of last year’s automotive market plunge (new sales of cars and commercial vehicles in Russia decreased by 59%; see Fig. 7), which evidenced the severity of the  car shortage problem. In its base case scenario, ACRA expects moderate and gradual growth of the industry against the background of expansion of parallel imports and the recovery of logistics chains, which will somewhat balance the withdrawal of foreign brands from the market.

The expected localization of automobile factories from China and other friendly countries in substitution of European manufacturers will help cover the shortage of passenger transport and will become a factor reducing car prices, which will drive up the demand for leasing.

Figure 8. Sales of new cars and commercial vehicles in Russia, units 

Source: Association of European Businesses (AEB)

A greater shift in the leasing business towards used cars is also possible. Some market participants have already noted an increased share of the portfolio, which corresponds to used car leasing.

The truck segment has demonstrated greater resilience to similar external shocks: the decline of sales was not so dramatic last year, while even an increase was recorded in comparison with 2019–2020. In the Agency’s opinion, this is explained by the smaller size of the segment in comparison, for example, with the lease of cars, which gives more opportunities for substituting foreign trucks by a feasible increase of the supply of domestic brands and brands of friendly jurisdictions, including production localization in Russia.

ACRA believes that in 2023, the truck leasing segment will manage to record moderate growth. In particular, the Agency has no doubt about the capabilities of Chinese manufacturers and KAMAZ PJSC to cover lessees’ needs for trucks. Demand is likely to grow, which, among other things, will be associated with an increase in trade turnover with friendly countries.

Figure 9. Sales of new trucks in Russia, units

Source: analytical agency AVTOSTAT with reference to JSC PPC’s data.

A growth scenario in the light vehicle and freight transport leasing segment over the next 12–18 months may be accompanied by enhanced credit risks. Small and medium-sized businesses, who are the main customers of leasing companies in this segment, have historically been sensitive to business downturns. Therefore, as mentioned above, ACRA does not exclude a deferred negative impact of adverse changes in the operating environment on the quality of leasing portfolios.

specialty and construction vehicle and equipment LEASING

Leasing companies focusing on specialty and construction vehicles and equipment experienced relatively fewer shocks in 2022. The majority of respondents from this segment returned to moderate growth in Q4 2022. This was due to the fact that, first, manufacturers of leased assets in this segment were less related to unfriendly jurisdictions and/or it was relatively easier to replace their products with similar Russian products or products from friendly countries. Second, import substitution efforts and the growth of the defense industry drove the leasing of industrial equipment, while expanded construction activities, including roads and infrastructure, fueled demand for appropriate equipment.

In ACRA’s opinion, the same factors may support the consistent growth of leasing of specialty and construction vehicles and equipment in the next 12–18 months, although the emphasis on small and medium-sized businesses does not completely exclude the deferred manifestation of credit losses.