Finance company earnings plunge into negative territory

• Sector ROI at negative 19% during April-June quarter
• In absolute terms, Rs.10bn loss compared to Rs.1.7bn profit a year ago
• Past data suggests sector going through extremely rough patch
• Continuation of lackluster returns could push for sector consolidation  
• Sector NPL at 14.14% at end-June up from 11.37% at end-March 

Cumulative earnings of Sri Lanka’s non-bank finance sector have turned sour during the second quarter of this year, plunging sector earnings into negative territory, and the data available since 2013 does not indicate such trying conditions ever faced by the sector. 

According to annualised return on equity (ROI), the closest proxy for sector earnings for the three months from April through June, has recorded a negative 19.35 percent, reflecting the deeper troubles facing the non-bank finance company sector. 

ROI is arrived at by comparing the annualised profit after tax of the entire sector as a percentage of average equity. 

In absolute terms, the sector has reported negative earnings of Rs.10.0 billion during the three months to June compared to Rs.1.7 billion in earnings reported in the comparable period in 2019. 

The problems at Sri Lanka’s non-bank finance company sector predate the coronavirus pandemic as the sector was reeling from faltering earnings, rising non-performing loans and sluggish growth since mid 2017. 

To put things into perspective, the sector reported ROI in the north of 20 percent until end-2016, after which the earnings and thereby the returns to the shareholders were on a downward spiral. 

Unless the sector stages a faster rebound, there is a risk of investors abandoning the sector for other industries, which offer more stable returns. The protracted negative earnings or lackluster returns compared to the heightened risks they take could also naturally compel companies to merge. 

During the August Monetary Policy press, the Central Bank Deputy Governor H.A. Karunaratne said they would soon unveil a sector revival plan, with industry consolidation by way of mergers and acquisitions being at its core. 

In response to the challenges to the business climate and the relief afforded to pandemic-affected borrowers, the Central Bank relaxed capital and liquidity requirements of the sector. 

However, the sector was losing business to banks, which became a part of the Saubhagya refinance scheme that offered working capital loans at 4 percent. Also, the banking sector is operating with more liquidity than its non-banking counterparts providing it with more wiggle room to offer loans at competitive rates. 

The Central Bank in an earlier instance said 20 out of 49 finance companies in the country were facing some kind of liquidity issue and the regulator is considering liquidity support for four such companies based on their requests. 

Non-banking finance sector also has a weak deposit franchise compared to banks, which saw a rapid buildup in their deposit bases during coronavirus lockdowns.  

Meanwhile, the sector gross non-performing loans reached 14.14 percent of its total outstanding loans by end-June, eclipsing its earlier highest of 11.37 percent in March.