Interrelation Between Products, Interest RATES & Terms Of Finance
Background of ULC
United Leasing Company (ULC) Limited is the second oldest leasing company in Bangladesh. It started its operation back in 1989 as a joint venture with reputed foreign and local sponsors.
Incorporated as a public limited company under the Companies Act 1913, ULC was also granted license under the Financial Institutions Act, 1993. The shares of the company are quoted on the Dhaka Stock Exchange since 1994.
The Company’s customers include most of the top corporate groups in the country including some of the multinationals. However, the Company’s major and most profitable business segments are leases to the small and medium enterprises.
The Company enjoys a sound reputation for excellent customer service. As an associate of a long established foreign company, it is recognized as a reliable financial partner among the business community. Its access to multilateral institutions like ADB and The World Bank permits it to arrange funds at competitive rates and get their assistance in areas such as staff training and information technology.
The main objectives of the company are to assist the development of productive private sector industries particularly in their balancing and modernizing programs. The company mainly extends lease financing for machinery, equipment to the industries & vehicles for commercial purpose. In addition it also provides project finance for expansion of business.
The primary activity of the company is to provide leases to different commercial organizations. It provides lease for all sorts of manufacturing equipment and for vehicles.
Capital, Sponsors and Share Structure
|Foreign||Lawrie Group Plc of the UK||20%|
|Local||United Insurance Company Ltd||9.69%|
|National Brokers Ltd||1.60%|
|Duncan Brothers (BD) Ltd.||1.00%|
|Octavious Steel & Company of Bangladesh Ltd.||0.71%|
Authorized Capital of ULC is Tk. 1000 million and issued, subscribed and paid up capital is Tk. 140 million. The sponsors and their current shareholding in the company are as follows:
Table 01: Type, Name and Share (%) of Sponsors.
Board of Directors
Its Board of Directors consisting of nine members who are the nominees of the Institutional Shareholders supervises the Company’s management. The Board appoints the Chairman from among the Directors.
|Chairman||Mr. Kafiluddin Mahmood|
|Directors||Mr. P. A. Leggatt. MBE||Lawrie Group Plc of the U.K.|
|Mr. A.S.M.O. Subhan||Lawrie Group Plc of the U.K.|
|Mr. O.R.A.R. Nizam||National Brokers Limited|
|Mr. A. Rouf||Amo Tea Co. Ltd|
|Mr. S. Aziz Ahmad||Surma Valley Tea Co. Ltd|
|Mr. M. A. Wahed||The Chandpore Tea Co. Ltd|
|Mr. M. Moyeedul Islam||United Insurance Company Ltd|
|Mr. M. M. Alam (MD)||The Allynugger Tea Co. Ltd|
|Comp. Sec.||M. Ataul Hoque|
Table 02: Board of Directors. (ULC web site)
The Company policy is to attract, motivate and retain top quality financial service professionals. At present ULC’s staff strength is 60. There are three branches in Chittagong, Gazipur and Jessore. The Managing Director with the power and authority vested in him by the Board of Directors manages the overall operation of the Company. He has a MBA and CA degree with more than 30 years of experience in Canada and Bangladesh with MNCs.
An Executive Committee of the Board of Directors comprising of three Directors nominated by the Board and the Managing Director approve lease proposals, periodical accounts and other administrative matters.
The Board of Directors comprising the Managing Director and three other directors nominated by the Board appoints the Executive Committee. The Committee is authorized to approve all financing proposals without any limit subject to the exposure limit specified in the policy statement. It also reviews periodical accounts and other administrative matters.
The Board has given authority to the Managing Director for approval of lease proposals up to an amount of Taka 1.0 million in the case of new lessees and up to Taka 2.5 million in case of existing lessees.
Here, organizational structure of United Leasing Company Limited has been illustrated.
Illustration 02: Organizational Structure of ULC.
