Financial leasing activities in vietnam practices, risks and solutions

SOUTHERN CALIFORNIA UNIVERSITY FOR FROFESSIONAL STUDIES INTERNATIONAL PROGRAMS VIETNAM PROGRAM HOANG NGOC TIEN FINANCIAL LEASING ACTIVITIES IN VIETNAM PRACTICES, RISKS AND SOLUTIONS Research (number two) Submitted to the Graduate Faculty of the Department of Business and Management In Candidacy for the Degree of Doctor of Business Administration Ho Chi Minh City, Vietnam August, 2003 SOUTHERN CALIFORNIA UNIVERSITY FOR FROFESSIONAL STUDIES INTERNATIONAL PROGRAMS VIETNAM PROGRAM FINANCIAL LEASING ACTIVITIES IN VIETNAM PRACTICES, RISKS AND SOLUTIONS Research (number two) Submitted to the Graduate Faculty of the Department of Business and Management In Candidacy for the Degree of Doctor of Business Administration By Mr HOANG NGOC TIEN BA (Banking – Banking Academy, Ha noi, Vietnam); BA (Politics – Ho Chi Minh National Academy of Politics, HCM city Vietnam) MA (Economics – National Economics University, Ha noi, Vietnam) Ho Chi Minh City, Vietnam August, 2003 HOANG NGOC TIEN – DBA CANDIDATE ABSTRACT In chapter 1, the author presented the overview of leasing industry, the basic theory and reality of financial leasing through the contents: Firstly, the thesis reviewed the development of leasing worldwide from early history of lease to the development of financial lease in US and other countries Nowadays, financial leasing becomes one of very important sources of fund for businesses and individuals to increase business activities and consumption Secondly, the thesis introduced the leasing market segments from small ticket market to large ticket market; with many different individuals and entity engaging this market from the independent leasing companies to captive lessors and lease brokers Thirdly, the thesis also gave to reader the diversification of lease, including financial lease, operating lease and hire purchase Finally, the thesis showed out the advantages and disadvantages of financial lease for the economy, leasing companies and lessees In chapter 2, the author focused on four main contents as following: The first: Introducing the legal framework of financial lease in Vietnam from 1995 to 1998, and from 1998 to 2002 The legal framework developed from Degree level to some contents of the Law on Credit Institutions, and then the new detail Degree on financial leasing was issued The second: Analyzing the reality of financial leasing activities in Vietnam from 1995 to 2002 These operations are developing well and have got some good results The third: Introducing the general risks that relating to financial lease, then evaluating the specific risks to leasing operations There are many types of risk are inherent with financial leasing operations: types of risk in general and types of risk in specific that occurring in Vietnam The last: Showing main factors that inhibiting the development of financial leasing activities in Vietnam i HOANG NGOC TIEN – DBA CANDIDATE In chapter 3: Based on the framework of theory in chapter 1, the result of analyzing in chapter, the Author gave out the solutions in order to obviate and mitigate financial lease risks in Vietnam The Author was focus on financial lease risks management, and go in detail solutions such as: create legal environment, lease asset management, portfolio management, analysis of potential lessees Finally, the Author also gave out 11 another solutions that make leasing companies successful ii HOANG NGOC TIEN – DBA CANDIDATE DECLARATION This is the research number of my two researches (two dissertations) to submit to the Graduate Faculty of the Department of Business and Management in candidacy for the degree of Doctor of Business Administration of Southern California University for Professional Studies, Santa Ana – CA 92705 – USA This thesis is carried out by myself and did not previously submit for a degree or diploma in any University To the best of my knowledge, it does not contain any materials previously published or written by another person except where due reference is made in the text; and all substantive contributions by others to the work presented, including jointly authored publications, are clearly acknowledged Author of Thesis Hoàng Ngọc Tiến iii HOANG NGOC TIEN – DBA CANDIDATE ACKNOWLEDGEMENT First of all, I would like to express my deep appreciation to my main Supervisor Professor Nguyen Huu Hien, who abundantly assistance, especially in the procedures and study documents Thank you to my other Supervisor, Dr Patrick Doan, who had supplemented and advised me to finish this thesis Thanking them for all the patience, valuable guidance, and perspectives throughout the research Without their exceptional support and encouragement, I could not have completed my thesis Thanks and love in abundance to my parents, my wife and my sons, who provided much support, both financial and emotional Thanks for their endless love and support that guided me through the hard times when I was staying away from home I would like also thank leaders and colleagues of VBARD and ALC2 and all my friends who had assisted and supported me while writing my thesis My appreciation also goes to postgraduate fellows and staff in the Southern California