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Finance companies shoring up for tougher times

Research from FundSource shows that a number of better-managed finance companies have been taking action over the last year to position themselves for tougher times ahead.

Thursday, 1 December 2005

Some companies have restructured their capitalisation by raising shareholders’ equity and improving their leverage ratios.

A few have also decided not to grow their assets in the short to medium term to ensure there is not excess liquidity, which will be a drag on interest earned.

This trend is already evidenced by the fall in advertisements for debentures in recent months.

Leading up to this point though, company performance has been strong. Assets continued to see healthy growth rates of about 15% to 18% per annum, similar to what has been seen over the last few years and at around $13 billion, over 80% of these assets have been funded by the investing public via secured debentures or unsecured deposits.

Average profitability margins are around 15%, but growth in profit margins has been mixed, with some companies seeing profit margins grow up to 5% while a few saw a contraction in profit margins.

Although FundSource have found diversity in the quality of companies, interest rates continue to remain in a tight margin of around 7% to 9% before tax for one year debentures.

This clearly indicates that some investors are not being compensated in line with the underlying risks.

The stresses from an economic slowdown will have varying degrees of impact on companies based primarily on the credit quality of who they lend to and the quality of the management.

FundSource believes that the prospect for individual companies will be vastly different from one to the other and that there is potential for some investors to be disappointed in the medium term.

However, some generalisations are possible.

Companies lending to property-related sectors are expected to find it increasingly difficult to identify good quality lending opportunities.

Numerous new operators have emerged but the pool of borrowers is shrinking, so competition for good opportunities will increase. A greater focus on costs due to tighter monetary conditions will put increased stress on those companies with a small asset base.

We expect that at least some of the many small companies will merge with the bigger ones to benefit from economies of scale.

Although attention has tended to focus on the impact of a slowdown in the property market on NBFCs lending to property and related areas, high market interest rates and any form of slowdown will potentially also impact companies focussed on consumer lending, and may impact other lending entities like banks too.

It is important that the more prudent investors who are invested with the better quality companies ensure that they do not get caught up in any knee-jerk reaction to possible stresses within the sector and not follow ‘irrational’ behaviour which may and typically does involve a lack of confidence in the sector as a whole and hence an outflow of funds.

In fact, one of the emerging concerns within the industry is the possible impact that the failure of one of the weaker companies may have on the industry as a whole.

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