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M&A - Back from the dead?

Just a few months ago at the start of the current recession, there was much talk, anticipation and excitement on the ‘buy’ side about the prospect of numerous portfolios coming on to the market at hugely discounted prices. It was expected that some lessors would have to sell their crown jewels just to stay afloat while a lack of liquidity would cause others to head for the emergency exit and sell what they could for whatever sum could be agreed.  So many theories and strategies were prepared by specialist M&A firms we almost ran out of code words !

On the ‘sell ‘side, those wanting to retire and sell the business, balance their sector exposure, move off some unexpected problems, faced a different set of challenges.  How do I part with my prize – or not so prized - assets? For many lessors, years or even decades of growth, have meant little practice in selling.   My (usually unappreciated) words of comfort/support to lessors preparing for sale has been ‘Due Diligence is good for the soul. It will tell you more about your business than you could possibly believe’.  That saying was never disproved but did lead to some alternative strategies about how to react to whatever problem or opportunity had been identified.  

Well, what happened to all of the M&A activity?  Of all the talk  - as usual – turned out to be mostly that – just talk.   Certainly, portfolios were for sale – some of them were even quite good, some were OK – just, but most were far from that and were perhaps an attempt to off load portfolios of dubious quality that wouldn’t be discovered in all the excitement of the expected ‘gold rush’.   Such vendors were doubly disappointed – firstly because the leasing community is usually pretty smart and even when at fever pitch, some pretty wise heads remain cool and still ask awkward questions.  Also, the pricing levels were usually unrealistic.  As a general rule,  anything at more than a 15-20% discount to NBV needed some serious probing.  There were – and perhaps still are – some serious discounts for some books but obvious questions on the topic of ‘who, what and why’ usually produce an answer along the lines of anything that cheap will cost you dear in the short to medium term!

Also, the market for buyers was pretty tough. The almost complete lack of liquidity in the market meant that even if portfolios did survive any decent DD analysis, there were very few sources of debt available to support any purchase irrespective of its price or strategic value.  I don’t believe that anyone really imagined the seriousness of the coming situation in the heady days of September/October 2008 when we spoke about trimming portfolios, attaining a better sector exposure profile  - and taking advantage of the downturn to make your operations as fit as possible. 

Certainly, there is now more money available for the right project. Although some larger consultancies have withdrawn from asset finance M&A, Invigors are engaged on a number of programmes at present with real chances of success.  BUT they have been a long time in the making and have been a combination of a long hard slog, patience, painstaking attention to detail and we have certainly not found any easy answers to some of the issues being faced. 

Just a few specific questions to ask about any portfolio are usually enough to send shivers or a tingle up the spine of the acquirer:-

• Is it really for sale – why; do I know/trust the vendor?
• Do I need it - can I buy it?
• Do I have the capability to do the ‘right’ deal?
• What will I do with it – can I integrate it or do I need duplicate systems – avoid at all costs !
• What is the net return after all costs – is growth by acquisition the only answer?
• .......and finally, always, ALWAYS trust your first instincts.

This latter point, in the midst of these most uncertain of times, is where market experience really pays off.  Anyone can be an advisor, but only a few can listen to and understand what you feel as well as what you say.  And today, tomorrow and for the foreseeable future that is one of the most important DD skills to practice.  No one can shrink to greatness but to take advantage of the current situation demands a deep knowledge of the market, attention to detail, good connections – and some luck if it is to all go as well as expected.

If you would like to discuss this subject further, Invigors' M&A team is very much open for business - contact Chris Boobyer on +44 (0)845 003 1000 or e-mail chris.boobyer@invigors.com

Authored by Chris Boobyer

Budget Review April 2009

In his Budget statement this year the Chancellor presented a relatively upbeat projection for moving out of recession towards the end of this year. This involves a significant cost to the Government’s finances with massive levels of borrowings in each of the next few years. Unfortunately most other forecasters take a much more pessimistic view and the general expectation is that the Chancellor will yet again be revising his forecasts down and further tax rises are expected to be required after the 2010 election.

