Orix Leasing, Pakistan – Managerial Policy Case Study

 

Leasing In Pakistan –  A Growing Industry

 

In Pakistan, the leasing sector comprises leasing companies, modarbas and investment banks. The regulatory bodies that monitor leasing sector are the State Bank of Pakistan, SECP and Ministry of Finance, Government of Pakistan[2].

The leasing companies initiated in 1985. There are currently 33 leasing companies, whose main business is financial lease. These companies include: ORIX, NDLC, First Grind lays Modarba, BRR International Modarba and Askari Leasing with 70% of industry share.

Most of the 48 modarbas[3], established to promote Islamic mode of financing, are also engaged in extensive leasing as well, with 8 of those registered with Leasing Association of Pakistan, such as: First Allied, Al Ata, Al Zamin & First Fidelity Modarbas etc.

The government has allowed investment and commercial banks to enter lease financing. These institutions enjoy strong financing ability and huge equity base.

Over the years leasing has become an increasingly important source of financing. However the share of leasing in capital formulation in Pakistan is 12 to 15 percent which is very low as compared to other financial institutions.

 

ORIX “The Leasing Experience”

Orix leasing Pakistan Limited, a subsidiary of ORIX Corporation Japan, is a leading leasing company in Pakistan with a total of 262 employees[4]. ORIX Corporation Japan, established in 1964, is the largest leasing company in Japan and one of the largest diversified financial services company in the world. It played a pioneering role in introducing the modern concept of lease and offers sophisticated services such as installment loans, rentals, securities, brokerage, venture capital, futures and options trading commodities funds, life insurance and real estate related activities. ORIX began setting up an international setup in early 1970s and today its overseas presence is represented in 23 countries including Pakistan. Following its parent company footsteps, OLP has played a major role in promoting the local leasing industry. ORIX was first to introduce Operating lease in 1998. Its has extensive branch network, a diversified portfolio of over 3000 clients, and wide range of financial products, personnel development and office automation. OLP has assets of Rs. 4.8 billion (US$ 92 million) and a net worth of Rs. 821 million (US$ 16 million). OLP established as a private limited company, is a joint venture between ORIX Corporation and local sponsors namely Bankers Equity Limited, Pak Kowait Investment Company (Pvt) Ltd and Saudi Pak Industrial & Agricultural Investment Company Pvt Ltd. In march 1988, the company raised its status to public limited company and its initial public offering was oversubscribed by 17 times. In 1996, the International Finance Corporation (IFC) acquired 5.6% of the company’s equity. Orix international and its nominees own 57% of equity, 5.62% is owned by IFC and general public owns 11.5%. ORIX operates its branches in 5 major cities with its head office located at Karachi. It serves as a regional base for the Orix group operations in the Middle East ORIX Leasing Pakistan also holds 20.25% equity in Oman ORIX and provides management support as well. ORIX Pakistan and ORIX international hold 23% of ORIX Egypt equity as well¹. OLP is also a founder shareholder of ORIX Investment Bank Pakistan Limited that is primarily engaged in providing a range of investment banking products. In 1999 its credit ratings have been up-graded to AA-and A1+ for long term and short term debt respectively by PACRA. It supports its objective and local industry through efficiency and extends leases to all sectors especially textile, cement, sugar, pharmaceutical, food, paper and board and financial services.

The Company has long-term credit lines from many international financial institutions including IFC, ADB, FMO (Nether land), IBRD (World Bank) and its local financers include Pak Kuwait Investment Company, HBL, UBL and Faysal Bank etc. Despite dealing in risky market, Orix has acquired a prominent position. It has a diversified portfolio of customers, with Textile sector being its major niche.

External Environment

Pakistan economic system is characterized by strong political influence. The last decade was the period of transition to a more open capitalized system. To facilitate this process, successive governments have been playing a positive role by allowing private  commercial and investment banks to operate. The government’s recent decision allowing banks to conduct lease operations has opened door towards a healthy competition[5].

The saving rates have always sown a gloomy picture as it revolves around 4 to 5 percent of GDP.  Due to low saving rates private investment is very low which hinders mobilization of funds. With lower capital formulation leasing companies find it difficult to obtain long term loans at compatible rates.

