Financial Times

Fitch warns of liquidity crisis in finance cos. if economy weakens

With a lot of attention these days on illegal finance companies, Fitch Ratings – part of the global Fitch ratings agency – has prepared a report on registered Sri Lankan finance companies (RFC) in which it says challenges to liquidity in this sector could arise if the weak macroeconomic environment continues.
Last week the government ordered a probe into the collapse of a unregistered finance company in Nugegoda that left depositors in the lurch with about a billion rupees worth of deposits and the owner vanishing to India, according to newspaper reports. This however is not the first time small-time, unregistered finance companies, have decamped with the money causing serious problems for gullible investors.

Fitch said it was concerned about the significant growth in a number of RFCs. “This could be detrimental,” it said, “ as the credit profile of these companies could deteriorate if the current economic climate were to persist”.

It said, “In such a scenario, improving liquidity by way of deposit mobilisation could become a challenge. Furthermore, Fitch notes that whilst the larger established RFCs are able to minimise re-financing risk as they continue to have access to institutional funding, most commercial banks have made policy decisions to curtail growth to the large majority of this sector; therefore short-term liquidity relief and refinancing of borrowings could be an increasing challenge to a number of the smaller companies.”

The Fitch report, timely in the context of bogus deposit collectors, says the sector outlook is ‘Stable to Negative’, reflecting the agency's view that the ratings of well capitalised RFCs with an established franchise should remain unchanged in the short to medium term - i.e. they should be better able to weather the current weak macroeconomic conditions.

However, some negative rating actions could be expected on the smaller RFCs with weak deposit franchises and low support elements if the high inflationary, high interest rate environment were to persist, with liquidity increasingly becoming a challenge.Fitch said whilst RFCs are currently meeting the statutory minimum liquid ratio of 15% as imposed by the Central Bank (CB), maintaining liquidity could become a challenge in a scenario where deposit growth slows or contracts, and asset quality weakens substantially over a short time horizon.

Rising interest rates since the latter part of 2006 coupled with inflationary pressures has impacted credit quality in the sector, with its client base coming mostly from the relatively riskier market segment lying beyond the risk appetite of commercial banks. This is depicted by rising delinquencies over the period with the gross NPL ratio rising to 13.8% at end-June 2008 (Q109) from 11.5% at end-March 2007 (FYE07). The RFCs' loan book primarily consists of leases and hire purchase for the financing of relatively lower-value commercial vehicles.

Deteriorating assets
Fitch observes that deteriorating asset quality is exacerbated by the challenge of fully recovering dues on the sale of foreclosed assets, owing to a declining demand for vehicles in tandem with falling profitability throughout the economy, the Fitch statement said.

In addition to credit risk, RFCs are subject to significant market risk, as fixed rate vehicle leases and hire purchase agreements with average tenures of five-years are primarily funded by customer deposits which mature in one-year or less.

Effective from April 2008, the CB reduced the ceiling on a one-year fixed deposit to 2% above the 364 day T-Bill rate. Fitch observes that the probable intention of the reduction was to mitigate aggressive growth in the current environment, and thereby minimise rising systemic risk in the RFC sector.

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