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Business


 

The All Share Price Index (ASPI) rose by 1.5% WoW to close at 2,624.5 points and the Milanka Price Index closed down 1.0% WoW at 3,554.7 points. The major gainers this week were LOLC (+44.0%), Hatton National Bank (+14.3%), Chemical Industries (+9.4%) and Asiri Surgical Services (+6.9%).
Average daily turnover for the week increased markedly to LKR1,038.5 mn (280.4% WoW), on the back of strategic transactions in the banking sector, John Keells Holdings and Dialog Telekom coupled with heavy trades in LOLC and Peoples Merchant Bank.
Retail interest was witnessed in LOLC, Peoples Merchant Bank , Hatton National Bank and Ceylon Leather Products.
Further more institutional investments were concerted around the Banking sector, Dialog Telekom, Aitken Spence and Distilleries.
Institutional and foreign participation mainly supported the total turnover of the week.
Net foreign purchases were witnessed in John Keells Holdings, Dialog Telekom and Aitken Spence.

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Rising interest spreads propel commercial banking profits

Driven by fiscal dominance, Sri Lanka’s commercial banking interest spreads have widened to their highest levels of over 9% in 2007 rising from the average levels of 5%. In 2007 YTD, on the back of a 563 bps rise in the benchmark 3 months government Treasury Bill yield to 18.40%, the prime Lending Rate (PLR) has surged 505 bps to 20.46% although the Average Weighted Deposit Rate (AWDR) has risen less sharply by 205 bps to 9.65%.

Relatively strong GDP growth and higher inflation has enabled banking sector loans and advances to grow by 21.7% YoY to LKR1,200.7 bn in 1H2007, whilst rising private foreign currency remittances (up 18.4% YoY to USD1,313.5 mn in 1H2007) has driven deposits by 29.6% YoY to LKR1,323.8 bn.

Banking sector Non Performing Loans (NPL) ratio has declined to an all time low of 5.2% in 2006 and has recorded a measured increase to 5.7% in 2Q2007 whilst NPL’s net of collateral are at only 1.9%. Meanwhile being well capitalized far ahead of the minimum core capital requirement (CAR) of 5% and total CAR of 10% the entire sector could easily withstand sudden adverse shocks.

Despite a higher effective tax rate of over 50% which has capped super normal profit growth, the banking sector profit continues to bolster with a ROE of over 16%.
Commercial banking sector net profit has grown by 48% YoY in 1H2007 despite being burdened with a high tax bill. Underpinned by rising interest spreads, we expect sector earnings to rise 28% YoY in 2007E and a further 20% YoY in 2008E.
Following the stride in share prices in 1H2007 the banking sector trades on 8.4X forecast 2007 net profit and 7.1X projected 2008 earnings.

Since the market peak in February 2007, the banking index also has come off by 15.9% mirroring the broad market dip of 17.9%. Thus banking stocks which normally command a premium over the market displays good value. Given the strong earnings growth outlook, relatively attractive valuations (2007 PER of 8.4X and PBV of 1.4X), high ROE of 16.1% and all time low NPL’s we are OVERWEIGHT in the commercial banking sector. Our picks in the sector are Commercial Bank (COMB), Hatton National Bank (HNB), Sampath Bank (SAMP) and National Development Bank (NDB).

During the past thirty six months average annual loan growth in the industry has neared 28% YoY driven by relatively higher GDP growth and inflation levels. Concurrently banking sector loans and advances has grown by 23% YoY to LKR1,377 bn in 1H2007. However the prevailing high interest rates may contain loan growth in 2H2007 though larger spreads would provide additional support to net interest incomes mitigating any drawbacks from slower loan book expansion.