In 1999, the GDP growth rate of 4.5% was achieved. This modest recovery in growth has been supported by 5.5% growth in agriculture sector, while the large-scale manufacturing showed growth of only 1.6%. The problem Pakistan faces today include both psychological and actual ones. There is average citizen lacks faith not only in the system but also on himself, because of which the country on the whole has to face problems such as, lower saving rates, loss of investors confidence, lack of available funds to promote economic activities, declining tax to GDP ratio etc[6]. despite all these factors, leasing industry showed a remarkable growth of over 100% in last 5 years. Although, the lessees faced declining ability to discharge their financial obligations the stringent risk evaluation paid-off.

The volatile political scenario had been a major setback for economic boost of leasing companies[7]. The overthrown of Nawaz Sharif government shattered the confidence of investors, as he, himself an investor, was regarded as patron for private investment. But, this setback was alleviated when government took some concrete measures towards the stability. In the year 1999-2000, the public sector investment grew by 9.6% while the private sector increased by 9.4%. The net foreign private investment inflows showed an overall increase of 8.3%. Successive governments have made attempts to narrow the revenue-expenditure gap by taking new fiscal measures in federal budget. The military government has focused on documentation of the economy, to streamline the economic activities. It revived the tax collection system by re-organizing Central Board of Revenue and imposed General Sales Tax, which previous governments were unable to do despite numerous attempts and documented the underground economy of Bara markets etc.  But, the political uncertainty still prevails and future economic prospects are blurred.

SECP had fixed a deadline for leasing companies to enhance their paid-up capital to Rs.200 million by end of November 1999, extended to June 2000[8].As a result of this regulation, a large number of companies may not be able to comply with the instructions; mergers, takeovers and acquisitions are the likely possibility, which will help in boosting the healthy competition and efficiency in the sector. SECP has also dispensed the minimum requirement of three-year period in case of IT products due to their high rate of obsolescence.

Widespread default culture goes parallel with a culture strongly dictated by religion. A significant of the population is express content for interest; leasing has been promoted as Islamic mode of financing. So the people are more attracted towards leasing companies. An increasing number of leasing companies manifest this reality.

Technological investments have become an important tool for product differentiation, quick response time, enhanced accessibility and improved customer satisfaction. The leasing companies are investing in state-of-the-art systems, which will lead them towards improved processes, faster turnaround times, smaller lead time for approvals. Proficiency in IT not only erects entry barriers but companies acquire a major competitive edge through technology. Shrewd decisions in acquiring latest technology keep a way ahead of competitors.  Latest simulation programs and decision support systems are of a great help as they help in sensitivity analysis of Leases.

COMPETITORS

The concept of leasing and hire purchase existed long before the fist leasing company, National development Leasing corporation limited was established in 1985. During 1985-91 only six companies were established while the figure rose to 27 in 1997. ORIX commenced its operations in 1987 and it has acquired major a share by now. There has been mounting increase in competition in leasing industry in Pakistan, as the number of financial institutions including: leasing companies, Modarba, consumer and investment banks had soared up. ORIX Leasing is facing a strong competition from other companies like NDLC, Askari Leasing, First Grindlays and B.R.R modarba. These companies including ORIX captured nearly 70 % of the leasing market by 1999. These large ticket companies are dominant not only in revenues but they have also grown considerably over the years increasing both their assets and equity base. These companies constitute about 39% of the lease investments but their profits comprise about 46 % of the industry as depicted by following two tables[9].

Strategic Group
	Industry	ORIX	Askari	First Grind lays	NDLC	B.R.R
Paid up Capital	4566	201.39	240	374.22	377.4	481.93
Retained Earnings	3305	669.38	288	250.05	856	179.35
Investment in Leases	29039	2371.44	4118	1811.4	2183.44	818.02
Revenues	5528	905.12	798	775.87	698	653.84
Net Profit	991.63	130.46	62	114.29	90.05	66.38

Source: Pakistan Leasing Year Book, 1999.  Percentage share of top 5 Companies
	Industry	Total of top 5 Companies	% of Industry	% of ORIX
Paid up Capital	4566	1674.94	3669%	4.41
Retained earnings	3305	2242.78	67.86	20.25
Inv in leases	29039	11302.3	38.92	8.17
Revenues	5528	3830.83	69.3	16.37
Net profit	991.63	463.18	46.71	13.16

 

The small ticket companies are finding it difficult to acquire enough share due to the presence of the strong players in the industry. The business has increased over the years but ORIX market share has not grown in to proportion to the industry’s growth. The company’s income stood forth among the top five players depicting an increase of 7.8 percent only. In 1999 the giants captured over 70% of the market.

