Barriers to the Financing of Leasing in Ukraine A personal view of Martin J. Elling 21 February 2006

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 2 Background My first attempt to start leasing in Ukraine was in 1995 while working for the EBRD On several occasions large sponsors backed off because of worries of legal and fiscal nature In 1999, the law changed, but big corporates could still not be persuaded to invest in Ukraine. Notwithstanding their reluctance, I saw an opportunity and decided to start a lease business with some “friends and family”. The result was First Lease, the first dedicated car fleet leasing company in Ukraine.

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 3 Today, 6 years later, First Lease: Is the undisputed market leader in Ukraine with 45% of the corporate car fleet leasing market Has leased over 3000 cars, i.e. >$ 45 M financed Its portfolio consists of: 75% large corporates, but 80% are SME’s 65% are Ukrainian companies 35% of the clients are outside Kyiv 60% of our cars are based outside Kyiv, thereby supporting regional development

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 4 And First Lease also has: An excellent client payment record (based on a thorough client acceptance policy). No bad debt Shown that repossession of cars is possible and That the residual risk for vehicles is minimal.  Hence, First Lease: Has successfully developed the lease product and proven that car fleet leasing is viable in Ukraine Is a commercial success, AND Contributes positively to the economic development of Ukraine through financing SME’s, creating employment and paying taxes

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 5 Financing Constraints Although First Lease is a success, the financing of its business has been a continuing struggle Already at the start in 1999, it proved impossible to find any financing and 100% of the initial cars were financed by the shareholders Slowly, some financing was obtained, but only for multi-national companies. Hence, banks were not willing to financing Ukrainian SME’s Although the situation has improved somewhat, the basic situation remains unaltered

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 6 Main issue 1. Lack of local financing. Banks:  Do not have sufficient financing with the required duration  Still do not understand the product, its technicalities or the underlying risks  Refuse to take the risk of the leasing company and concentrate on large corporate clients  Insist on costly and elaborate monitoring and security arrangements

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 7 Main issue 2. High Cost High borrowing cost, partly reflecting the high perceived country risk However, the main issue is NOT simply the high interest rates, but banks also charge: High up front fees Notary pledges and Pension Fund charges Demand monthly repayment in hard currency, ie high monthly transaction costs (banking and pension fund) The result: excessively high borrowing costs

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 8 Example of total borrowing costs

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 9 Main issue 2. High Secondary and Tertiary Costs First Lease at one stage had loan agreements with 16 banks and anything up to 35 credit lines. Each bank insists that all monies pass through their account, i.e. High organizational costs to manage the accounts Impossible to optimize cash flow Additional staff to manage disbursements and repayments In First Lease we had a principal repayment virtually every day, while in Europe this is perhaps once a month or once a quarter.

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 10 Main issue 2. High Secondary and Tertiary Costs (ii) Banks also insist that each lease agreement is submitted to the bank for approval. This leads to: The need to hire additional staff to prepare and follow up each file Excessive response time to clients. This is commercially not acceptable

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 11 Main issue 3. Inadequate Terms (i) Almost without exception Banks finance only 80% of the lease object value. Hence, leasing companies are obliged to demand a down payment which is a constraint to business. Banks refuse to look at the overall lease portfolio as security. The result is that most lease contracts in Ukraine are financed at only around 70% because of additional costs Loans become over-secured and additional assets cannot be used to attract additional funds

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 12 Main issue 3. Inadequate Terms (ii) Most loans have a tenor that equals the lease contract duration. i.e. the financing does not take into account the rest value of the asset. The monthly repayment is therefore too high and it leads to a negative cashflow on most contracts. This means that leasing companies in Ukraine need to be capitalised higher than in Western Europe

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 13 Main issue 3. Inadequate Terms

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 14 Main issue 3. Inadequate Terms: cashflow implications

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 15 Main issue 4. Other conditions (i) Each contract has to be approved by the bank Banks are double-guessing the credit risk analysis of the leasing company Hence banks in Ukraine First assess the risk of the leasing company Then the risk of the ultimate client. Take the asset AND the lease contract as security. Hence Banks have a triple or quadruple security on each lease contract. In this context the margins are excessive

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 16 Conclusion The lack of sufficient and—more importantly— adequate financing: Means that many potential clients, especially SME’s, are not or inadequately served, thereby holding back Ukraine economic growth Doesn’t allow the product to be fully developed Creates excessive financial and organisational costs for leasing companies and hence higher prices for clients Forced the shareholders of First Lease to sell its business to a major international player with access to competitive financing.

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 17 Conclusion (ii) Unless these issues are addressed, leasing will remain small in Ukraine, even with further improvements in the legal and tax environment The much needed financing that leasing provides for SME’s will not be forthcoming, thereby holding back economic growth. It also means that foreign banks will rapidly impose themselves in this market.

Barriers to the Financing of Leasing in Ukraine: a personal view of Martin J. Elling 18 Contact More information can be obtained from: Martin J. Elling