18 October 2007 The impact of the CRD on the leasing industry in plain language Dr. Mathias Schmit.

18 October 2007www.sagora.eu

The impact of the CRD on the leasing industry in plain language

Dr. Mathias Schmit

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Managing Risk in Leasing Business

Agenda

• CRD: Impact on financial performance

• Business opportunities under the CRD

• Conclusions

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Managing Risk in Leasing Business

Basel II: A new framework

CAPITAL DISCLOSURESUPERVISION

FINANCIAL STABILITY

capital requirements

based on market, credit, and

operational risk

disclosure including the

control of risks

qualitative supervision internal process & risk control

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Basel II or CRD?

• First draft of Basel II in 1999

• EU Official Journal on 30/06/2006 Ref: L 177/201

• How far along is the national transposition process?

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Managing Risk in Leasing Business

CRD complemented…• ”

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Basel II Credit Risk and the Balance Sheet

new risk weights for

capital requirements

ROE will be impacted

credit spreads will change

credit spreads will

change

Balance sheet

RRE/CRE

Loan

Leasing

Other

Funding

Funding

Capital

Off-balance instruments

Capital

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Regulatory capital for real estate investment

• Capital may differ from a ratio of 1 to 5 in respect to:

– The approach adopted by the credit institution• STD: product vs. counterparty approach• IRB approaches (PD, LGD)

– The type of product / Counterparty (STD)• CRE/ Lease/ Specialized lending• Retail / Corporate / PSE• What if a lease to a PSE?

– Qualitative requirements are met or not• Independent valuation• Legal certainty• Insurance

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Managing Risk in Leasing Business

Source: Schmit M., Journal of Banking and Finance, April 2004.

Basel I I vs. Internal Model - Automotive leasing -

(age: 12-23 months, maturity: >47 months)

0123456789

10

Standardised IRBF(corporate;LGD: 40%)

IRBA (retail) Internal Model

%

Standardised

IRBF (corporate;LGD: 40%)

IRBA (retail)

Internal Model

Hiiiiiiiiiiiii !!!

Yeahhhhh!!

OK but…

Regulatory capital for equipment lease

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EU translation : IRB Guaranteed Residual Values or Bargain Option

Basel II EU Directive

lease exposures as the minimum lease payments under IAS 17

Guaranted residual value

0%

20%

40%

2,6%

3,7%

4,8%

2,6%

2,6%

2,6%

Assumptions:PD=1%LGD=30%

Guaranteed residual value

Guarantee: conditions on the guarantor and on the guarantee

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Managing Risk in Leasing Business

Evolving business environment• Competition and pressures

– Pressure to have higher RV (e.g. car manufacturers)

– Business needs and opportunities are evolving

• Product lifecycle decreases

• Assess the value chain to define adequate actions

• New regulations (IAS, Basel II, etc…)

– Give new incentives and opportunities to leverage business benefits if:

• All impacts of regulations are clearly understood by all parties (and thus to the bank partners and other stakeholders)

• A clear vision of the business partners emerges to generate collaborative advantages

• A wide buy-in by the different stakeholders

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Managing Risk in Leasing Business

New opportunities

Vendor Bank

•Portfolio management

•Market and commercial knowledge

•Ancillary services

•Risk appraisal

•Calibration and managing RV

•Risk coverage (premium)

•Buy risk mitigants

•Reduction in ‘excess capital requirement’

•Response to change pricing dynamics

Client

•Fleet management •Leasing contract

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New opportunities

• Identify your potential partners given your strategic objectives

– Multi or mono brand vendor

– Proposed ancillary services

– Re-marketing strengths

– Etc…

• Understand the benefit and risks of all parts of the business value chain

– Customers: creditworthiness, volume, country

– Structure of the transactions

– Vendor characteristics and services

• Build your win-win relationship

– Adequate structure

– Mitigate risk if needed: e.g. lower LGDs, PD, EAD

– Adequate rewards: risk vs. volume

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Conclusions

• The better knowledge of risk is key to be compliant and/or in

line with the best practices

– Regulated vs. non-regulated

– Lease specificities

• Having an integrated risk management framework will allow

to better identified and assessed business opportunities

• Rethinking leasing business relationships will offer new

opportunities under the EU implementation of the CRD

• Examples of new business models already (being) achieved

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Managing Risk in Leasing Business

Some references• Schmit M., “Credit risk in the leasing industry”, Journal of Banking and Finance, 2004, 28,

pp. 811-833.

• Schmit M., “Is automotive leasing a risky business?”, Finance, forthcoming.

• Schmit M., “The new Basel capital accord and the future of the European financial system”, Report of a CEPS (Centre for European Policy Studies) Task Force, pp. 47-50, 2004.

• Laurent M- P and M. Schmit, “Estimating “distressed” LGD on defaulted exposures: A portfolio model applied to leasing contracts”, in Recovery risk: the next challenge in credit risk management, a RiskBooks publication edited by Altman E., A. Resti and A. Sironi, pp. 307-322, 2005.

• Laurent M-P, “Asset return correlation in Basel II: Implications for credit risk management”, under review in Risk.

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For More Information

Dr. Mathias Schmit

Partner

SAGORA, Lease and Risk Management

Avenue de Haveskercke, 28

B-1190 Brussels

Mobile: (32)-496.93.22.70

Email: [email protected]

Website: www.sagora.eu

Thank you for your attention !

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(Un)guaranteed Residual Values

Major step forward

RESULT Substantial gains of capital and opportunity cost

Initial text Actual calculation of capital requirement for leasing:

100% * 8% * RV to be set aside over all the term of the lease

(100% /T) * 8% * RV each year

Major commitment in terms of cost of opportunity

Inappropriate compared to the risk incurredBUT