Name and designation of management personnel are given below:
|Syed Ehsan Quadir||Managing Director|
|M. A. Azim||Deputy Managing Director|
|M. Ataul Hoque||General Manager|
|Md. Shahabuddin||Deputy General Manager|
|Avijit Bhattacharjee||Head of Accounts|
|Mohiuddin Rasti Morshed||Head of Marketing|
|Shahidul Islam Majumder||Head of IT|
|Eva Rahman||Head of Operations and Human Resources|
|Ashfaqul Haq Chowdhury||Head of Marketing Services|
|Jamal Mahmud Choudhury||Head of Monitoring|
|Sabrina Mehnaz||Head of Treasury|
|Md. Russel Shahriar||Head of Credit|
Table 03: Management of ULC. (ULC web site)
Lease Portfolio and Sector wise Exposure
ULC provides lease finance to the following sectors:
- Apparels and accessories
- Other services
- Construction and engineering
- Financial intermediations
- Food and Beverage
- Paper and printing
- Agro based industries
- Other manufacturing industries
- IT firms
Now, Sector wise Exposure (2004) has been illustrated below:
Illustration 03: Sector wise Exposure (2004) of ULC.
(Annual Report- 2004)
Performance of ULC at a Glance
Here, United Leasing Company’s performance from year 2000 to 2004 has been illustrated.
Illustration 04: Net Profit. (Appendix-01)
Illustration 05: Operating Revenue (restated). (Appendix-02)
Illustration 06: Financial Assets (restated). (Appendix-03)
Illustration 07: Earning Per Share. (Appendix-04)
Illustration 08: Contracts. (Appendix-05)
(Annual Report- 2004)
SWOT Analyses of ULC
Ø It was among the first in this industry and therefore enjoys first mover advantages.
Ø At the moment they are the market leader as they are paying 32% Dividend and giving 2:1 Bonus Share to its shareholders this year, which is more than any other leasing company in the country.
Ø ULC has very high skilled, energetic, hard working and motivated human resources.
Ø ULC believes and practices participative management.
Ø ULC is engaged in product diversification, this year they have introduced a new product syndicate financing and they are also planning to introduce house loan in near future.
Ø ULC has a very strong client base among the leasing companies; most of which are the giant local and multinational organization such as, British American Tobacco Bangladesh, HSBC, Square, Navana, Transcom etc.
Ø ULC do not comply undue political influence.
Ø With its diversified business, ULC is better equipped to compete in an ever changing and challenging business environment.
Ø One thing might be their lack of commitment to one big huge investment project since they do not want to put all their eggs in one basket.
Ø Another major weakness of ULC is it has a very low pay structure for entry-level employees, which can become a de-motivating factor.
Ø With growth in our corporate sector, the demand for lease financing is also growing and consequently, the lease financing industry.
Ø Among visible non-functioning of development financial institutions, ailing capital market and lack of interest of commercial banks in term financing, the leasing industry remains the only vibrant financial intermediaries for the medium term financing with less than 5 % non-performing loans.
Ø By introducing new products such as house loan ULC can expand its market.
Ø Continuously increasing deflation rate result into less disbursement of fund.
Ø There is a clear trend of increasing competition in the lease market with the entry of more leasing companies and leasing by commercial banks.
Ø Employees of ULC are not satisfied with their low salary structure and other benefits as a result they can switch to other competing financial organization.
Among the NBFIs doing business in Bangladesh United Leasing Compnay is the second largest in terms of Credit portfolio which totals around Tk. Six billion at present. But the list of financial services ULC is offering is shorter compared to other NBFIs.
Credit offers by ULC
Among many products listed in its operational software, only the following six are traded in practice.
- Lease finance:
i. Sale & Leaseback
a. Lease Local
b. Lease Foreign
ii. Hire Purchase
- Working capital finance:
i. Short Term Loan
iii. Revolving Loan
- Long Term Finance:
i. Term Loan
Unlike most of the large NBFIs ULC does not have a merchant banking license, and cannot perform underwriting, issue management & portfolio management services. The deposit schemes offered do not have much variety.
