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  • How is 2017 shaping up for the asset finance market? Posted on 23 January 2017

    In the days after the World Economic Forum in Davos, after Prime Minister May’s 12-point Brexit plan, and President Trump’s ‘America First’ plan, it seems a good time to consider how the leasing industry is shaping up for a what is widely expected to be an economically turbulent 2017.

    Originations

    Growing business uncertainty, particularly over the effects of the weaker pound, is being widely reported in the press. The good news is that business investment has held up and many lessors continue to see high single-digit growth.

    In its quarterly Agents’ Summary of Business Conditions published in December, the Bank of England reported a softening in investment intentions. Overall, companies still expected to increase investment over 2016, despite a growing level of uncertainty over the economy. Increased costs for imported capital equipment were starting to deter some investment but other purchases were being brought forward to avoid the expected price rises. For businesses that export the business case had improved, supporting investment.

    For the time being then there are some positives, with lessors helping businesses to invest during this period of uncertainty and allowing firms to secure today’s equipment prices.

    This all works while the effects of the weaker pound are being anticipated but is the UK economy - as George Soros suggested last week at Davos - in denial? Higher inflation and interest rates, should they materialise this year, would be the real test of whether businesses are sufficiently confident in the longer-term benefits of Brexit to keep investing, whether using leasing or not.

    Term Funding Scheme

    The Bank of England’s Funding for Lending Scheme (FLS) is being replaced by the Term Funding Scheme (TFS) that promises more low-cost funding for banks that keep increasing their eligible lending. 

    Like the FLS, participating banks in TFS can lend to non-bank lessors for onward lending to businesses. Unlike FLS, in TFS lending via non-bank lessors is as useful under the Scheme rules as direct lending. That gives participating banks a greater incentive to work with non-bank lessors and could address what many heads of asset finance companies see as a significant distortion to the market (although before blaming FLS/TFS for banks’ rock-bottom rates, we should note that only two of the largest five banks - Lloyds and Santander - are participating at present).

    All lending to the ‘real economy’ counts for TFS but that could change. There have been strong signals from the BoE and Government in the past fortnight that the pace of consumer credit growth is becoming a problem.  Press reports suggest that continuing growth in car finance is to blame, although in absolute terms it’s far from the largest part of the consumer credit market (perhaps it’s because there isn’t much data available on some other parts of the consumer credit market).

    Given these concerns we may see a tightening of the rules for TFS, possibly around the March Budget statement. The Government and Bank of England could refocus the scheme on business rather than consumer lending, as they did for the extension phase of the FLS. Consumer lending might not be cut out altogether but different weights might be applied to different sectors.

    Will TFS participating banks be keen to set up arrangements with non-bank lessors, particularly given possible changes to the Scheme? It probably depends how close the individual banks are to meeting the Scheme requirement to keep increasing eligible lending to access the lowest cost funding. As well as Lloyds and Santander, Aldermore, Close, Metro Bank and Shawbrook are among the other confirmed TFS participants

    Back to Davos, and former deputy governor of the Bank of England Paul Tucker (a key figure behind the launch of FLS) was reported as saying that central banks have failed the public by allowing governments to pass the buck on growth to [monetary] policy makers. So, is there a need for more action by governments rather than central banks, for example through direct investment and tax incentives?

    Tax changes

    The UK Government has changed the Annual Investment Allowance, offering accelerated capital allowances for business investment, regularly since the 2008 recession. It started at £25,000 and currently sits at £200,000. One option would be to increase it back to its previous level of £500,000. This seems unlikely. The current level was set as fixed for the life of the current Parliament, and HMRC statistics show that the higher limit was used by only a small minority of companies.

    Jane Ellison, Financial Secretary to the Treasury, spoke last week about the need for a steady, predictable tax regime. Where changes will be made, these will be signalled in advance (Ellison cited the Government’s repeated signals about salary sacrifice tax changes ahead of the eventual announcement in the Autumn Statement). 

    If tax changes to support investment during the Brexit transition aren’t likely, can we expect to see more direct intervention to support business investment?

    The Government’s British Business Bank has already made half a dozen investments directly into individual smaller leasing businesses. The overall impact on the market, as least so far, doesn’t seem very large (the second edition of the Asset Finance 50 industry ranking survey will be published in the next few weeks and will show the changes) but it’s early days and the BBB may well have other market interventions planned.

    The Enterprise Finance Guarantee, which after ten years’ discussion may eventually be extended to include leasing, is likely to remain a niche support tool. It’s less generous and more bureaucratic than guarantee schemes available in other countries.

    Loan support schemes

    More direct, targeted and generous support for individual small businesses looking to invest is available elsewhere, such as the wide range of loan support schemes operated by the Small Business Administration (SBA) in the USA. The evidence is that they can be very effective.

    An article in Forbes this month by Karen Mills, a senior fellow with Harvard Business School, described the SBA as perhaps the perfect prototype for a Trump administration agency: a public-private partnership driving valuable outcomes to a critical (but often neglected) part of the economy, all at a low cost to taxpayers.

    It is difficult the for the Government and the BBB to match the terms of the American schemes because of the complex European State Aid restrictions. Lessors in other parts of Europe have obtained support from schemes operated by the European Investment Bank (EIB) including the European Investment Fund’s (EIF) loan guarantee schemes.  Kennet and SG participate but most UK lessors haven’t taken advantage of these schemes, access to which will presumably be limited after 2019.

    A positive result of Brexit should be that the Government will be free to set up new Schemes to support investment, perhaps akin to the US SBA. It’s a long way off, but a good time for the leasing industry to begin to propose how this could work.

    IFRS 16

    With everyone else going on in the world, it’s easy - or perhaps tempting - to forget the imminent major changes to lease accounting and taxation. IFRS 16 is expected to be endorsed for use in Europe by the end of 2017 although the Commission may decide to give companies an extra year after the current January 2019 deadline to implement it. Brexit won’t have an impact here (unless Europe decides not to endorse, which is highly unlikely) as the UK is firmly committed to international standards.

    Meanwhile HMRC continues to consider how the UK tax system, particularly capital allowances for leases, will cope with the change. Some of HMRC’s options could remove access to capital allowances for lessors, so the knock-on tax changes could turn out to cause more harm to the leasing industry and business investment than the accounting rules themselves. We should expect some form of progress update from HMRC around the March budget statement.

    A positive development this month has been a signal from the UK’s Financial Reporting Council (FRC). In a public session of the European Financial Reporting Advisory Board earlier this month, the FRC representative reported that proposals to copy the key parts of IFRS into UK accounting rules are being reconsidered. This apparently follows feedback from accounting firms over the practicability of the rules for small and medium-size companies.

    If confirmed in due course by the FRC, this would mean that over 99% of UK companies (in general, non-listed companies) would avoid having to change how they account for leases for the foreseeable future. It would be a major development in the ten-year history of the new lease accounting standard, and one that could help to protect UK business investment levels (as businesses that use leasing invest more than those that don’t).

    The challenges for listed companies, especially those using operating leases including for cars and trucks, remain and will become a priority for the industry as 2017 progresses. In addition to new tools to help with the extra accounting burdens, expect to see a gradual shift towards contracts with listed companies that will be accounted for as loans or services rather than leases.

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