The average deposit growth has averaged around 18% YoY during the past thirty six months driven by rising individual wealth growing on a 15.5% CAGR, 2003-06 and foreign exchange remittances increasing by a CAGR 20% CAGR during the same period. Thus we believe deposit growth to be robust with an aggressive drive by the commercial banks to attract, low cost deposits (current and savings accounts) whilst growth in time deposits would be fairly high given the high interest rate scenario.
Further given the larger mix of low cost deposits, COMB, SAMP and HNB would be in a better footing to exploit the widening spreads. However growing from a low base NDB also has shown commendable deposit growth whilst stepping up its loan book expansion.

Central Bank statistics reveals that banking sector health has been continuously improving with net NPL ratios dipping towards 1.9% and gross NPL ratios also edging down towards 5.2% in 2006 whilst gross NPL ratios have been maintained around 5.7% in 1H2007 despite a high interest rate environment. NDB and COMB leads the pack in asset quality, benefiting from their stringent credit evaluation policies whilst having only a meager impact despite rising rates.
The Central Bank implemented a fresh policy in further mitigating any potential credit risk through increased provisioning. Thus the banking sector is required to have a general provision amounting to 1% of all performing advances under by 2Q2009. Thus since end 2006 the provisioning cost has continued to increase with industry continuing to increase the general provision by one tenth of the stipulated requirement.

Further the banking sector is well capitalized with NDB being in the forefront having a total CAR of around 21.4% whilst COMB and DFCC also pursued a fresh cash call in 1H2007 to increase their capital base inline with BASEL 2 requirements.
Meanwhile taxation continues to hold back net profit growth with the banking industry burdened with an effective tax rate of over 50%, whilst subject to a corporate tax rate of 35% and a value added tax of 20% on banking income.
Nevertheless despite a high tax burden the banking industry net profit had grown at around 35.7% per annum, 2004-2006 whilst we believe net profit to increase by a 21.9% CAGR, 2006-2008E. Thus sector ROA is also expected edge up towards 1.4% in 2007.

Despite the SL banking sector still dominated by the two state banks (People’s Bank and Bank of Ceylon), the private commercial banks are cashing on the inefficiencies of state institutions, growing corporate sector and increasing personal wealth levels for growth, whilst accounting for nearly 58% of the total commercial banking assets.
Since the market peak in February 2007, the banking index also has come off by 15.9% mirroring the broad market dip of 17.9%. Thus banking stocks which normally command a premium over the market displays good value. Given the strong earnings growth outlook, relatively attractive valuations (2007 PER of 8.4X and PBV of 1.4X), high ROE of 16.1% and all time low NPL’s we are OVERWEIGHT in the commercial banking sector. Our picks in the sector are Commercial Bank (COMB), Hatton National Bank (HNB), Sampath Bank (SAMP) and National Development Bank (NDB).

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Bank of Ceylon ‘AA(lka)’ national rating affirmed by Fitch

(LBO) – Fitch Ratings Lanka has affirmed the National Long-term rating and Individual Rating of Bank of Ceylon (BOC) at ‘AA(lka)’ and ‘D/E’ respectively.

It said in a statement the affirmation reflected “the bank’s systemic importance as the largest bank in Sri Lanka with 18.2% of the banking system assets, its relatively stable financial profile, and state ownership.”
The Outlook on the rating remains Stable.
Bank of Ceylon is the main commercial banker to the government, and one of the two commercial bankers to state-owned enterprises, extending direct credit, trade finance facilities and foreign currency funding through its large deposit base and cross-border borrowings.

The bank’s loan book grew well above the banking system at a rate of 32.1 percent between FYE05 and FYE06, and at an annualised rate of 38.1 percent between FYE06 and H107, Fitch said.
“This enabled the bank’s non-performing loans (NPL)/gross loans ratio to improve sharply to 5.7 percent at H107 from 6.7 percent at FYE06 and 7.8 percent at FYE05.”
Despite an increase in absolute NPLs, as well as the high NPL ratio for non-state sector exposures at 12.3 percent at FYE06, the overall NPL ratio was on par with the system.

