Too Much Money Too Few Assets
But this year 30th September was expected to be different for two reasons. First, it was the first year when MAT (the minimum alternative tax) was introduced and as a result, the need for tax shelter, to the extent the tax is payable stands reduced. Thus, as conventional logic goes, so should the demand from lessors. Secondly, many players in the market felt that the reduction of corporate tax by three per cent would adversely affect the attractiveness of leasing also. So many people ventured that the lease rates, which normally decline as September 30th approaches, would rule firm this year.
To the contrary and belying all expectations, the rates have fallen tremendously. Says Rajiv Saran, vice president, Kotak Mahindra, There are too many players chasing too few assets. And thus initial indications suggest that the rates would fall considerably this year. According to a lease broker, some die-hard players are quoting as low as 5-6 per cent post-tax internal rate of return for 100 per cent depreciation assets; assets which normally cost around 12-14 per cent to lease.
Too few assets
What is the reason for this crash? And why have rates which were supposed to stay firm portray signs of falling even further this year? The reason goes back to the budget when the finance minister ruled that all future sale-and-lease-back deals from October first this year would have to be done at the written down value of these assets. In other words, no revaluation of old assets would be allowed for the purposes of a lease-and-sale-back after September 30th. This ruling has meant that corporates have been busy revaluing their written down assets and leasing it to some other corporate so that the latter can again avail depreciation which has already been consumed.
Sensing this as the last opportunity for windfall gains, many state electricity boards (SEBs) like those in Rajasthan, Punjab, Madhya Pradesh and Haryana have been busy revaluating all their possible old assets and offering them on a sale and lease back basis to many corporates.
On the other side, the corporates are looking eagerly for tax-shelters. Many consider this to be the ideal time to procure a depreciation cover because they feel that with the embargo on sale and lease backs starting, it would become difficult to procure 100 per cent depreciation items. This is because in the past two years most of the 100 per cent depreciation assets have come from state electricity boards. All this has resulted in a major scramble for assets. According to a north-based broker, companies like Nagarjuna Fertiliser which needs Rs 150 crore of depreciation shelter besides others like Bajaj Auto and some Tata companies have pushed the rates down.
Why are the assets available so less? Says Saran, For the last one year there has been virtually no capital formulation in our country. If at all, new plants are being set up, it is by big companies. And they themselves need the depreciation shield. In effect, the only companies willing to sell assets and lease them back are loss-making companies like SEBs which don't need tax shelters. Apart from SEBs, most of the other high depreciation items tend to come from captive power plants and given the liquidity crunch the commissioning of many such projects have been delayed till the second half of the 1997. Many corporate groups are also themselves revaluing the assets of their group companies and are selling the assets to each other.
SEBs to the fore
Even the financial fragility of the SEBs have not stopped companies from leasing assets back to them. SEBs have been able to raise finance in this manner by providing lessors the comfort of an escrow account. This gives the lessor the first right on receivables of the lessee. Says a senior IFCI official:, The initial experience with SEBs has been encouraging as none of them have defaulted as yet. Emboldened by low-risk, more and more corporates are ready to take exposure on them and thus the rates are crashing.
Though escrow account provides full safety to the lessor but the transfer of all payments to the account cause loss of interest for few days to SEBs. This happens as there is some time lag between the payments coming in over a period of time and the date of payment to the lessor. As the money remains idle during this period in SEB's current account, it loses interest on the amount. Thus a few SEBs are trying out new options such as letter of credit. Here also, there are practical difficulties as L/Cs are valid only for one year and need to be renewed every year which does not suit a lessor.
In the absence of regular receivables and thus an escrow account route, other loss-making companies normally fail to tap lease finance. Says a broker, Even if I am lending Rs one, I need to have some security. Normally in such cases we insist for bank guarantees but this reduces the economic advantage of lease finance. Hence such deals normally don't sail through.
It is not that every financier is quoting ridiculously low rates. Generally, the rates have fallen by 1-2 per cent this year as compared to the rates of the last year. Hire-purchase lending at 26-27 per cent nets a lender 16-17 per cent post tax returns. The post-tax return in a leasing transaction are lower (around 12-14 per cent) because the financier is able to save administrative expenses and credit risk is less as well. Keeping this in view trade-off, most lenders are ready to compromise by a per cent or two at the most.
But brokers say few corporate players have spoiled the market by quoting unimaginably low rates. While there is not much difference in the rates for 25 per cent items, there is significant difference in the rates for 40 per cent depreciation and 100 per cent depreciation items being offered by commercial lessors, those who do it as a line of business and corporate lessors, those just looking for tax shelter. Says the IFCI official, It is believed that a few corporates have struck deals with an SEB at even negative internal rate of return. Their desperation can be explained by the fact that they might have some capital expansion plans lined up two years down the line and if they are able to defer tax liability in the interim period they might not be required to pay tax for a long time.
Secondly, these low rates could be due to corporates' belief that they still would not pay any tax despite MAT as either the union government would give some relaxation or by exploiting some loophole in the relevant section.
Barring these few off-the-mark quotes of five and six per cent, the rates for 100 per cent depreciable assets tend to give returns in the region of 8-10 per cent. The rates could further vary by two per cent depending upon the quality of asset, its age, borrower's track record, security provided, etc. Besides above mentioned factors in such cases, the rates vary depending on the deposit structure of the deal.
This means if the lease structure is such that a major portion of the cost of asset is paid back to the lessor as deposit and thus the net outflow from the lessor is far less than the cost of asset but the depreciation is higher than the amount actually financed. In such a case the cost to the lessee is far less than the rates on ordinary deals.
The high-deposit structure deals are viewed with suspicion by the top players in the industry and they don't participate in such deals. Says a broker, Generally the north based companies are more audacious than the west based companies so they are ready to take high risk by accepting such structured deals if the returns available are higher.
The rates also depend upon the players involved. Institutional players like the Industrial Finance Corporation of India, the Industrial Development Bank of India, and the State Bank of India are very conservative about such deals and the post-tax internal rate of return they look for in their case is not less than 20 per cent. The institutions accept only new assets and sale and lease back transactions are religiously spurned. In stark contrast, ICICI is bullish on leasing and has picked up many assets from SEBs at competitive rates.
This year, brokers say, financiers have become far more prudent and are directly approaching SEBs thus eliminating the intermediaries' role in process. All activity will quieten down on the lease front now that October is here as the players start their elusive hunt for leaseable assets for the March rush.