Nonetheless, over the last 17 years of operation it has emerged to be a major player in non-bank lending market
A detailed analysis of the products/ schemes offered by ULC is appended at the end of the report (Appendix 2)
Credit Approval Process of ULC
Dealing Officer (i.e. the ME) prepares the appraisal, along with the help of the AGM or the Manager, whoever is responsible for bringing the client. Then it is passed onto the GM who reviews the appraisal. The next person in the approval process is the MD himself. He may either approve of it right away or recommend it to the Executive Committee. Even if the MD gives his approval for a particular appraisal, it is reported to the Executive Committee.
Illustration 10: Credit Approval Process.
Leasing industry of Bangladesh is growing rapidly. The increasing demand of leasing is inviting more and more new entrants into the industry. Even banks have started leasing at a lower rate than the existing leasing firms. Moreover, with the liberalization of trade, domestic firms are going to face high competition from foreign firms. To survive the strong competitive wave the future is going to bring, firms should collaborate with each other to increase their market share and hence tap the whole domestic market.
The main focus of this internship paper was to study certain key features e.g. Implicit Rate, IRR and Terms of different products, offered by United Leasing Company Limited. The List includes Bill Discounting – Revolving, Hire Purchase – Foreign, Hire Purchase – Sale & Hire Back, Lease – Foreign, Lease – Local, Leasing-Sale & Lease Back, Short Term Finance and Term Loan.
The key statistics of portfolio were analyzed for interrelationship.
Apart from these key aggregate stats the composition of ULC’s outstanding portfolio on the basis of finance types and finance tenure was also studied.
A specific discrepancy of the portfolio -regarding choice of finance scheme to offer- was pointed out in the later part of analysis.
All the observations and findings were explained from both empirical knowledge base and database analysis.
ULC’s portfolio mainly comprises of two different types of product, namely Sale & Lease Back & Hire Purchase. Lease & Hire Purchase does not make any practical difference for the borrower. For a given amount of finance with same tenure and interest rate, the rent / installment from both will be identical, the entire cash flow will be the same and so will be the IRR. But Return on Equity originates from accounting and taxation practices. ROE varies across terms and asset type. In general it is such that –‘For shorter term return out of Hire Purchase is higher and in longer term return from Lease is higher’.
While studying the relationship between Interest Rate and Terms, it was observed that -Interest rates for longer term finance schemes are lower than shorter term products. E.g. rate for Bill Discounting and Short Term Finance is higher than Term Loan and Lease. But this observation had an exception. Compared to Hire Purchase Interest Rate for Lease is higher. Although Hire Purchase term is usually shorter than Lease. This phenomenon can be explained by a tenure matching of short term loans to short term funds which are expensive and about Hire Purchase a part of the tax benefit is passed on to borrower in terms of lower interest rate.
The study of interest rate in relation to finance amount gave evidence that for smaller credits interest rat is charged higher and for larger credit the rate is lower. This is partly because of stronger negotiation power of large borrowers and SMEs’ inaccessibility to finance on the other end. Indifference to slightly higher rents for smaller finance is also responsible.
ULC has a particular product bias toward Sale & lease back. This bias is justified by one observation where we would see that in most cases the lease term was appropriate for choosing S&LB in stead of Hire Purchase. Nonetheless, in many other cases Hire Purchase was ignored quite unjustifiably.
Scope & objectives of study:
- To find out the difference in return parameters i.e. Implicit Rate <href=”#_ftn1″ name=”_ftnref1″ title=””>(herein after referred as IR), IRR<href=”#_ftn2″ name=”_ftnref2″ title=””>, Spread<href=”#_ftn3″ name=”_ftnref3″ title=””>, NPV across different products/schemes.
- To find out the difference in Terms/tenure across different products/schemes.
- To find out the relationship between Return and Terms across different products/schemes.
- To find out the trend of Implicit Rates for the period January, 2000- April, 2006 and identify seasonality if present.