Specific tax and related measures affecting the leasing industry are:

• A temporary first year capital allowance of 40% for expenditure on plant and machinery incurred in the 12 months from April 2009. However, this does not apply to expenditure on assets for leasing, to cars or to assets that only qualify for WDA at 10%. Various organisations, including the FLA, had been promoting an increase in capital allowances as a route to stimulating investment. The exclusion of leased assets from this increased allowance, especially when linked with the enhanced tax loss carry back arrangements, will mean that it will be relatively more attractive for the user rather than the lessor to be eligible to claim capital allowances on eligible assets. This will favour HP, loans and long funding leases against leases where the lessor retains the entitlement to capital allowances.
• Confirmation that the new capital allowance and lease rental restriction scheme for cars applies from 1 April, with WDA at 20% for cars emitting 160g/km of CO2 or less and 10% for higher emissions. Alongside this, there are changes to the income tax benefit in kind rules, including the CO2 bandings being reduced by 5g/km from April 2011.
• Relaxation and a temporary deferral of the “worldwide debt cap” restriction, although the subsequent Finance Bill still seems to leave concerns for wholly UK groups involved in operating leasing.
• Various relaxations are being made to the sale of lessors legislation (FA 2006 Sch10) in areas identified in the Summer 2008 consultation where the existing provisions imposed an unreasonable liability and there is also an extension to 5 years in the period over which the expense can be relieved.
• There are changes to the sale and leaseback rules, to remove some avoidance opportunities. In addition changes are being made to the provisions covering disposals of income streams without a disposal of the underlying asset.
• A car scrappage allowance of £2,000 has been introduced as a reduction in the price of a new car when one over 10 years old (and owned for at least 12 months) is traded in. The cost will be shared between the Government and participating car manufacturers.
• The Finance Bill includes clauses to implement the revised EU VAT “place of supply” rules for services from 1 January 2010, impacting on cross border leasing.

To discuss the implications of the 2009 Budget further contact George Tonks on +44 (0)845 003 1000 or e-mail george.tonks@invigors.com.

Authored by George Tonks

Vendor Finance - Relationships under strain

Invigors recently conducted some pan European research on the impact of the credit crunch on the relationship between vendors and their funding partners.  Predictably the current business climate is tough. Over 70% of vendors surveyed had experienced a decrease in sales over the last 12 months and only 9% expected there to be any improvement over the coming year.  That said, many were aware of increasing pending demand which would be released once the economic climate showed signs of improvement.

Over 90% of vendors had witnessed a decrease in the availability of funding during the past 12 months and in the ‘flight to quality’ which is mainly towards the public sector, the market is becoming very overcrowded and subject to price competition.  Funder service levels to vendors have in many cases showed a decline for usually two reasons; either the funder has downsized and is now reliant on less experienced staff or is so overwhelmed by demand that they have been unable to cope.

55% of vendors said lower acceptance rates had a direct impact on their sales performance.  Sectors worst affected appeared to be markets such as CEE and also the dealer channel – some vendors felt that many of the latter won’t survive. Vendors commented that sales targets had been missed as a consequence of funders’ withdrawal from some sectors with flow systems being particularly impacted where support was withdrawn.

The current situation has led over 40% of vendors interviewed to actively consider establishing their own captive operation. Many feel exposed because they had invested heavily in either solus or duo funder relationships which now threaten their survival.  For this reason many vendors do not feel in control of their own business and are considering a captive, or variant thereof, as a possible answer.

Finally, the quality of communication between funders and vendors had changed - not always for the better. Some funders had worked hard at advising, discussing and agreeing future actions affecting the vendor's business whereas others had simply advised changes - often with minimal notice. These latter actions threatened and in some cased destroyed business relationships often built up over many years

To learn more about our research into the changing Vendor Finance relationships contact Mike Roberts on +44 (0)845 003 1000 or e-mail mike.roberts@invigors.com.

New tax regime for cars

Final proposals for the new capital allowance and rental regime for cars are included within the Finance Bill, published on 30 April. The new provisions are confirmed as taking effect from April this year, but generally do not apply to cars acquired or to leases entered into before that date.

Under the new capital allowance rules, cars with CO2 emissions of over 160g/km will only qualify for 10% writing down allowances. This replaces the current system where allowances have been restricted to £3,000 pa per car, which historically has affected cars costing over £12,000 (although the April 2008 changes have affected that value). The new rules will also bring these 10% cars into a capital allowance pool, so that there will no longer be a balancing allowance on disposal.

The restricted tax deduction for car leasing rentals is also being changed for leases entered into from April 2009. A straight 15% disallowance for cars with CO2 emissions of over 160g/km will replace the current formula based on the car’s cost and £12,000. In addition for new leases this restriction will apply no more than once in any lease chain.

These changes will affect any company that owns or leases cars. For lessors, pricing and the relative attractiveness of different financing products will need to be addressed, which may lead to changes in product offerings. There will also be matters to deal with on the transition into the new regime. In addition, the deferred tax effect and its impact on returns will need to be considered.