University for Professional Studies for their support and assistance iv HOANG NGOC TIEN – DBA CANDIDATE LIST OF ABREVIATIONS ABBREVIATIONS ADB ALCII GDP IFC FLC ODA SOE SRV US VBARD VND WB MEANING Asian Development Bank Agribank Financial Leasing Company Gross Domestic Products International Finance Corporation Financial Leasing Company Official Development Aid Stated Owned Enterprises Socialist Republic of Vietnam United States Vietnam Bank for Agriculture & Rural Development Vietnam dong World Bank v HOANG NGOC TIEN – DBA CANDIDATE LIST OF TABLES Table - Top 50 leasing markets, 1988-1994 Table - Financial Leasing Companies’ capital source Table 3- Capital utility by FLCs at the end 2002 Table 4- Capital utility structure at the end of 2002 Table - Leased debt balance performance at the end 2002 vi HOANG NGOC TIEN – DBA CANDIDATE TABLE OF CONTENTS ABSTRACT DECLARATION ACKNOWLEDGEMENT LIST OF ABBREVIATIONS LIST OF TABLES CONTENTS ITEMS PART I HEADING PAGE INTRODUCTION I - THE NECESSARY OF THIS RESEARCH II – OBJECT, DUTY AND SCOPE OF RESEARCH III –RESEARCH’S METHODOLOGY 2 PART II PRACTICES AND RESULTS OF RESEARCH CHAPTER I OVERVIEW OF LEASING INDUSTRY I- DEVELOPMENT OF LEASING WORLDWIDE I.1- EARLY HISTORY I.2- BACKGROUND OF LEASING WORLDWIDE I.3- DEVELOPMENT OF THE UNITED STATES LEASING INDUSTRY I.4- LEASING MARKET SEGMENTS 1- Small ticket market 2- Large ticket market 10 3- Middle market 10 I.5- TODAY’S LESSORS 10 1- Independent leasing companies 10 2- Captive lessor 11 3- Lease broker 11 II- DISCRIMINATION BETWEEN LEASES 1- Financial leases 2- Operating leases vii 12 12 HOANG NGOC TIEN – DBA CANDIDATE 3- Hire purchase 13 IIIADVANTAGES AND FINANCIAL LEASE II.1- ADVANTAGES 1- For the economy 2- For Leasing companies 3- For the lessees DISADVANTAGES OF 13 14 14 15 16 II.2- DISADVANTAGES CHAPTER II FINANCIAL LEASING PRACTICES AND RISKS 19 ACTIVITIES IN VIETNAM 21 I- THE LEGAL FRAMEWORK FOR FINANCIAL LEASE 1- Legal regulations a- Stage 1: from 1995 to 1998 b- Stage 2: from1998 to date 2- The concept of financial lease in Vietnam a- As by the Law on credit entities b- As by Decree 16/CP: 3- Types of financial leasing company (FLC) 4- Operation scope of FLCs 5- Operation content of FLCs a- Capital for operation: b- Financial leasing activities: c- Other activities: 21 22 22 22 23 23 23 24 24 25 25 25 25 II- FINANCIAL LEASING RESULTS IN VIETNAM UP TO 2002 26 1- Financial leasing companies' performance 26 1.1- Network and organization 26 1.2- Capital: 26 1.3- Capital using 28 a- Financial leasing activities: 28 b- Overdue debts: 28 c- Business outcome: 28 2- Case study at ALCII 30 2.1-Functions of ALCII 30 2.2- Operating areas 30 2.3- Financial leasing performance by ALCII 30 viii HOANG NGOC TIEN – DBA CANDIDATE III.4- CONDUCTING A THOROUGH ANALYSIS OF POTENTIAL LESSEES One of the primary goals for a leasing company, as for any commercial organization, is to earn a profit In order to achieve that goal, a leasing company must make balanced decisions about whether or not to invest in certain projects, taking into account the risks involved and the potential for profit Leasing companies can dramatically reduce the risk of incurring losses by conducting a thorough financial analysis of potential lessees and weeding out projects that are likely to fail We will look at some of the main components of a standard financial evaluation The amount of detail that is required in this kind of analysis will vary from case to case, depending on a number of factors, such as the amount of funds involved, the size of a given project in relation to the leasing company's total portfolio, the project's strategic importance, etc 1- The main components of a financial analysis Evaluating a potential lessee is one of the first steps in deciding whether to invest in a particular project or not The process of evaluating a lessee can essentially be divided into two components: - An analysis of the lessee's current financial condition (the past) - An analysis of the project's potential or project feasibility (the future) Depending on the amount of funds involved and other factors, leasing companies may require potential lessees to submit detailed business plans, Research number Page 76 HOANG NGOC TIEN – DBA CANDIDATE demonstrating the feasibility of their projects, or they may simply ask for essential financial data In other case, the leasing company must conduct its own, independent analysis of the lessee and his proposal, using the lessee's own documents for comparison only 2- Analyzing a lessee's financial condition Analyzing the lessee's financial condition means evaluating how the company has performed to date It includes analyzing the lessee's profitability, liquidity, financial stability, management of working capital, etc All of these factors must be studied as a whole and individually in order to get a clear picture of the company's financial trends and outlook This analysis should not be limited to a simple calculation based on standard indicators The leasing company should integrate all of the available data and try to understand how it has evolved over time We shall write in more detail about the methods of analyzing and interpreting quantitative data later First, we shall explain