Business Times

Finance firms to boom but lending prudence advised

By Duruthu Edirimuni Chandrasekera

Listed finance firms have bounced back significantly from the lows of the 2008/09 macroeconomic climate according to some analysts, but others caution their aggressive lending as an increase in interest rates will see them in a tight spot.

“The risk element for Finance Companies (FC) is stemming from the fact that their clients are from a comparatively riskier segment than that of a Licensed Commercial Bank (LCB). We did see a significant fall in the sector asset quality over 2008/09 period but are optimistic of a recovery given the high demand for motor vehicles, higher disposable income and profitability in the Sri Lankan macroeconomic picture,” Nikitha Tissera, Head of Research, Sampath Securities said.

More cars will drive FCs
He noted that the prevailing low interest rate scenario in the economy will continue to act as a catalyst for higher borrowing while this could also reduce the funding cost of the FCs. “The reduction in the import duties of motor vehicles will impact positively on the topline of the sector as a whole. The sector margins and profitability levels have been under somewhat pressure over the last two years, but we believe the combined positivism of the top line growth, decline in borrowing rates and an improvement in asset quality could bode well to the capital along with improved deposit growth,” he added.

Sarath Rajapakse, Director Capital Trust agreed, noting that with the reduction in import duty vehicle imports (used and new) sales have increased tremendously. “In Sri Lanka practically all the vehicles are purchased using leasing facilities from banks and leasing companies. Though the interest rates charged are generally higher at FCs, people like to obtain their leasing facilities from them rather than from banks since when dealing with the former less paper work and red tape is involved. As the economy picks up finance companies will benefit more than the banks from the boom,” he said.

FCs more attractive than FDs
Mr. Tissera noted that the downside threat of the higher risk profile and tolerance of the finance companies will be counterbalanced with the deposit growth where the rates offered by the sector are higher in comparison to the commercial banks.

Deshan Pushparajah, Manager Corporate Finance agreed saying the fall in interest rates makes the fixed deposits (FD) in banks unviable especially for pensioners and now because of this reason, the FCs are more attractive.

“Traditionally finance companies borrow short term (FD for one year or less) and lend long term (4-year leases etc.). Hence right now under the falling interest rate environment they have high interest rate lending portfolio financed by borrowings at much lower interest rates. Hence you will see the FCs posting very good returns in the next 2-years," he said.

He said that the recent cut in vehicle duties has ignited the vehicle market, hence those companies exposed to vehicle leasing has seen a big pick up in volumes.

Are FCs worth their salt?
However, he noted that FCs have traditionally had a smaller and more limited portfolio on both sides of the balance sheet as opposed to LCBs. “This is why they are more risky and with the current aggressive trend in lending, a turn in rates could find them in big trouble, with both borrowing rates going up while lending rates are fixed at lower rates and also bad debts due to waning macro economic conditions,” he noted.

He added that the growing profile of FCs needs to be taken with a pinch of salt and attached a higher risk premium to that of banks.

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