To discuss these changes and the impact on your business contact George Tonks on +44 (0)845 003 1000 or e-mail george.tonks@invigors.com.

Authored by George Tonks

IASB/ FASB proposals to put all leases on balance sheet

In late March the IASB and FASB finally issued their joint discussion paper on leases, aimed at removing the current “off-balance sheet” treatment of operating leases for lessees. This is the first formal step towards a new accounting standard, to be in place by mid 2011. There are some areas where the two Boards differ in their views on the detail and these will need to be resolved before a common standard can be issued. The paper does not address lessor accounting, which will be considered in the future.

Under the current accounting standards (IAS17 and FAS13, as well as SSAP21), leases are divided between finance (or capital) and operating leases, with no asset or liability appearing on the lessee’s balance sheet for an operating lease. These new proposals will abolish that distinction and require lessees to recognise an asset and a liability on the balance sheet for any lease. The impact for lessees will be increased gearing disclosed on the balance sheet and the need to undertake potentially complex calculations. Consequential impacts will be on the availability of financial facilities and banking covenants.

A study undertaken by the University of Stirling around 10 years ago showed overall gearing as a result of capitalising all leases for their sample of 200 companies increasing by a factor of over 200%, whilst for some individual companies the effects would be even more dramatic. The principal impact comes from property leases, although there can be significant effects for other major assets currently financed on operating leases.

The proposals are that at the start of any lease the lessee should include on its balance sheet an asset and a liability equal to the present value of the minimum lease payments over the lease term, with the lease term being assessed on a “most likely” basis. The asset and the liability would then reduce over the lease term, using an “amortised cost” basis. The discussion paper, which runs to over 100 pages sets out detailed arguments and proposals around lessee accounting, although no clear conclusion in reached on a number of areas of detail.

The overall stance of the European equipment leasing industry is to not disagree with the principles behind the proposals, but to seek to minimise the impact through exclusion of leases that are not material or core to the lessee’s business.

For more information contact George Tonks on +44 (0)845 003 1000 or e-mail george.tonks@invigors.com

Authored by George Tonks

Taking Advantage of the Economic Downturn – 6 key insights

In October we ran the first in a series of Asset Finance Executive Briefings, featuring a series of high profile guest speakers. As you would expect, the seminar generated lively engagement and key insights to help asset finance executives shape their future business strategies. 6 of these insights were:-

1. The good news is that although investment levels are down, the attraction to customers of some fundamental benefits of asset finance (extra line of credit, liquidity and cashflow protection, transfer of disposition risk) has never been stronger. Funding margins can be attractive even for strong credits, and a number of traditional non-finance customers are now switching. New business is available for sales teams that are suitably trained, focused and motivated.
2. Competitor weaknesses will appear rapidly. There will be opportunities to target their best customers and staff but this will require the combination of articulate market intelligence processes and the ability to shift sales focus and marketing activity at speed. It’s no good having a direct mail and telesales campaign landing 3 months later - the opportunity will be long gone!
3. Bad debt has grown rapidly, and notably within the SME and broker sectors. Liquidity and capital shortages are likely to drive a) higher margin expectations from these areas b) tighter scrutiny of the profitability of broker accounts, including funder withdrawals from some or all the market c) lower broker commissions d) broker consolidation.
4. In some sectors, bad debts have gone from all-time lows to all-time highs within a 12 month period. Bad debts over the next 12 months will be driven by lending decisions made during a previously benign period of economic growth. Many credit and collections staff, at least up to middle management level, will have no experience of operating in current conditions and need up-skilling fast. It’s likely processes and procedures will need to change.
5. Finance companies will be pressured into re-gearing, typically from 9:1 to 6-7:1. As ROE requirements won’t change or may even increase, there is likely to be a) a drive towards increased operating efficiencies, including through increased scale, b) market withdrawal from sub-scale players, or those with aggressive profitability targets c) M&A activity to drive scale and consolidation.
6. M&A deals (large and small) are available for those with funding capacity. Deals are more likely to be done bilaterally than by public auction, and at considerable speed. In this environment you need at least a pre-researched, target list of companies you’d like to acquire to reduce the risk of a rushing a bad decision. And be bold in your target choices - previously unbuyable businesses may now be within your grasp.

This drives two key insights of my own:-

• Invigors exists to help finance providers with exactly these sorts of issues – if you don’t have the skills or capacity to move as fast as you need to in the current market, please call us on +44 (0)845 003 1000 or e-mail peter.hunt@invigors.com (even just to bounce around some ideas).
• The next Asset Finance Executive Briefing is on 20^th November and will focus on ways of increasing profitability for finance providers, an essential requirement for many businesses. For more information and to register please call +44 (0)845 003 1000, at our website, or by downloading the brochure here.

