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T F E W
+94 112 553089 +94 112 503551 +94 112 553090 ram@ram.com.lk www.ram.com.lk
JUNE 2013
Analytical Contacts:
Excluding the migrated entities Of this, Peoples Leasing Finance PLC (PLC) accounted for 35 branches (Source: PLC Annual Report 2012) Central Bank of Sri Lanka (CBSL) Annual Report 2011/12
Published by :
T F E W
+94 112 553089 +94 112 503551 +94 112 553090 ram@ram.com.lk www.ram.com.lk
The LFC sectors asset quality had weakened in the 9M ended FY Mar 2013 as envisaged. Unfavourable macroeconomic conditions and the seasoning of loans subsequent to the aggressive loan growth witnessed the previous year had resulted in a deterioration of credit quality. As LFCs cater to a social stratum whose risk profile is higher than that of a banks clientele, the impact of the unfavourable macroeconomic environment had been magnified in the sector. In the short term, delinquencies are expected to increase as loans have yet to season and the sector continues to be challenged to maintain credit quality; overall asset quality, therefore, is expected to remain at current levels. In the longer term, however, we expect asset quality to be supported by better macroeconomic conditions, resulting in reduced incidence of non-performing loans (NPLs) and improved recoveries. The sector demonstrated only a modest improvement in performance due to slower credit growth in 9M FY Mar 2013. Overall margins had narrowed as funding costs increased amid a faster repricing of shorter-tenured deposits in a high-interest rate scenario. However, the sectors yields stood higher than that of banks, thereby resulting in wider margins. Increased lending to lower-income earners in the form of micro-finance loans had also given rise to lucrative margins. Notably, a strengthening of core income was witnessed as the bulk of funding was channelled to interest-earning credit assets. This is viewed positively in light of the volatility of returns from non-core assets such as real estate and equity investments. Going forward, while easing interest rates are expected to result in broader margins, the benefits are expected to be offset to some extent by a probable increase in credit costs as new NPLs trickle in with the seasoning of loans. While customer deposits continued to be the sectors chief funding source, the funding mix increasingly tilted towards borrowings. Given the removal of withholding tax (WHT) on listed debentures and the benefits associated with funding via long-term debt such as the easing of inherent maturity mismatches, we expect a further tilt towards corporate debt. Moreover, the interest rate caps on medium-term deposits ranging from 2-3 years effective January 2013 may result in LFCs increasingly relying on longer-term borrowings. However, the funding mix is expected to remain dominated by deposits. Meanwhile, liquidity levels are expected to remain stable amid the gradual uptick in credit demand. Elsewhere, with almost all LFCs listed, increased transparency has resulted in better corporate governance across the industry. While many LFCs are still closely held, regulatory requirements such as regular Central Bank of Sri Lanka (CBSL) reporting, onsite audits by the CBSL, and increased regulatory criteria imposed on the senior management of LFCs have contributed towards improved corporate governance. Given the recent adoption of International Financial Reporting Standards (IFRS), we opine that financial statements will better reflect the underlying risks faced by LFCs. The most significant change in this regard is the move towards provisioning based on incurred loss, from time-based provisioning previously. While the shift will increase transparency in reporting in the medium term, many players are yet to gear themselves up for the recruitment of skilled personnel and system changes.