why it is necessary to evaluate a potential lessee's current finances a- The main goals of a financial analysis Analyzing a potential lessee's current finances enables the leasing company: - To uncover negative trends in the lessee's business activities; - To verify financial data supplied by the lessee; and - To predict the lessee's future cash flow The most important reason for analyzing the lessee's financial condition is to determine whether the company will be able to meet its lease payments Research number Page 77 HOANG NGOC TIEN – DBA CANDIDATE and whether there is a serious risk of default Negative financial indicators may serve as sufficient grounds for rejecting a potential lessee, in which case the leasing company does not need to make any further calculations The importance of evaluating the lessee's past and present finances cannot be overstated, as the success of the proposed project will largely depend on the lessee's financial stability This is especially true if the leased asset constitutes an essential and inseparable part of the lessee's enterprise Furthermore, the financial analysis will enable the leasing company to judge whether the lessee's projections of future cash flows are realistic The leasing company should compare the lessee's current sales figures, transitional and regular expenses, and relationships with suppliers and customers (consistency of deliveries and payments) with the figures that the lessee has forecast in his business plan If there are any large discrepancies between the lessee's current performance and forecasts, they must be explained and justify them thoroughly Acceptable forms of proof may include signed agreements with new suppliers and distributors, market research, etc The lessee's quantitative indicators, such as turnover, current expenses, working capital, etc., can be used to verify not only the starting figures reported in his business plan, but also forecasts about future cash flow If the proposed project is not an independent commercial unit, but is inextricably linked to the lessee's operations, the leasing company must be sure to evaluate the lessee's current cash flow as an indicator of the project's future solvency This is especially true if the project is small in comparison with the lessee's total operations In such cases, income generated through the project will not be the lessee's only source of revenue from which to make the lease Research number Page 78 HOANG NGOC TIEN – DBA CANDIDATE payments However, if the lessee is already operating at a loss, he may use the income generated by the leasing project to fund his other activities Of course, there are cases where it is not really necessary to analyze the potential lessee's current finances This is true, for example, when the project involves the creation of a new and independent company, or when the amount of investment and expected turnover far exceed the enterprise's current assets and turnover In such cases, the lessee will obviously not be able to provide sufficient guarantees on the lease, and some additional form of collateral, such as a bank guarantee, will be required This means that rather than evaluating the lessee; the leasing company will have to analyze the guarantor b- The main sources of information for a financial analysis The financial analysis of a potential lessee should be based on accounting documents, credit history, bank statements, tax reports, etc As everyone knows, a Vietnamese company's accounts not really correspond to reality Therefore, one must be very careful about drawing important conclusions based on formal indicators However, by analyzing a company's accounts over the past several years (leasing companies usually require accounting records from the last two years) and comparing the data from different periods, you can trace the basic development of the company's business By comparing important indicators, you can deduce the original data, and by substituting real market values, you can correct many of the figures In other words, a leasing company can get a fairly accurate picture of a potential lessee's finances by scrutinizing the accounts and comparing them to external data Research number Page 79 HOANG NGOC TIEN – DBA CANDIDATE 3- Evaluating the feasibility of a project The second important component in evaluating a potential lessee is the analyzing the project's feasibility The method for carrying out this analysis will depend on the nature of the project (i.e., whether it involves creating new production facilities, expanding existing facilities, modernization, etc.) In any case, the evaluation should be based on the project's predicted cash flow Leasing companies should keep the following principles in mind when predicting the future cash flow of a potential leasing project: - Make an accurate calculation of all previous revenue and expenses associated with the project - Consider fluctuations in payments over time - Plan through the end of the lease term and break the forecast down into payment periods in accordance with the lease payment schedule - Make sure that the currency used in the calculations corresponds to the expected currency of the lease payments - Important aspects of evaluating a project: + Analyzing the project's solvency: How liquid is the project? In other words, will it be able to meet all of its financial liabilities (payments) at every stage of its development? + Analyzing the project's feasibility: Will the project provide a sufficient return on investment? + Analyzing the project's risks Research number Page 80 HOANG NGOC TIEN – DBA CANDIDATE IV- SOME SOLUTIONS MAKE LEASING COMPANIES SUCCESSFUL Beside with the solutions to obviate and minimize the risks in financial leasing activities in Vietnam, the following factors enable leasing companies to flourish: 1- Management - The lessor must establish a sound and written credit policy The separation between those positions that originate transactions and those that approve them should be implemented Although senior management should be involved, credit authority above a threshold should not be vested in one or two positions Either a credit committee or a stepped, one-up structure involving several people is necessary - One of the main activities of the leasing companies is education by means training programs throughout the country and the group’s publications 2- Competent partner In many markets where leasing is being introduced, it is important to have an active, committed and competent foreign technical partner The technical partner, which should have enough equity to ensure active participation, should: establish and monitor standards and procedures; train local staff; advice on lease pricing, marketing and administration; and perhaps second the first general manager Research number Page 81 HOANG NGOC TIEN – DBA CANDIDATE 3- Funding The single biggest obstacle to the growth of foreign leasing companies is access to term local currency funds Access to term deposits from insurance companies or pension funds or to a local bond market helps overcome this problem 4- Asset-liability matching Leasing companies must match fixed-rate leases with fixed-rate term funding, or if only floating rates are available (locally or internationally); it needs a regulatory framework that allows periodic adjustments of lease rates 5- Attractiveness to lenders Given their high debt-equity ratios, leasing companies must remain attractive to lenders Security sharing agreements that establish equal rights to a pool of collateral for senior lenders are often used in agreements Asking some one for guarantees or direct loans, particularly to new companies that have not yet established credit histories that allow them to borrow locally 6- Pricing controls The leasing company should incorporate pricing controls into the way that allow an area of the company (usually internal finance) to verify the pricing methodology used by sales and marketing Research number Page 82 HOANG NGOC TIEN – DBA CANDIDATE 7- Tax forecasting and compliance It is importance that the tax position of the entire corporation is coordinated, especially if the leasing company offers a product that is tax sensitive (such as leveraged leases) This precept is applicable for national, state and foreign income taxes, as well as state and local sales, use and properly taxes 8- Residual management Sound management in this area requires that a residual audit be performed at least annually This audit ensures that residual policies are followed and that no permanently impaired residuals remain in the portfolio Such an audit should involve someone outside the asset management group and the results should be reported to the board 9- Compensation policies A compensation committee must be established to set and control compensation practices Involvement of an outside consultant also may be appropriate Periodic reports should be make to the board 10- Efficient measurement Specific performance and work measurements should be established, tracked and reported for each functional position Research number Page 83 HOANG NGOC TIEN – DBA CANDIDATE 11- Board of directors A strong board of directors provides a focus on strategic fit and commitment, and a deeper, broader source of advice and counsel to management It also sends a strong and positive message to the credit markets Research number Page 84 HOANG NGOC TIEN – DBA CANDIDATE SUMMARY OF CHAPTER Based on the framework of theory in chapter 1, the result of analyzing in chapter, the Author gave out the solutions in order to obviate and mitigate financial lease risks in Vietnam The Author was focus on financial lease risks management, and go in detail solutions such as: create legal environment, lease asset management, portfolio management, analysis of potential lessees Finally, the Author also gave out 11 another solutions that make leasing companies successful Research number Page 85 HOANG NGOC TIEN – DBA CANDIDATE PART III CONCLUSION With the method of collecting, studying and synthesizing the theory about the financial leasing activities; synthesizing and analyzing the contents in brief reports and documents relating to the financial leasing activities in worldwide and Vietnam; surveying at Agribank Financial Leasing Company II – ALCII in Ho Chi Minh City – Vietnam; we can give a conclusion that: Financial leasing activity is, without doubt, the creative financing alternative of so many enterprises in the