Profitability, as measured by post tax return on assets, increased to 0.9 percent in FY06 from 0.6 percent in FY05, before dipping back to 0.6 percent in H107, Fitch said.
“BOC’s profitability remains constrained by tight net interest margins (3.3 percent in H107 and 3.8 percent in FY06) and a high cost base - both of which are expected to impact profitability in the short term.” BOC has a 1.78 percent shareholding in Fitch Ratings Lanka but is not involved in either the day-to-day operations or credit rating reviews undertaken by Fitch Ratings Lanka, the rating agency said.

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Entrepreneur of the Year Awards announced soon

By Quintus Perera
The Sri Lankan Entrepreneur of the Year Awards is a uniquely national honour, which recognizes the valuable contribution made by entrepreneurs to society. The prize has been awarded for the past 12 years, said Nawaz Rajabdeen, President, Federation of Chambers of Commerce and Industry of Sri Lanka (FCCISL) at the Press Conference following the signing of the MOU with Suntel Ltd, who will be the strategic sponsor at this years awards ceremony.

This is the third consecutive occasion Suntel has been the strategic sponsor for this prestigious awards ceremony.
Rajabdeen stated the awards honour those innovative entrepreneurs who endeavour to reach new horizons in business and industry.

The president went on to add the awards ceremony has become the greatest of its kind as the FCCISL are not only honouring the entrepreneurs in the metropolis, but are embracing entrepreneurs from the entire country, including North and East.
Rajabdeen said that this is the only such programme that recognizes the provincial and national level entrepreneurs, which provides a great impetus for the Sri Lankan entrepreneur, especially in spurring greater competitiveness of small and medium level entrepreneurs.

The National Sri Lankan Entrepreneur Awards is scheduled to be held on the 30 November at the BMICH, while the awards for the North and East Regions will take place on the 18th of October, in Uva on the 19th of October, in the North Central and Wiayamba on the 14th of November, in Central on November 15, and in the Southern Region the Awards Ceremony will be held on the 16th of November.

Hasitha Abeywardene, Director, Marketing and Sales, Suntel explaining as to why Suntel decided to sponsor Sri Lankan Entrepreneur of the Year Awards for the third time said that a country’s progress is determined by the enterprising spirit of its people, especially in countries like Sri Lanka where the private sector is a key driver of the economy.

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SEC amends CSE Member Regulations

Credit by brokerage firms to clients reduced from 75% to 50 %

The Securities and Exchange Commission announced that the percentage of credit which may be extended by brokerage firms to their clients, in accordance with Rule 25(iii) of the Member Regulations, be amended to reflect 50% instead of 75%, as is currently stated, and that the same be incorporated to the Member Regulations of the Colombo Stock Exchange with effect from 1st of January 2008.

The rule will limit brokerage firms from lending more than 50% of the market value of an investor’s portfolio. This is in line with the internationally accepted credit margin exposure limit, which is followed by advanced jurisdictions and large markets such as USA, and India. It is expected that this initiative will further complement the risk mitigation and management stance the commission has adopted with the reduction of the settlement cycle risk by adopting a single tier settlement cycle (T+3) with effect from 10th December 2007. Again, this move is consistent with worldwide best practice.

In most markets credit margin exposure allowed on initial purchases of Equity (Shares) has been limited to 50% of total value of such purchases of shares marked to market on a daily basis. In addition, in response to downturns in share prices, periodic margin calls are made (this threshold differs from country to country) on the buyer to maintain the 50% equation. In many other markets (Ex. India), Stock Brokers who are much better capitalized than in Sri Lanka (currently only Rs.25 million per stock broker) are not allowed to extend credit at all or allowed only very conservative exposure limits. Only margin providers, who are separately capitalised, are allowed extension of credit to purchase shares subject to 50% limit.

However, at the CSE, Stockbrokers are not explicitly prohibited from extending credit. Our recent efforts have ascertained that approximately Rs.1 billion had been extended by Stockbrokers to the market. The Commission is committed to continuously monitor this figure and use Rule 25 of CSE and Net Capital formula to prevent excessive credit expansion to the market and possible credit fueled speculation not to mention the risk to individual Brokerages. Such a stance, we believe is in the interest of all stakeholders in the marketplace.

