The asset quality in the registered finance company (RFC) industry has been deteriorating over the past two years, having been affected by the economic downturn. According to a report by RAM Ratings (Lanka) Ltd, loan growth is expected to decelerate while asset quality is likely to be tied to macroeconomic fundamentals and overall business sentiments.
RAM noted that although asset quality varies significantly among the different industry players, many RFCs have improved their credit-origination standards and monitoring procedures aside from strengthening their recovery efforts in a bid to maintain asset quality.
RAM stated in the report that the much-publicized collapse of two finance companies in 2008 had focused the spotlight on deposit-taking financial institutions. As a result of sudden and substantial withdrawals, many of these entities faced liquidity pressures while the segment which was hit hardest was the RFC sector.
However, well-rated or prudently managed RFCs had been able to withstand the pressures better than others. Moreover, the timely intervention of the Central Bank (CB) and a spate of ownership and/or stewardship changes have helped stabilize the industry.
According to the report, one of the key indicators of the health of a financial institution’s loan portfolio is its gross non-performing-loan (NPL) ratio. The NPL ratio of an RFC measures the proportion of loans that have been in arrears for a period of six months or more. RAM noted that the industry’s gross NPL ratio has been deteriorating in the past two years, rising to 6.46% as at end-March 2009 from 4.56% as at end-March 2007. The quality of loans has weakened as many borrowers have been unable to service their debts as a result of elevated interest rates and inflationary pressures.
The report stated that in line with the poorer asset quality, most RFC’s have taken steps to curtail lending and have adopted a relatively conservative approach when expanding their loan books.
However, it is vital to note the significant level of variance among the different RFC’s with regard to risk management and hence, asset quality. Certain players have successfully maintained consistently healthy, better-than-industry asset quality due to their commendable credit-origination standards and unmitigated focus on monitoring.
The report stated that it is evident that most RFCs have strengthened their recovery procedures with regard to repossessing vehicles for which payments are in arrears.
Accordingly, RAM noted that there has been a build-up of seized assets in the industry. Given the slump in demand for vehicles, many RFCs face difficulties when trying to dispose of these repossessed items. This is viewed with concern as several players have been forced to sell off such vehicles at a loss.
RAM says that another concern is the industry’s heightened exposure to real-estate assets. The RFC industry’s investments in real estate spiked up Rs.5.4 billion to Rs.14 billion in the year ended 31 March 2009, translating into 8.6% of the sector’s total assets. Increasing exposure to real estate is deemed risky because of the current slump in the property market and the inability to dispose of assets in the short term, thereby exposing RFCs to liquidity risk.