- To find out the interest rate sensitivity of clients to be depicted by a relation between Implicit Rate and Loan/Lease amount
The schemes listed in the following were included in the data range for analysis
1. BILL DISCOUNTING – REVOLVING
2. HIRE PURCHASE – FOREIGN
3. HIRE PURCHASE – SALE & HIRE BACK
4. LEASE – FOREIGN
5. LEASE – LOCAL
6. LEASING-SALE & LEASE BACK
7. SHORT TERM FINANCE
8. TERM LOAN
Variables & PARAMETERS:
The variables and aggregate statistics listed below, were taken into account for relation and regression analyses across the schemes listed above.
1. Count of Finance
2. Average of IR
3. Max of IR
4. Min of IR
5. Average of IRR
6. Max of IRR
7. Min of IRR
8. Average of Spread
9. Max of Spread
10. Min of Spread
11. Average of Term
12. Max of Term
13. Min of Term
Methodology & ANALYSIS:
- Charts and tables for Products and the given parameters like Average Implicit Rate, Avg. IRR, Avg. Term etc among different products are used to illustrate useful observations.
- Time series analysis for interest rates throughout the last 24 months.
- Multidimensional Correlation analysis among Term, Principal, IR, IRR, Spread is done to find out inter-relations between every two variables.
- Finance with structured payments was excluded from database for analysis. Unequal monthly/quarterly repayments are rare. The operational software VIEW 21 used by ULC has certain problems in reporting key figures like IRR, IR when the rents/repayments are broken down into cascaded unequal installments.
- Hypothesis testing was not done to prove relationships and observations due to lack of explanatory variable. Rather simple correlation analysis, rank and cross tabulations are used to support key observations.
- Costs and Tenure of sources of funds for ULC was relevant in certain analyses. But data regarding this was not available.
Sale & Leaseback – For an asset already bought and in use , the lessor/borrower sells the asset to ULC & ULC leases it back to the lessor , ownership & depreciation benefit is retained by ULC.
Sale & Hire Back – Although much less frequent than sale-leaseback, ULC still offers the product with no practical difference from sale-leaseback. In general the equity participation from the part of borrower in Hire Purchase is higher.
Hire Purchase –Local The asset is bought from local source
Hire Purchase – Foreign ULC opens LC or stands as guarantor to import the asset from a foreign source.
Working capital finance:
Factoring ULC goes through the borrowers ledger, selects some of the renowned companies to which the borrower supplies and approves the relevant a/c receivables for immediate discounting, the borrower needs to get the bill endorsed for payment in favor of ULC from its customers.
Revolving Loan ( a line of credit offered by ULC, disbursement may be made in several tranches, the total outstanding will never exceed the approved limit, terms and conditions are set each time before disbursement)
Long Term Finance:
The difference between lease and Hire Purchase
Lease & Hire Purchase does not make ant practical difference in the cash stream of a particular finance.
For a given amount of finance with same tenure and interest rate, the rent / installment from both will be identical, the entire cash flow will be the same and so will be the IRR.
But Return on Equity from these two differs mainly due to terms (also on the basis of asset type). This difference in ROE across loan tenure originates from accounting and taxation practices.
The accounting standard in use requires that for Lease ‘Rent’ is reported as revenue and ‘Depreciation’ on leased asset as expense. The resultant difference will be ‘Income’. On Income ULC will have to pay Tax. So how much income, essentially how much expense is shown in different years is important. The depreciation Schedule allows different percentage of depreciation (from Initial rate to Normal Rate) depending on the assets age.
The Depreciation Schedule is such that it allows unequal tax benefit in different years. Cash outflow for Tax varies accordingly.
In Hire Purchase only interest income is reported as income, not depreciation. So tax benefit and cash outflow relating to Tax is evenly distributed.
The integrated cash inflow –outflow from Finance and for tax is complicated and influences the complete return out of a Lease and return of a Hire Purchase. So it becomes a complex decision – when to offer which. A detailed table in this regard is appended in appendix 1.
But in general it is such that –‘For shorter term return out of Hire Purchase is higher and in longer term return from Lease is higher’.