world generally, and in Vietnam particularly today It is an imposing industry in terms of scope, size and potential, as more and more of the world’s equipment needs are met through this from of financing Financial leasing offers many benefits to all parties in the transaction, including low payments and off balance sheet financing to lessee and financing income to the lessor The range of equipment being leased is vast Leasing truly has something to offer everyone Although financial leasing has just applied in Vietnam, this financing activity has been developing steadily and getting good results Financial leasing is an important source of long and medium-term financing for companies regardless of their size and production profile, allowing them to increase production and grow their fixed assets They can be re-equipped with modern facilities to increase outputs, goods quality and export and import value However, so many risks have been occurring with financial leasing companies in Vietnam So that, through this research we used the experience Research number Page 86 HOANG NGOC TIEN – DBA CANDIDATE of leasing companies under the existing conditions and to develop a framework for risk analysis; focusing on the valuation of the risks arising at each stage of lease We also presented solutions and mechanisms for managing and minimizing these risks Moreover, some practical examples, simulating real situations as closely as possible, were also included as part of the research General speaking, the research have finished all its objects, they are: - Research and collect necessary information about the financial leasing activities worldwide generally and in Vietnam particularly - Find out the practical risks and potential risks relating to financial leasing companies that establish and operate in Vietnam - Based on available knowledge related to the financial leasing activities generally and the risks particularly and with above-mentioned actual situations, we have evaluated and proposed several solutions in order to obviate and mitigate the risks in Vietnam’s financial leasing activities We hope that, this research will become one of useful documents for financial leasing companies in Vietnam to find out solutions in order to obviate and mitigate risks in financial leasing activities At the same time, participating to the development of financial institutions in Vietnam Research number Page 87 HOANG NGOC TIEN – DBA CANDIDATE LIST OF AUTHOR’S SCIENTIFIC ARTICLES ON MAGAZINES 1- Hoang Ngoc Tien, The methods of interest calculating in Banking Financial Market and Monetary Magazine, 1997 2- Hoang Ngoc Tien, The Break- even -point in Commercial Banking Banking Review, Feb - 1998 3- Hoang Ngoc Tien, Extend of finance on renewing of equipment and technology via financial leasing - Banking Review Nov 1999 4- Hoang Ngoc Tien, The concept of lease-purchase and financial leasing Financial Market and Monetary Magazine, Feb 2000 5- Hoang Ngoc Tien, Experiences of financial leasing in Russia, Financial Market and Monetary Magazine Nov 2003 Research number Page 88 HOANG NGOC TIEN – DBA CANDIDATE REFERENCES 1- Rose – Kolari “Financial Institutions” Fifth Edition 2- Ho Dieu, “Banking Management” The Statistic Publish House 2002, Vietnam 3- Tran To Tu – Nguyen Hai San “ Understand and Use Lease” The Young Publish House – Vietnam, May 1996 4- Shawn D Halladay – Sudhir P Amembal “ The Handbook of Equipment Leasing” Volume and 2, Amembal & Halladay International Lease Educators and Consultants, 1995 5- Dr Nguyen Van Tien “ Evaluate and Obviate Risks in Banking Activities” Statistic Publish House – Vietnam, 2002 6- International Finance Corporation “Leasing in emerging markets” The World Bank Washington, D.C, 1996 7- H.R Machihaju, “Merchant Banking Principles and Practice” Copyright 1995 Wiley Eastern Limited New Age International Publishers Limited Printed in India 8- Steven I Davis, “Managing Change in the Excellent Banks” 1989 9- Richard B Johnson, “New Perspectives For bank Directprs” SMU Press – Dallas 1977 10- State Bank of Vietnam, “ Banking Review” Monthly Review from 2000 to 2002 11- The Vietnam Bank Association “The Financial – Monetary Market Review” Semimonthly Review from 2000 to 2002 12- Newspapers: Saigon Economics, Business, and Investment Daily and Weekly Journal in 2002 13- Sum-up Reports and Regulations of the State Bank of Vietnam before 2003 Research number Page 89 HOANG NGOC TIEN – DBA CANDIDATE 14- The Reports and Plans of Agribank Financial Leasing Company II from 2000 to 20002 15- U.C.C - Article 2A – Leases (www.law.cornell.edu/uniform/ucc.htm) Research number Page 90 ... of Vietnam on studying and preparing regulations on financial lease in order to bring the technology of financial lease into Vietnam The results and assessment show that financial leasing activities. .. the financial leasing activities worldwide generally and in Vietnam particularly; find out the practical risks and potential risks relating to financial leasing companies that establish and operate... types of risk in general and types of risk in specific that occurring in Vietnam The last: Showing main factors that inhibiting the development of financial leasing activities in Vietnam i HOANG