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Sri Lanka’s once-distressed licensed finance company (LFC) sector, which had revitalised in 2011, will immediately face the key challenges of having to preserve their asset quality amid inflationary pressures and aggressive growth, while maintaining margins in a scenario of rising interest rates as well as increasing competition from the banking sector, a top rating agency has predicted.
According to a recent industry update commentary published by RAM Ratings (Lanka) Ltd, the LFC industry’s asset quality is expected to be pressured, testing the strength of underwriting and collection procedures against the backdrop of rising interest rates and inflationary pressures.
“Despite the rising interest rates, the industry’s credit assets are anticipated to expand some 40%-50%, albeit at a slower pace than the previous year. The uptrend in credit demand for LFCs is also likely to be driven by the limits imposed on Licensed Commercial Bank’s credit growth by the regulator, the Central Bank of Sri Lanka,” the March 2012 LFC Sector update titled ‘Bracing for winds of change’ stated.
It noted that credit demand will remain anchored by the convenience of obtaining loans from the LFC sector and the relatively less stringent underwriting criteria, which will continue appealing to high-risk borrowers whilst the LFC industry’s growth is also underpinned by its adequate capitalisation and liquidity levels.
The industry’s margins are expected to thin amid the anticipated escalation in funding costs given the environment of increasing interest rates,” analysts pointed out in their Standpoint Commentary.
The report noted that although LFCs are expected to seek alternative funding options to fuel their rapid loan growth, deposits would gain prominence in an environment of rising interest rates.
“Despite the expected growth in deposits, we presume the loans-to-deposits ratio to remain elevated through the medium term – a level which we view with concern,” analysts predicted.
However, they highlighted that increased focus on subordinated debt and better internal capital generation are envisaged to preserve the industry’s overall capitalisation at adequate levels whilst in line with the anticipated loan expansion, the industry’s liquidity levels are expected to moderate, albeit maintained at adequate levels.
The LFC sector remains a small contributor to the Sri Lankan financial sector, accounting for only 3.49% of the sector’s total assets as at end-December 2011. Currently, 40 players operate in the LFC sector with 532 branches island-wide, catering to a perceived high risk clientele.
“Generally, LFCs’ asset quality is weaker than banks’, given the higher risk levels of their targeted clients. Increased awareness and efforts in improving asset quality bore fruit in fiscal 2011, as reflected by the slower accretion of non-performing loans compared to previous years. Nonetheless, the industry’s loan portfolio has yet to be sufficiently seasoned given the aggressive loan growth in 2011; RAM Ratings Lanka remains concerned that incidences of delinquencies will increase as the portfolio seasons,” the research report pointed out.
It added that despite the robust credit growth seen in 2011, most LFCs had managed to maintain adequate capitalisation levels, underpinned by strong internal capital generation and capital infusions by way of initial public offerings, to comply with the regulatory listing requirement by mid-2011.
“However, the industry’s funding mix had tilted towards borrowings, as deposit growth had not kept pace with credit expansion. Many industry players had increased their reliance on long-term borrowings due to the low interest rates, thereby reducing near-term maturity mismatches. This had also resulted in the worsening of the industry’s loans-to-deposits ratio to 139.13% as at end-December 2011 (end-March 2010: 90.28%),” this report further mentioned.
According to a recent industry update commentary published by RAM Ratings (Lanka) Ltd, the LFC industry’s asset quality is expected to be pressured, testing the strength of underwriting and collection procedures against the backdrop of rising interest rates and inflationary pressures.
“Despite the rising interest rates, the industry’s credit assets are anticipated to expand some 40%-50%, albeit at a slower pace than the previous year. The uptrend in credit demand for LFCs is also likely to be driven by the limits imposed on Licensed Commercial Bank’s credit growth by the regulator, the Central Bank of Sri Lanka,” the March 2012 LFC Sector update titled ‘Bracing for winds of change’ stated.
It noted that credit demand will remain anchored by the convenience of obtaining loans from the LFC sector and the relatively less stringent underwriting criteria, which will continue appealing to high-risk borrowers whilst the LFC industry’s growth is also underpinned by its adequate capitalisation and liquidity levels.
The industry’s margins are expected to thin amid the anticipated escalation in funding costs given the environment of increasing interest rates,” analysts pointed out in their Standpoint Commentary.
The report noted that although LFCs are expected to seek alternative funding options to fuel their rapid loan growth, deposits would gain prominence in an environment of rising interest rates.
“Despite the expected growth in deposits, we presume the loans-to-deposits ratio to remain elevated through the medium term – a level which we view with concern,” analysts predicted.
However, they highlighted that increased focus on subordinated debt and better internal capital generation are envisaged to preserve the industry’s overall capitalisation at adequate levels whilst in line with the anticipated loan expansion, the industry’s liquidity levels are expected to moderate, albeit maintained at adequate levels.
The LFC sector remains a small contributor to the Sri Lankan financial sector, accounting for only 3.49% of the sector’s total assets as at end-December 2011. Currently, 40 players operate in the LFC sector with 532 branches island-wide, catering to a perceived high risk clientele.
“Generally, LFCs’ asset quality is weaker than banks’, given the higher risk levels of their targeted clients. Increased awareness and efforts in improving asset quality bore fruit in fiscal 2011, as reflected by the slower accretion of non-performing loans compared to previous years. Nonetheless, the industry’s loan portfolio has yet to be sufficiently seasoned given the aggressive loan growth in 2011; RAM Ratings Lanka remains concerned that incidences of delinquencies will increase as the portfolio seasons,” the research report pointed out.
It added that despite the robust credit growth seen in 2011, most LFCs had managed to maintain adequate capitalisation levels, underpinned by strong internal capital generation and capital infusions by way of initial public offerings, to comply with the regulatory listing requirement by mid-2011.
“However, the industry’s funding mix had tilted towards borrowings, as deposit growth had not kept pace with credit expansion. Many industry players had increased their reliance on long-term borrowings due to the low interest rates, thereby reducing near-term maturity mismatches. This had also resulted in the worsening of the industry’s loans-to-deposits ratio to 139.13% as at end-December 2011 (end-March 2010: 90.28%),” this report further mentioned.