Implacit Rate Across Products and TERMS (Bearing of Type and Terms on Interest Rate)
The average interest rate charged for Rents<href=”#_ftn4″ name=”_ftnref4″ title=””> varies maximum with a range of two percent across the common schemes. The following table depicts the observation while the table below gives figures.
|Average of IR|
|BILL DISCOUNTING – REVOLVING||16.38|
|HIRE PURCHASE – FOREIGN||14.65|
|HIRE PURCHASE – SALE & HIRE BACK||14.65|
|LEASE – FOREIGN||15.53|
|LEASE – LOCAL||15.18|
|LEASING-SALE & LEASE BACK||15.72|
|SHORT TERM FINANCE||15.61|
Findings & Explanations
- Interest rates for longer term finance schemes are lower than shorter term product. E.g. rate for Bill Discounting and Short Term Finance is higher than Term Loan and Lease.
- Compared to Hire Purchase Interest Rate for Lease is higher. Although Hire Purchase term is usually shorter than Lease.
The reasons for a higher interest rate in the short term are;:-
- Empirically it has been seen that short term finances are riskier than long term finances. The bad debt percentages for short term products are higher than long tenure finance. In fact, Bill Discounting is abolished (modified and then revived as Factoring) while Short Term Finance is for the time being postponed.
- Tenure Matching principal of assets and liabilities prescribes that since ULC pays higher interest rate for deposits and loans taken in the short run it should also charge a higher interest rate in the short run.
- Although Hire Purchase is provided for shorter terms, the product is different in certain aspects. Firstly, for taxation purposes the accounting for Hire Purchase is different than lease and because of a different structure in the financed asset depreciation schedule, Hire Purchase return i.e. ROE is higher in the short sun. (See Appendix 1). So part of this extra return advantage is passed on to the borrower in terms of lower interest rate.
- Although Short Term Finances are usually perceived as more risky, in case of Hire Purchase the risk is minimized by higher equity participation from the part of borrower. The financed asset’s ownership in Hire Purchase will be in ULC’s name, while the borrower might have paid as high as 20% of the asset’s purchase price.
Interest rate sensitivity of borrowers (Relationship between Interest Rate and Loan Size)
A common observation of ULC’s day-to-day loan/lease approvals will testify that the higher the finance amount the lower the interest rate. Although from risk perspective the opposite should have been true.
In the following there is a summery correlation analysis among Principal Amount, Implicit Rate and IRR.
From the correlation coefficient we can say that there is a not so strong negative relationship of IR and IRR with Principal.
The ranked tables below will give a clearer message
Highest 10 Finance Amount
|LEASING-SALE & LEASE BACK||110,000,000||12.00||14.03|
|LEASING-SALE & LEASE BACK||100,000,000||14.00||14.17|
|HIRE PURCHASE – SALE & HIRE BACK||100,000,000||14.00||14.00|
|LEASING-SALE & LEASE BACK||98,456,451||14.00||14.04|
|LEASING-SALE & LEASE BACK||76,000,000||14.50||15.03|
|LEASING-SALE & LEASE BACK||73,000,000||14.00||14.56|
|LEASE – FOREIGN||70,256,491||13.50||15.80|
|HIRE PURCHASE – SALE & HIRE BACK||70,000,000||14.00||14.00|
|LEASING-SALE & LEASE BACK||60,000,000||15.00||15.10|
|LEASING-SALE & LEASE BACK||55,000,000||12.75||14.15|
Lowest 10 finance amount
|LEASE – FOREIGN||55,315||18.96||20.96|
|LEASING-SALE & LEASE BACK||93,000||15.00||17.00|
|LEASING-SALE & LEASE BACK||100,000||18.00||20.44|
|BILL DISCOUNTING – REVOLVING||100,370||16.65||18.65|
|LEASING-SALE & LEASE BACK||100,500||16.00||17.23|
|LEASING-SALE & LEASE BACK||113,850||14.00||14.79|
|LEASING-SALE & LEASE BACK||115,000||17.50||19.50|
|LEASING-SALE & LEASE BACK||150,000||15.00||16.47|
|BILL DISCOUNTING – REVOLVING||155,520||16.67||18.67|
Finding & Explanation
- The tables above give evidence that the interest rate charged for higher finance amount averages lower than the interest rate charged for lower finance amount.