SSET QUALITY:
100%
90% 80% 70% 60%
Asset Composition %
50%
40% 30% 20% 10%
0%
FY Mar 2009 Property, plant & equipment Other assets Investments in land and property 8.34% 9.10% 8.60% 63.37% 0.52% FY Mar 2010 7.32% 10.71% 8.46% 61.40% 0.77% FY Mar 2011 6.08% 8.37% 6.11% 68.46% 0.87% FY Mar 2012 4.55% 6.52% 2.81% 76.71% 0.77%
10.07%
11.35%
10.11%
8.63%
8.35%
50%
40% 30% 20% 10% 0% FY Mar 2009 FY Mar 2010 28.60% 36.13% 9.10% 7.12% 3.72% 15.34% FY Mar 2011 32.69% 32.69% 6.24% 8.86% 2.23% 17.28% FY Mar 2012 39.25% 27.67% 4.53% 7.76% 1.44% 19.36% 9M FY Dec 2013 42.82% 27.67% 3.30% 7.44% 1.23% 17.55%
500%
400% 300% 200% 100% 0% -100% Motor Cars & dual purpose vehicles Three Wheelers Motor Cycles
2008
-16.92% 4.03%
2009
-69.51% -16.61%
2010
393.95% 129.23%
2011
162.78% 61.62%
2012
-24.57% -28.62%
-14.55%
-23.74% 4.60%
-13.16%
-41.41% -41.34%
51.31%
44.01% 38.28%
23.63%
25.10% 23.86%
-24.10%
-17.22% -8.95%
Lorries
Others
Source: Department of Motor Traffic
margins, compensating for the high risk exposure. That said, we understand that the extensive branch reach of players, close customer relationships, and continuous collection and monitoring play a crucial role in preserving loan quality in micro-financing. In our experience, the group lending approach is widely adopted among many players, which has resulted in better collections and low delinquency rates thus far. As such, we opine that loan quality in this segment would depend largely on the competence of its personnel, as successful implementation relies on constant interaction with the borrower. Higher interest rates are charged for micro-financing loans to compensate for the high credit risk of the target market. Consequently, the LFC sector benefited from broader margins due to increased exposure to this segment. Still considered an under-served segment, micro-financing presents much potential for growth.
ROFITABILITY:
NIMs pressured
Subsequent to broader NIMs in FY Mar 2012 as a result of increased investments in high-yielding credit assets at the time, the industrys NIM clocked in at 9.18% in 9M FY Mar 2013. Excluding the migrant SLCs, the margin narrowed to 8.48% compared to 8.74% in FY Mar 2012. While yields improved following increased exposure to lucrative products such as pawn loans, small-ticket loans and micro-finance loans, funding costs grew at a faster pace owing to a rising interest-rate scenario, where deposits repriced faster than credit assets, which resulted in narrower NIMs. Going forward, the sectors NIMs are expected to benefit from lower interest rates coupled with increased investments in higher-yielding assets in the immediate near term. however the margins are expected to stabilise in the medium term.
Customer deposits continued to be the sectors chief source of funding, accounting for 57.45% of its funding composition as at end-December 2012 (Chart 5). However, the sector increased its reliance on long-term borrowings in FY Mar 2012, given the slower growth of customer deposits compared to credit assets and to address inherent asset-liability maturity mismatches. Borrowings surged 151.01% in FY Mar 2012, charting a further growth of 66.73% in 9M FY Mar 2013. However, migrated SLCs accounted for 68.60% of growth in 9M FY Mar 2013, given that borrowings are the chief source of funding of SLCs. Customer deposits rose 27.06% and 28.33%, respectively in FY Mar 2012 and 9M FY Mar 2013. Increased reliance on borrowing to finance credit assets resulted in the industrys loans to deposits ratio deteriorating to 157.79% as at end-December 2012 (endMarch 2012: 141.31%). Going forward, the industry is expected to increase its dependence on long-term borrowings, given the removal of WHT in respect of listed debentures, and the medium-term deposit interestrate cap introduced by the CBSL, with effect from (w.e.f) 1 January 2013.
