Fresh challenges for financial sector firms from policy rate hike

The recent policy rate hike from the Central Bank is expected to bring fresh challenges to the financial sector firms, according to CT Smith Stockbrokers.

It said the finance sector companies are likely to go through a tighter economic period as the general consumer debt servicing capacity is expected to deteriorate in the short to medium term.

“As a result we expect a slight deterioration in the finance sector NPAs during FY2012,” CT Smith said.

“We however do not expect Licensed Commercial Bank (LCB) Net Interest Margins (NIMs) to come under severe pressure, as the Asset-Liability Mismatch (ALM) of LCBs is highly regulated compared to Registered Finance Companies (RFCs) and Specialised Leasing Companies (SLCs),” the stock broking firm said in an analysis.

It also expects the LCB sector Current And Saving Account (CASA) ratio to slightly deteriorate during FY2012E due to the rising interest rate scenario. NIMs of RFCs and SLC are also expected to come under pressure during 2012, as general business practice is to borrow short term to fund their relatively fixed long term investments.

“Nonetheless, we expect the recent policy measures to improve stability in the banking sector, though at the cost of growth,” CT Smith said.

While the Central Bank directed the LCBs to limit credit expansion to 18% in 2012E (as opposed to 34.5% in FY2011), this is consequently likely to limit financial sector fund growth resulting in a slowdown in sector core income growth. However, if LCBs manage to obtain foreign Tier II funding, the said growth in credit is allowed to reach a maximum of 23%, which is also expected to increase foreign fund flows to the economy.

“We maintain our top line growth forecasts for our banking sector stocks as we have already taken effected revisions to our LCB top line growth targets to factor the aforementioned criteria,” CT Smith said.

With regard to the impact on the non Financial Sector companies, it said highly geared companies are likely to have a negative impact owing to increased finance costs, whilst several more are also expected to be negatively impacted owing to CBSL’s policy move.

They include businesses which depend on (low cost) debt capital to promote sales, i.e. land and property, motor vehicles and consumer durables; and Companies engaged in (credit driven) import related businesses.

CT Smith also said that the increase in policy rates should impact the stock market negatively. Reasons listed include - Reduce interest in equities while encouraging a switch from equities to fixed income instruments; Reduce corporate profit expectations (especially for highly geared companies); Relatively expensive stock valuations (owing to higher cost of capital) compared to regional stock markets and Higher costs on margin facilities.

Overall CT Smith said that the recent policy measures together with the policy rate revision done in April 2012 are expected to bring in stability to the economy, economic growth will however likely be sacrificed in the near term.

In its Monetary Policy Review for April, the Central Bank of Sri Lanka (CBSL) increased its repurchase rate and reverse repurchase rate by 25bps and 75bps to 7.75% and 9.75% respectively (w.e.f. end 5 April 2012) in order to further decelerate credit growth and anchor inflation expectations. See tomorrow’s FT for the full analysis of CT Smith Stockbrokers.