SECP has set a benchmark figure of Rs.200 million paid-up capital for new and existing players. Debt would become an onerous task for all the companies below the required capital .New entrants find it difficult to enter into this field. This will weed out unhealthy competition and will result in mergers.  Investment in consumer banks is also making an inroad into this business after SECP’s approval[10]. This has unnerved in the leasing industry, as the banks are not only after term-financing at very competitive pricing, but are also prone to get the existing leasing financing replaced by the long-term management of finance.  The banks enjoy lower cost funds in resources that is an added advantage. The people in the industry do not think it as a greater threat because banks have been restricted to finance only 25% of their equity base. Banks have been major financers of leasing companies and the fact that interest rates are showing upper trend in the last few months, the bargaining position of banks has increased, much to the distress of leasing companies. The clients are price sensitive and therefore are oblivious of past relationships. This is true especially for medium sized enterprises. A large number of leasing and Modarba companies mostly offer undifferentiated lease services with respect to type of leasing, mark-up rates and customer response time. Expected mergers will weed out unhealthy competition of small ticket companies thus ensuring a healthy competition.

Operations:

ORIX commenced with lease financing as its core business and needed ancillary financial services to its product range over the time[11]. These include: installment loan for household equipment to corporate employees, auto leasing to salaried employees, self-employed professional and businessmen and provision of vehicles and equipment on operating lease. The company’s policy on internal diversification is to enter into fields closely allied to leasing to reduce risk and make use of best available expertise in OLP. The graph depicts the exposure in various fields. Orix has small fragment in fuel & energy sector and transport & communication sector, which are most active and capitalized sectors. The exposure in cement sector is zero.

Source: Pakistan Leasting Year Book, 1999.

Marketing:

Originally, ORIX focused its marketing activities to the institutional clients only[12]. Niches that may qualify for different type of businesses are selected judiciously. As one of the pioneers in leasing industry ORIX has established a rapport in business circles, therefore it enjoys the benefit of old players of the market. Its branch network comprise of 5 offices in the major cities of the country. These are located at Karachi, Lahore, Faisalabad, Peshawer and Islamabad. Over the years it has developed a large customer base of over 3000 clients through strong emphasis on personal selling and consider it sufficient for the company. With the wider geographic market reach it has even acquired diversified Leases in remote areas of Gilgit and Swat. OLP extends facilities to all segments of markets.  However its main target market remains small and medium sized companies, spread across different manufacturing and industrial sectors which include mainly Textile, Sugar, Cement, Pharmaceutical, engineering, energy, food, papers and board, financial services and distributions. By understanding the needs of its niche market it has achieved high level of risk diversification. The minimization of risk is much more emphasized and focus markets with little risk only. Being very selective, leases are not extended to the new projects. In 1991, it entered in to the  consumer market through auto finance. The auto lease was also marketed through personal selling only. This segment could not captured a reasonable share in the market and it stays back from its rivals such as Askari leasing who opted for aggressive promotional activities. The aggressive advertising and promotional activities of Citi bank’s auto finance attracted a great deal of customers towards it.

The Company follows a philosophy of sustained growth and do not go above the 5% of their targets. Yet ORIX is securing a sustained growth but is unable to capture the maximum of the potential in the leasing sector. It could only extract only a 16% share of total income, which is just an increase of 0.03% as compared to 1998. While Askari was ahead at an increase of 0.05% and BRR International Modaraba at 1.6% increase in the market share. ORIX looks at its growth with content to its increasing income but ignores the competitors increasing share as the management philosophy is that it is not in direct competition with other companies. It has a large client base and technical support from its mother company.  In 1999, OLP has provided services to 1289 clients. The clients are contacted through sales calls .The only marketers are their Salespersons as the company’s marketing manager says “All our employees are marketers so why to opt for brand marketing or advertising, we believe in personalized marketing in the selected niches”. The management considers leasing an industrial marketing service and is of the view that it can be captured by focused sales force and do not need promotional activities. So it is more of a providing personalized services.