Key questions facing Captives and Vendors

While the credit crunch has been breaking around us the initial impacts on Captive and Vendor Finance Companies has generally been indirect in nature, such as a rising delinquencies. Now as we head down into a recession there are a number of key questions, challenges and actions that Captives and Vendor Finance companies should be addressing. It is a good time for leasing companies to review their positioning and assess how well they can survive the turbulence ahead.

Some of the key challenges and actions are:-

Portfolio Credit risk profile. In the present environment the leasing companies will need to understand the latest credit risk profile of their existing portfolio. As various industrial segments consolidate during this recession, and other customers credit ratings change, the Leasing Company needs to be sure of the true risk they are taking.

Collections. Now is the right time to invest in the collections process to reduce aged tails. It would make sense to promote the direct debit penetration on new business to improve the process. Equally if the recession is as bad as some fear then you will need to check that the legal collections process has the capacity to handle increased activity.

Partners. Having a slick process to pay partners for business in a short period of time will ease their liquidity concerns and gain you more business. However you need to have a clear view of any exposure you have to them and their financial stability to weather the storm. What contingency plans do you have to cover the marketplace should one fail?

Interest Rates. Despite headline rate reductions the true cost of new borrowings is likely to rise as the financial institutions seek to increase their provision levels and recoup their profitability. This will interact with pricing issues and could result in squeezed margins.

Residuals. To the extent there are residual positions these need to be reviewed to validate if they are still achievable. Particularly if new products are being discounted and there is a glut of off lease equipment to be disposed of, it will make the realisation of residuals more challenging.

Expenses. With a squeeze on margins is the expense base appropriate for the current environment and activity? If cuts are being made then you need to ensure that core business activities are protected.

These are some of the key questions and actions. It is always beneficial to make an objective and honest assessment of your business so you can identify both the strengths and weaknesses and take appropriate action on a timely basis.

• New Customers. With the increasing focus on capital utilisation although general activity may be down there may be an increase in leasing. Given that the marketplace is going to get tough you may end up with less competition as some businesses withdraw. Keeping in touch with the market will leave you well positioned to take up any opportunities as they arise.
• New Resources. Building on this last point, as businesses withdraw there may be good quality resources available to help position yourself for the future.
• New Partners. Equally if competitors withdraw from the market then the opportunity arises to secure new partners and outlets if you are nimble and know what you are looking for.
• New Portfolios. The inevitable consequence of businesses withdrawing from the marketplace is that portfolios may be available for purchase. If you have the funding lines available and the right team and advice to manage the due diligence process and negotiate the deal then you could emerge from this recession bigger and better!

Of course other competitors may move in to your segment or a vendor may decide to create a captive, however we are probably all used to those sorts of challenges.

If you would like to discuss a structured ‘fitness assessment’ or any other issues raised by this article please contact Brian Thompson on +44(0)845 003 1000 or email brian.thompson@invigors.com

Authored by Brian Thompson

The Credit Crunch and Capital/Gearing

Much has been said in recent weeks about banks raising additional capital as a consequence of the credit crunch. Whilst some of this is to replenish capital eroded through losses, the amounts being raised are typically much higher than the reported losses. In addition, banks have been reducing their lending and other exposures and so reducing their minimum regulatory capital requirements.

The overall effect of the measures taken is that capital ratios generally will be higher in future than they have been over recent years. This reduction in gearing will be felt by asset finance businesses as well, with a direct impact on companies within banking groups and a reduction in the appetite of banks to finance independent companies. For example, a company that has been used to operating with gearing of 9:1 may find that it now has to operate at 6:1. Reduced gearing will then affect profitability in terms of both reported profits and return on equity or economic value added; even reducing these below hurdle rates.

As a consequence all companies in the financial services sector should be reconsidering operating models, margins and expense structures to ensure these are appropriate to delivering financial and other targets. Some business sectors may be uneconomic on current bases, with major restructuring or divestment required. Others may find that third party divestments allow the opportunity to create a financially viable scale operation.

Invigors has the expertise and experience to work with you to reassess your business and to structure it for the new economic climate. To find out more contact George Tonks on +44 (0)845 003 1000 or e-mail george.tonks@invigors.com

Now is the time to demonstrate leadership

The top jobs in our industry are tough – we need to demonstrate we are on top of the game and able to think and lead our teams towards a competitive future. I am sure that by now everyone is fed up with the saying "We are really lucky to be witnessing such dramatic events ……etc." Undoubtedly,this is history in the making but whilst the global crisis may be out of our hands local solutions are definitely within reach.