- The same also implies that borrowers with larger finance need are more sensitive to the interest rate.
The phenomena witnessed can be explained by the following observations,:-
- Borrowers / Client with need of larger finance amount are larger in size, whereas smaller size credit is in demand mainly from the part of SMEs. Because of better negotiation power and greater eligibility/ accessibility to finance, large organizations can win favorable terms. SMEs due to lack of accessibility have to give in to the terms offered by lending institution.
- In case of SMEs not the Implicit Rate, only the ‘Rent’ is disclosed. Often they even lack expertise to gauge the Interest Rate. Lack of accessibility, comparison and expertise often leave them without any idea about the Implicit Rate. Moreover, loan/lease advance are utilized to leverage the return out of small finances.
- A higher interest with lower finance amount does not increase the monthly/quarterly annuity significantly. The increase in the annuity may go unnoticed, or client might be indifferent to this ‘small monthly difference’.
Product Bias (Frequency Distribution of Products)
Among the products/finance schemes that are in the offer list of ULC Sale & Lease Back is much too common. Apart from different types of lease, Term Loan stands next, then Hire Purchase. This is illustrated in the following pie diagram and frequency distribution.
|BILL DISCOUNTING – REVOLVING||51|
|HIRE PURCHASE – FOREIGN||5|
|HIRE PURCHASE – SALE & HIRE BACK||52|
|LEASE – FOREIGN||148|
|LEASE – LOCAL||108|
|LEASING-SALE & LEASE BACK||1070|
|SHORT TERM FINANCE||21|
A reason for such bias in favor of Sale & Lease back and Lease as a whole is that most of the finances are for Four (4) year (freq. 517). At this length of the term return from Lease is higher than Hire Purchase. (see Appendix 1)
|Count of Term|
But evenly noticeable is that a good many number of finances were provided for three or less years. In these cases Hire Purchase could have been profitable. The following cross tabulation of Terms across types shows that contrary to the thumbs rule – ‘For shorter term Hire Purchase return is higher’, (see Appendix 1) Lease is still the majority in 1 to 3 years range.
|Term||HIRE PURCHASE – FOREIGN||HIRE PURCHASE – SALE & HIRE BACK||LEASE – FOREIGN||LEASE – LOCAL||LEASING-SALE & LEASE BACK||Grand Total|
Findings & explanation
- The frequency of finances is adversely in favor of Sale & Lease Back. Marketing force of ULC is biased toward Sale & Lease Back.
- The frequency of finances is adversely in favor of 3 to 4 years range.
- If tenure is shorter than 3 years Hire Purchase should have been preferable, although Sale & Lease Back is frequent even in shorter terms (less than 3 years).
- In earlier years, in many instances Lease was preferred to Hire Purchase, although the later is supposed to be profitable.
The reason behind this bias for sale & lease Back are,-
- Majority finances belonged to 4+ year category, so Lease was indeed the right choice.
- Prior to development of a return calculation model used by ULC, Marketing persons were not fully aware of this decision making criterion.
United Leasing Company has entered a self fueling cycle over the long period of operation. The clientele is growing very slowly, although larger credit appetite of existing clients has sustained its growth so far. To further enhance and diversify clientele ULC will have to add diversity to its scheme line. Revere worthy competitors are stretching their menu. Initially this enhancement of offer may not fetch a good return, but eventually this diversity will be needed to sustain the primary items of the offer. A particular product bias should be avoided.
Concentration of portfolio in a particular range of time scale 3-4 years should also be avoided. Better fund management and credit risk analysis should be developed, which are not yet at a standard level for ULC. Better matching of fund and scattering the schemes across the time scale would make the portfolio more stable.
Over the years ULC has developed its pool of human resources both from business and non business academic background. If employees with non-business background are recruited anyway, thorough training should be arranged, so that the entire workforce has comprehensive knowledge of financial aspects. Then they can make decisions in the best interest of the organization and maximize its wealth.