OLP is very conservative in its strategies and works for slow and steady manageable growth. It completely gets dictation from its mother company in Japan and follows Japanese style of conservative marketing. The management peruses only sort-term marketing plans and for that reason it is usually involved in short-term planning without focusing on long term planning. As ORIX believe in operating in safe environment and for that reason the company most of the time do not go for long-term plans.

Credit:

The marketing department sends the proposals for credit extension to credit department for evaluation[13]. Credit department follows ORIX guidelines, internal restrictions and IFC’s loan covenants for extending credit. It looks into credit worthiness and ensures the potential lessee as an established corporation in 3 years of profitable business. New projects are not financed as well as not more than 50% of the fixed assets are financed, so the credit extension rules prohibit credit arrangement for new small-medium sized arrangements (SMEs) without a long history of financial statements. Which restricts the small medium sized to get lease finance. ORIX has mainly focused on its existing customer base.

Credit department assesses customers on point charge filled by marketing personnel. The acquired points show the lessees exposure and credit worthiness. It extend credit below certain amount without a thorough investigation and after disbursement go into the details. This is done usually for small businesses. Similarly the department follows the hard and fast rules and does not look for customer friendly credit evaluation that suits the local environment.

Treasury:

The treasury department in ORIX rather performs functions that are not in line with conventional treasury norms. It is involved both in long and short term financing[14]. It generates enough means for day-to-day operations and disbursements as well. It is extensively involved in negotiations with IFC and domestic and foreign donor agencies for extending lines of credit. It continues to have adequate funding commitments to meet its business requirement. In the aftermath of economic sanctions, it has become extremely difficult to acquire loans from international donors, so it has to be more competitive locally to acquire enough funs to fulfill its commitments. The credit has continued to have adequate funding commitments to meet its business requirements but in the recent two years the foreign funding has been restricted and the creditors are seeking loans from local financers. The treasury function also needs to improve its funding ability for SME’s in the local market as it has been mainly funded by international donors and ORIX international.

Rental recovery and collection:

This department coordinates with the credit and MIS department and schedule intervals, contacts with lessees to recover lease rentals. Due to rigorous credit evaluation, its task is much easier. It is evident from its financial statements that ORIX has excellent history of recovery, as it has not written off any non-performing loan or taken provision for it. An allowance for lease loses is maintained at a level that in the judgment of management is adequate to provide for potential losses that can be reasonably anticipated. But in 1998 the recovery level decreased a bit because of the nuclear blast, which gave rise to economic down fall. This showed up a decrease in the lessee’s ability to discharge off their liabilities. Potential lease losses increased by 13.3% against 7.8% increase in revenues.

Accounts & Finance:

This department is mainly responsible for reporting activities that include reporting to SECP, SBP & Orix International. It receives data from marketing, treasury and credit departments and then uses it for generating different reports. It interacts with tax authorities and decides about specific treatment under different accounting heads[1]. It works in close collaboration with MIS department for reporting purposes.

MIS:

There are 14 employees in MIS, half of them are IT specialists and the remaining are data entry operators and accounting experts who use different software for generating three kind of reports and coordinating with audit, account and finance departments. It prepares concise reports for top management, complicated and detailed reports for middle management and reports for mother the company. It has a well-established Local Area Network to have the quick and ready access to data and personal communication. The policy regarding the responsibilities of the department is dictated by top management and individuals do not find any way for creative development. No such investment has been made to acquire competitive edge from efficient use of IT except for faster procedure execution.  The management is planning to have a computer on every desk by the year 2001 for efficiency and coordination among the employees.

 Internal Audit:

The responsibilities of this department are to ensure transparency in all functions, especially finance, tax and accounts[15]. It looks into staff and company matters and coordinates with CBR. Its main responsibility is of reporting to its principal sponsors. Also monthly and half-yearly reports are prepared for MD. It exerts control in operational activities to ensure best services for its clients. The internal audit has a very well trained staff to complete the process efficiently and effectively but it does not possess much authority in its decisions and their job is only restricted to reporting not evaluating the plans.

