A recently released update on Licensed Finance Companies (LFCs), by ratings agency RAM, is forecasting that, while the industry's credit assets are set to expand by upto 50% over 2012, asset quality will become "pressured" due to rising interest rates and inflation. As a result, the industry is also likely to face tests to the "strength of its underwriting and collection procedures."
Further, RAM suggests that "industry's margins are expected to thin amid the anticipated escalation in funding costs given the environment of increasing interest rates. Although LFCs are expected to seek alternative funding options to fuel their rapid loan growth, we envisage deposits to gain prominence in an environment of rising interest rates."
According to RAM's update; "In line with our expectations, the once-distressed licensed finance company ('LFC'), formerly known as the registered finance company ('RFC') sector had revitalised in 2011. The industry's credit assets posted robust growth, driven by rising credit demand amid a more conducive economic climate. In contrast to the previous financial year, the industry' liquidity levels moderated in FYE 31 March 2011 ('FY Mar 2011'), fuelled by aggressive loan expansion of around 40%."
However, RAM also cautions that "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 ('LD') ratio to 139.13% as at end-December 2011 (end-March 2010: 90.28%)."
On the other hand, RAM also comments: "Despite these challenges, we opine that demand for lending within the LFC sector will be anchored by the ease with which loans can be obtained; their relatively less stringent underwriting criteria will continue to appeal to high-risk borrowers. Meanwhile, weakening asset quality will be mitigated by adequate capitalisation while liquidity is perceived to be able to adequately support loan expansion. All said, the outlook on the long-term financial institution ratings of LFCs rated by RAM Ratings Lanka will remain stable in 2012, as reflected by the stable outlook on the long-term ratings of the majority of the rated entities in our portfolio."