Is it difficult to do good business? Yes. Are we see any shortage of demand? No. Are funders making money? Well, if they are not making strong margins now then there really is a problem - but the bottom line may be a different story!

Never before have banks or leasing operations been forced to take such a good look at themselves. Some are horrified at what they see – and some are even more horrified at what they don’t know. For example, current cost income ratios: what should they be – what’s the plan? Which are the most efficient costs – internal/external sales, marketing, customer support, Collections?

These ‘live wire’ costs play havoc with your bottom line and ratios – but do you know all there is to know about them? They should now be your specialist subject.

To start thinking about getting the business into better shape here are some practical actions discussed at the Invigors Executive Briefing last month:

1. Maximise the return from existing customers – use intelligent applications with pre-underwritten credit lines and offers of help to customers not sure of where to go for funding. This is as much about recalibration of risk as marketing. Focus on what is best for today – and tomorrow; and then look again the day after.
2. Don’t give customers surprises – other than good ones, e.g. "We have been thinking about you – many of our customers are worried about their finance contracts – you shouldn’t be. Here are your current commitments – this is what else we can do for you."
3. Critically review your business sources – which ones are too hot to handle / not profitable? Now is the time to jettison your unwanted baggage.
4. This is no time for order takers – a practical application of knowledge and experience is now very much required. Undertake a skills audit; focus on three key things to improve your finance sales. Make sure everyone is up to speed and competent.
5. Who are the top performing sales people and why? Don’t just measure volume; customer quality is critical; what are their territories and customer concentration; is their success built on solid foundations or luck?
6. Refresh the gene pool – there is available talent in the market through no fault of their own. Grab them but make sure you know what you are getting and how you can develop them further.
7. How many steps from customer to CEO? Is it two, three, four…. Anything more than three needs more thought in today’s market. How fast can you actually react to changes in demand; what are your customers trying to tell you – are you to far away to hear them?
8. How much of the back office is automated – are you satisfied with the cost savings – how do you know? Customer access to systems i.e. self serve, is the most efficient way of reducing resource costs providing the customer experience is excellent. When did you last take a customer journey – and when did you do the last competitor comparison?
9. Communicate, communicate, communicate – with everyone! Customers, staff – and their families, shareholders – your local business community. There are many people in our companies and in our communities who don’t know which way to go.

We have to restructure our businesses – now, today - when it is exactly the right time to do it, not tomorrow when it may be too late. To discuss how this approach could be applied to your business contact Chris Boobyer on +44 (0)845 003 1000 or e-mail chris.boobyer@invigors.com

Authored by Chris Boobyer

Smaller leasing companies – a question of survival?

After the seismic shifts in the banking world over the last few weeks the aftershocks continue to be felt across the leasing industry, not least amongst the smaller leasing companies, many of whom rely on continued market liquidity in order to be able to operate.

For many, the year started well enough with many achieving strong volumes in the first half of 2008. But the short-term outlook is bleak, either because experiments in non-core areas like venture leasing or property have left them with significant write-offs or because the supply of funding from lenders and block discounters of receivables has been capped or frozen.

There is certainly no shortage of transactions coming from brokers, some of whom are struggling to place decent “mid-range” transactions at high margins, which only months ago would have been snapped up by smaller lessors. One small lessor commented to me that he sees brokers working twice as hard to generate the same income – some would view this as no bad thing and a long-awaited shift of power away from the brokers to the lessors. But when brokers CVs start appearing in the market, it’s likely that customers and lessors will be suffering just as much.

Indeed most of the quoted smaller lessors have seen their share prices drop significantly in the last 12 months. The outlook for 2009 is not expected to improve as SME failures drive increased write-offs for those who have pushed the credit boundaries.

Selling either the business or the portfolio at anything close to book value is viewed as almost impossible at the moment, so what can smaller companies do to survive? The answer lies in looking at the current environment as an opportunity and applying a series of straightforward but effective tests to every part of the business – from basic overheads to future strategy – to determine the optimal outcome for both survival and future growth.

Invigors has unrivalled experience and a unique understanding of the way in which smaller leasing companies operate. Consequently we can deliver a fast, cost-effective review and action plan to enable the best possible advantage to be taken from today’s difficult circumstances. To learn more contact Richard Guilbert on +44 (0)845 003 1000 or e-mail richard.guilbert@invigors.com.