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Finance Company Margins to Dip, Leases to Moderate, but Asset Quality to Remain High: Research Report

Published on Mirror Business on 2017-04-07

The interest margins of finance companies in the country are expected to shrink during this year amid rising interest rates, as bulk of the loan portfolios comprises of fixed rate leasing, mostly given on vehicles, according to a finance sector report by a leading investment banking group. The average credit growth in the finance company sector is forecast to remain around 17-18 percent, a moderation from the high of 30 percent in 2016.

Sri Lanka’s licensed finance companies and specialized leasing companies together own about Rs.853 billion in assets, roughly 7.0 percent of the total assets of the financial system. They had a party time during the last two years with record high profits and growth.

According to data compiled by F C Research, the research arm of the First Capital Group, they reported total earnings of Rs.21.2 billion for 2016, up from Rs.16.9 billion in 2015.

Sri Lanka’s banks and finance companies were the direct beneficiaries of the slashing of taxes on vehicle imports and the lower interest rates in early 2015 by the good governance regime to keep their election promise to enable every family to own a car.

But that party did not last long as the economy was plunged into a balance of payment crisis with the Central Bank selling reserves to defend the rupee. The Monetary authority was also compelled to keep the interest rates artificially low by printing scores of money to make way for the fiscal profligacy.

Credit to the private sector soared recording historically highs year-after-year, of which most of the moneys went to satisfy the unfettered consumerism on the part of the Lankans, including close to 1.5 million units of vehicle imports during 2015 and 2016, causing chaos on the streets.  Then the excise duties were raised and higher down-payments were mandated by the authorities to curb the influx of vehicles into the country.

This has a significant impact on the margins of finance companies, profitability and growth because at least 50 to 60 percent of their portfolios comprise of leasing and hire purchase.  The margins come under pressure because leasing, mostly 5 – year contracts, cannot be re-priced but the deposits, of which over 90 percent tend to be 1-year deposits, get re-priced frequently.

However, the larger finance companies with better credit ratings and access to cheaper funds could be less affected as their overall cost of funds could be maintained at a minimum.  There could also be a possibility of finance companies shifting from vehicle leases to vehicle loans to ward off any future impact on margins. But this may come with the risk of not being able to re-possess the vehicle when the borrower defaults.

But the default risk becomes lower when the vehicle prices rise because the borrower now has an asset worth more than the original value for which he had entered into the lease or the loan agreement.

F C Research forecasts the private sector credit growth to moderate to 12-14 percent during 2017 from 21 percent in 2016.  But the finance sector is expected to show a faster credit growth of 16-18 percent because they have traditionally been growing at a faster rate than the banks.

Nevertheless the research house does not expect the rise in interest rates to have an adverse impact on the finance companies’ asset quality because the re-sale value of the vehicle stock tends to increase resulting in lower provisions for possible bad loans.

“New LTV regulations, rupee depreciation and increased taxes have led to a significant rise in vehicle prices in the brand new vehicles market invariably resulting in rise in second hand market vehicle prices.

We believe the appreciation in asset value discourages borrowers from defaulting while also it helps finance companies to easily dispose the asset in case of a default without financial loss as the value of the asset is higher,” F C Research said in their sector report. Considering these mixed outlook, where negatives will be offset by positives, FC Research advises the investors to ‘hold’ the finance sector stocks but singled out a few stocks with a ‘strong buy’ advise.