Human Resources:

In February 2000 HR department was formed. It is still streamlining its activities[16]. Although there exists a high level of informality among employees but the decision making process is much formal and employees are not involved in this process. The management conservative approach does not allow personnel to participate in decision-making process. Employees are paid fixed salaries but no commission regardless of their performance. Low salary level for the new entrants make it difficult for the organization to retain its employees as starting salaries are at much lower level as compared to other companies. Employees are hired on permanent basis as management follows Japanese sayings that “Permanent employees are always loyal”. The employees enjoy a no firing policy and employees are not laid off for their incompetence.   Japanese values of hard work, loyalty and ethics are well embedded in every employee.

HR main responsibility is to developing job description and in-house training sessions. The performance appraisal process is much simpler. First the employee evaluates himself on specific factors and is then confirmed by his immediate boss.  Incentives for good performance are both monetary and non-monetary based. The promotion is mostly dependent on seniority and not directly on performance[17].

Finance – The Strength

Orix leasing has scaled new heights in lease business by booking net receivables of Rs. 2.9 bn and was leading holder of market share and at the same has reversed the declining trend of profits wither in the last two year[18]. It hosted 12% rise in pretax profit at Rs 150.5m and total revenues about to sought the billion Rs. threshold as it hosted total revenue from its all operations at Rs 0.905 bn; which comprises total revenue from finance leases at Rs. 720.46 m, installment loan Rs.42.26 m operating leases at 35.861 m and other income at Rs. 106.8 m. Resources mobilization is the growth engine of leasing engine. During the year 1999 there was total dependence of resource mobilization in domestic sources and no foreign currency loan was utilize and undrawn amount of US$ 10.2m from ADB loan was canceled but average total borrowing of Rs. 3 bn during the year were higher than the previous year by 5% and repayment of the obligations for all foreign lenders were current. The company earned net profit at Rs. 130.4 m and declared 40% cash dividend.

4.1 LIQUIDITY:

The liquidity measures such, as current ratio has been sufficiently stable during the period 1995-1999. The current ratios were lower during 1996 and 1997. It improved by 10.6 % in 1998 but again declined by 2.05% in 1999. Net working capital is about 13.5 % (in 1999) of the total assets that implies good liquidity position. There has been 4% decrease in financial charges expense.

 

4.2 SOLVENCY

In the years 1995-98, though TIE ratio deteriorated about 11.5% increasing vulnerability but it has recorded an upward tendency in 1999. But, the industry ratio has worsened from 1.47 to 1.17. This shows the strong position of the firm relative to firms in industry. The firm’s gearing ration is 3.67, which is third best in the industry. This shows a healthy debt position and its ability to acquire more debt at competitive rates.[19].

 

4.3 PROFITIBALITY:

After a decline in Net profit margin for the years 1995-98,the company has shown a considerable increase in the net profit (14.41), which is 43 % higher than the industry average of 8.16. The net profit margin of the company has decreased from 21.53% to 14.41%, but is well placed against the competitors, as the industry average has declined from 20.51% to 8.16%. This shows that company has to face fierce competition in the future, when the profit margin is being trimmed. The Assets turnover has decreased in 99 implying decrease in efficient use of assets. The other ratios such as ROA and ROE have again started to rev up with an increase of 15% and 14% respectively against the decline in the industry average of about 5.1%. The Total Assets/Net worth has gone up 7% against the industry’s 4%. These all indicate the strong profitability position of ORIX. The company has also stable policy of distributing the profits to the stockholders, as is depicted from the graph.

 

4.4 ANALYSIS FOR INVESTORS:

The ORIX is emerging as a lucrative investment opportunity. It has EPS of 4.66 which is well above the industry’s average of 0.79 but EPS in 1999 is lower than that of 98,this may be due to the increase in the number of shares outstanding The Revenue per share has also declined to 44.94 . Last year the company paid 40% dividend.

Despite all the encouraging figures the cash flows has considerably deteriorated in 1999.The company need to maintain an adequate cash flow position for a sustainable growth and should be able to generate cash flows for sustainable operations.

As conventional rule of thumb[20], leasing companies has to grow by at least 8% annually in order to avoid the deferred taxation being reversed. This shows strong possibility of setting higher targets and in the process relaxing the credit-approval policy, which might have bitter impact on the future profitability.