Impact of the above recommendation on the market
The following illustration using actual and estimated figures calculates the actual outflow to be expected from the reversal to 50% margin.
As stated above, collection of data by the Supervision Division of SEC in the last two months has ascertained that all brokers put-together have extended approximately Rs. 1000 million in credit for share purchases. If one assumes all have adjusted to the earlier 75% rule (which is the worst case), the total portfolio backed by above is Rs.1333 million of which equity portion is Rs.333 million (ie.25%).

With the reverting to 50% rule, the brokers can make a margin call from the clients to the tune of Rs.667 million to make the total assets of Rs.2000 million funded by Rs.1000 million debt and Rs.1000 million equity. However, this is unlikely to happen due to unwillingness of clients to put up more equity funds.

The most likely scenario would be to reduce the portfolio size to meet the 50% equity requirement. Sell down of only Rs.667 million worth of shares would meet this requirement. Debt portion will come down from current level of Rs.1 billion to Rs.333 million to match equity portion in a total portfolio of Rs.666 million.

We can therefore conclude that the impact of the above recommendation on the market is limited, as it will only result in an outflow of Rs.667 million over three months. Since we are assuming worst case scenario of all brokers having already adjusted to the 75% rule (which is not the actual position) actual amount of outflow will be substantially less.
Finally, it is also pertinent to mention that delay in reversing this decision will only make the impact of reversal harder on the market and thus more difficult to implement.

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CCC seminar on “How Competitive is Sri Lanka for Business?”

The latest issue of The Global Competitiveness Report, published by the World Economic Forum, will be released on the 31st of October 2007. In assessing the competitiveness of countries, this report includes The Global Competitiveness Index featuring the 12 pillars of competitiveness, The Business Competitiveness Index, detailed country profiles and data tables covering more than 100 social and economic indicators. This year a record 131 economies worldwide were polled.

The Ceylon Chamber of Commerce is organising a seminar on “How Competitive is Sri Lanka for Business”. The seminar is scheduled for the 1st of November 2007 at 3.45 p.m. at the Ground Floor Auditorium of The Ceylon Chamber of Commerce, No. 50, Navam Mawatha, Colombo 02.

The Global Competitiveness Report is widely used by investors and policy makers all around the world. The report assesses the Competitiveness of countries based on hard data and an opinion survey carried out among nearly 11,500 business executives worldwide

Business competitiveness is dependent on a host of factors such as institutions, infrastructure, macro economic performance, education, technology, market efficiency, innovation and business sophistication. Being at the forefront of Global Competitiveness is a combined effort of both the Government and the private sector.

The objective of the seminar is to enlighten the business community on the status of Sri Lanka on Her competitiveness ranking and the improvements that have taken place and are necessary compared to the other countries.

The Ceylon Chamber of Commerce will make a presentation on ‘How competitive is Sri Lanka for Business?’ which will be a review of the results of the latest report, followed by a panel discussion. Panellists at the discussion include; Dr. Saman Kelegama, Executive Director, Institute of Policy Studies, Dr. Nihal Samarappuli, Executive Director-Research, Board of Investment of Sri Lanka, Mr. John Varley, Chief of Party, The Competitiveness Program, Mr. Sunil Wijesinha, Chairman/MD, Dankotuwa Porcelain Ltd., and Mr. Indrajith Aponso, Senior Lecturer, University of Colombo. In addition to the panellists Secretaries to Ministries, Department heads and senior officials have been invited from relevant Government Ministries and Departments. An open forum will follow the panel discussion where participants will be given the opportunity to clarify and raise their concerns from the eminent panel of discussants and invitees. Registration will be on a first-come-first-served basis. Please contact the Ceylon Chamber of Commerce secretariat for details.

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