100% 90%
Funding Composition %
20%
10% 0% FY Mar 2009 Customer deposits Borrowings Shareholders' funds 66.52% 17.28% 16.20% FY Mar 2010 75.44% 11.48% 13.08% FY Mar 2011 72.63% 14.89% 12.47% FY Mar 2012 59.92% 24.36% 15.72% 9M FY Dec 2013 57.45% 23.48% 19.07%
Per cent
25 20 15
10
5 0
Apr-10
Apr-11
Dec-09
Dec-10
Dec-11
Apr-12
Jun-11
Aug-10
Aug-11
LCBs
LSBs
LFCs
Overall
Source: CBSL LCB: Licensed Commercial Bank; LSB: Licensed Specialised Bank;
Aug-12
Dec-12
Oct-10
Oct-11
Feb-10
Feb-11
Feb-12
Oct-12
Jun-10
Jun-12
APITALISATION:
The sectors capitalisation levels improved in FY Mar 2012 owing to several strategic capital injections to previously distressed LFCs. As at end-December 2012, capital funds grew only 12.49%, excluding the migrant entities, in 9M FY Mar 2013 (52.24% including migrant entities), given minimal capital injections and a lower internal capital-generation ratio of 19.64% during the period. The CBSL has revised the minimal core capital requirement of LFCs from LKR 300 million to LKR 400 million, w.e.f 1 January 2015. Although larger players in the industry have already met the requirement, we understand that smaller LFCs would be challenged to raise additional equity. Overall, we note that most LFCs had, by end-March 2012, adhered to the tier 1 and tier 2 Risk Weighted Capital Adequacy Ratio (RWCAR) levels of 5.00% and 10.00%, respectively, stipulated by the CBSL; some players reported a moderation in their RWCARs amid aggressive loan growth. Going forward, given an increased focus on 5 raising long term debt, the industrys tier-2 capitalisation levels could strengthen in the medium term. As demand for credit is expected to increase with a lag effect following rate cuts, capitalisation levels are not expected to be challenged in the near term.
Borrowings will be included in tier-2 capital only if they are subordinated and adhere to specific requirements of the CBSL
Following the listing of most LFCs by end-December 2012, the sectors corporate governance framework is has strengthened, with greater transparency in reporting financial statements and other related disclosures. Larger players were seen to focus more on risk management-related activities. However, we note that players owned by conglomerates could be exposed to group-related risks. On another note, LFCs adopted the Sri Lanka Financial Reporting Standards, w.e.f 1 January 2012, as opposed to the previous Sri Lankan Accounting standards. The most significant change is the move towards provisioning based incurred loss, from time-based provisioning previously. The new reporting standards are expected to better reflect the underlying risk profile of financial institutions, as they identify impairment based on assetspecific risk factors as opposed to the blanket time-based method used previously. However, the shift requires significant changes to the Information Technology (IT) systems of the companies in order to generate past probabilities of default in each risk pool and the resultant loss given default. Further, the move places great emphasis on personnel involved in identifying impaired loans, given that credit staff are now required to identify impaired loans a function carried out mainly by the finance division in the past. In this regard, many industry players are still to have systems and personnel in place to fully benefit from the adoption of IFRS.
ATING CONSIDERATIONS:
As loan seasoning took effect subsequent to aggressive loan growth in FY Mar 2012, most players witnessed a weakening of credit quality. This has continued to weigh down the sector in 9M ended FY Mar 2013 and LFCs continue to be challenged to maintain credit quality in the short to medium term. As such, overall asset quality is expected to remain at current levels. In the longer term, however, we expect asset quality to be supported by improving macroeconomic conditions, resulting in fewer incidences of NPLs and improved recoveries. Growth in credit assets had upheld the sectors overall performance in fiscal 2012 and in 9M FY Mar 2013. Anticipated broader margins amid easing interest rates, while auguring well for the sector, are expected to be offset, to some extent, by the probable increase in credit costs as new NPLs trickle in. All in all, an overall gradual improvement in performance is expected in the short to medium term, resulting in improved capitalisation levels. While funding mix is expected to remain relatively unchanged, however, an increasing tilt towards corporate debt is expected as LFCs seek funding from listed debentures. Meanwhile, liquidity levels are expected to remain at current levels with the gradual uptick in demand for credit expected going forward. All said, we opine that the outlook on the long-term financial institution ratings of LFCs rated by RAM Ratings Lanka will be stable in 2013, as reflected by the stable outlook on the long-term ratings of most entities within our portfolio.
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77,764.78
2,739.50 27,920.61 312,828.05 30,114.53 0.00 20,536.04 4,701.71 (3,405.57) 51,946.71 364,774.76
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StandPoint Commentary
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