The Road Ahead

The future of leasing industry in Pakistan is linked to the overall economic future of Pakistan. The late has shown signs of stability in the last year[21]. The leasing companies of Pakistan have not yet penetrated the market to its maximum. The concept of leasing is still alien to the masses. In the western countries most of the business is done on credit as can be observed by the fact that on average 85% of an American’s salary goes in paying debts[22].

Over the years, the slowdown in the economic activities and depressed conditions for investment pose new challenges for the leasing business. Low investment in plant and machinery has a direct bearing on leasing business which is asset based financing, thus necessitating new market strategies to develop sufficient volume of business. The local environment is not yet very conducive but ORIX will have to take in to account the development in small and medium sized enterprises and concrete measures are to be taken to ensure that the lease portfolio quality do not deteriorate. The consumer finance has become a large potential market and the company will have to focus on  this market not through its personal selling techniques but through effective media campaigns.   The foreign currency loans as a major source of funding has dried completely due to inability to hedge the exchange rate risk forcing of exchange all funding to be raised from domestic sources. OLP has acquired 15% of the equity in ORIX Investment Bank Pakistan as its diversification strategy. The bank is primarily engaged in providing a range of investment banking products which include corporate advisory services ,structuring and placement of the capital market debt products, issuance and discounting of bankers acceptance and treasury operations.

OLP is also looking for geographic diversification and in 1999 it finalized its deal regarding investment in the joint venture leasing company in the kingdom of Saudi- Arabia. The company is looking ahead to capitalize up on the Saudi government’s policy of promoting small and medium sized enterprises. On November 24, 2000 the company opened its new branch at Hyderabad ;pursuing its strategy towards market penetration.

The top players of leasing industry have started developing the market by offering more and varied products for their existing and new customers. The availability of automobiles leasing has been made possible by many companies including ORIX Leasing, Gandahra Leasing, Crescent Leasing etc. in addition to that more and more consumer products are now available on lease. For example, appliances of LG, Sony & Dawlance Electronics have been financed by leasing companies. It can be anticipated that in the near future the concept of lease finance will penetrate more in the market and the industry will be able to show a faster growth rate than in the past.

 

 

[1] Interview with Mr. Raymon Alfrey, GM, Accounts & Finance, OLP

 

End notes:

 

[1] Lesson in emerging markets (1996) IFC Publication, Lessons of experience.

[2] Pakistan Leasing Year Book (1999)

[3] Modarba Association Of Pakistan Year Book (1999)

[4] Annual Report, ORIX Leasing (1995-99).

[5] Shah, Shabbir. H, “Outlook for the year”, Pak. & Gulf Economist, Feb 28-Mar 5, 2000, Pp.13.

[6] Economic Survey of Pakistan (1999-2000) State Bank of Pakistan.

[7] “Leasing Companies: Growth Recedes”, Daily Business Recorder, April 26, 2000.

[8] Annual Report, ORIX Leasing (1995-99).

[9] Pakistan Leasing Year Book (1999)

[10] Shah, Shabbir. H, “Outlook for the year”, Pak. & Gulf Economist, Feb 28-Mar 5, 2000, Pp.13.

[11] Interview with Mr. Hiralal Bharwani, AGM, Credit & Marketing, OLP.

[12] Interview with Mr. Hiralal Bharwani, AGM, Credit & Marketing, OLP.

[13] Interview with Mr. Taizoon Kisaat, GM, Business Development, OLP.

[14] Interview with Mr. Raymon Alfrey, GM, Accounts & Finance, OLP.

[15] Interview with Mr. Khalid Rehman, AGM, Internal Audit, OLP.

[16] Interview with Mr. Mobin Junaidi, AGM, Human Resources, OLP.

[17] Interview with Mr. Raymon Alfrey, GM, Accounts & Finance, OLP.

[18] Pakistan Leasing Year Book (1999) Pp. 100-101.

[19] Annual Reports (1995-1999) OLP.

[20] Interview with Mr. Ayaz Dawood, CEO, Dawood & General Leasing & Visiting Faculty member, IBA

[21] Newsweek, October 2000.

[22] Almanac 2000 (facts & figures)