Russian Companies Discover a New Lease on Life

Only a couple weeks ago, a fire and equipment failure at the 1960s Chagino electricity substation brought Moscow to a standstill, highlighting the lingering problem of unreliable and outdated Soviet-era equipment. People were stranded on the metro and along tram lines, businesses suffered great losses, and the power supply was fully restored only after 40 hours.

In many ways, the state of power stations, the majority of which have not been upgraded for decades, epitomizes the situation in most Russian factories and plants. It spells potential problems for the country's economy but also a bright future for the leasing industry, experts say.

Russia's leasing market has been showing exemplary growth for several years, and it now has roughly 250 companies, according to the Russian Association of Leasing Companies, or RosLeasing. The industry skyrocketed by 50 percent in 2004, reaching an all-time high of $5.5 billion, and is currently three times bigger than in 2001, when it was worth only $1.7 billion.

In one the largest deals in the industry, Russian Railways Co. in April signed a 20.4 billion ruble ($730 million) leasing agreement for roughly 7,000 cargo gondola cars, locomotives, fitting platforms and passenger carriages. Since 2003, the company has held several large tenders to lease thousands of new cargo and passenger cars, and it plans to sign many more leasing deals in the near future.

In another landmark deal in February, in what was the aviation industry's largest-ever leasing contract, the airline Transaero sealed a $600 million agreement with Financial Leasing Company to lease 10 Tu-214 airplanes for 15 years.

Favorable Taxes

Favorable tax legislation is the main driving force behind industry's growth, experts say. All leasing payments are recognized as costs of production, while one of the latest changes in the Tax Code exempts leasing companies from tax on property.

Especially for small and medium-sized businesses, which are particularly sensitive to high bank loan rates, leasing is increasingly becoming a popular option to acquire new equipment while freeing up some financial resources.

"Leasing companies are playing a major role in financing small and medium-sized enterprises in the West," said Alexei Kuznetsov, senior tax manager at Ernst & Young. "In Russia their role is growing, but the share of small businesses in leasing volume still remains marginal."

Despite spectacular growth rates, in absolute terms Russia's leasing market lags behind many Western and Central European countries. Leasing as a financial tool emerged only after the 1998 financial crisis, and at the moment market in Russia remains smaller than that in Portugal or the Czech Republic.

"Until recently, Russian companies wouldn't even consider leasing as an option," said Laura Brank, managing partner at Chadbourne & Parke in Moscow. "The leasing market is developing very fast, but it is still nowhere near where it is in Western Europe or the United States."

One of the hindrances to the sector's growth is the rigid attitude of many smaller companies, which continue to regard leasing with mistrust. "In the past few years, a lot of 'independent,' fly-by-night leasing companies emerged that did a lot of harm for the leasing industry as a whole," said Alexander Kozhevnikov, general director of Avangard Leasing, the leasing arm of Avangard Bank. The clients constantly need to be "educated about leasing," he said.

From Planes to Pencils

Like any new industry, the leasing market in Russia is very diverse, ranging from airplanes, production lines and machinery of entire factories, to trucks, refrigerators and office equipment.

Telecommunications equipment accounted for 20 percent of all leasing deals concluded last year -- the largest share of the market, according to Expert RA. It was followed by road transport vehicles and passenger cars, which made up 10 and 8 percent of the market respectively.

One sector that is widespread in the West but has yet to take root in Russia is real estate leasing.

"Until land ownership rights are settled and long-term credits to finance property transactions become accessible, it is impossible to predict an explosive growth in real estate leasing," said Vasily Kashkin, a project manager at Expert RA. No more than 30 companies are currently dealing with real estate leasing, which accounts for only 1 percent of the leasing market, he said.

Russian leasing market also differs from Western countries in several other ways. For example, perhaps somewhat surprisingly to investors used to red tape, leasing agreements in Russia tend to be much shorter, "simpler" and "more straightforward" than the ones in the West, Brank said.

However, she attributed that to the fact that here most deals are "targeted at one piece of equipment only."

Also, leases in Russia tend to have shorter terms and higher interest rates than the ones in Western Europe or the United States. According to RosLeasing's estimates, contracts that are longer than five years account for only 4 percent of the market. In comparison, the corresponding figure in Germany is more than 16 percent.

Locals Hold the Front

Despite attractive growth rate of the banking sector, Western financial institutions have so far been extremely cautious in entering the local leasing market. Foreign-capital lessors are less familiar with the Russian market and therefore are less willing to take risks, industry insiders say.

Kozhevnikov estimated that "at least two-thirds" of the leasing market was controlled by Russian lessors.

Austria's Raiffaisen Leasing is the leading foreign capital company in the sector. It signed $62.2 million worth of deals in the first nine months of 2004, but it ranked only fourth countrywide, according to Expert RA. Meanwhile, domestic RTS-Leasing, No. 1 on the market, completed deals worth $302.5 million over the same period.

"Local subsidiaries of international companies -- UniCredito Italiano's Locat leasing, Societe Generale's ALD or Raiffeisen Bank's Raiffeisen Leasing -- work mostly with large Russian corporate clients or Western companies," said Nikolai Volyansky, marketing director at Europlan. "They possess large financial capabilities but lack the experience or infrastructure to work with small and medium-sized businesses," he said.

"Western banks depend on their parent companies for financing and therefore operate in relatively small volumes," Kozhevnikov said.

Western lenders tend to be less flexible and more cautious than their Russian counterparts, said Chadbourne & Parke's Brank. "Western banks are only starting to look at the market," she said.