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15 Sep 2005

Financial Markets

Auto Financing, H2/2005: Rising Interest and Competition Denting Margins

The auto financing market over the latter half of this year (H2/2005) will likely experience tougher competition. The expected stiff rivalry can be attributed to projections of slowing car sales in comparison to the first half due to economic slowdown. Meanwhile, several new players have entered the market, particularly, companies operated by commercial banks or newly-established subsidiaries per the recent Bank of Thailand (BOT) policy permitting commercial banks to offer auto loans to private individuals. In the midst of ebbing demand for such loans, and along with slowing car sales, contrasting a rising number of lenders, rivalry has thus increased.

Conditions for auto financing loans offered by each company are basically the same. Amid stiff rivalry, almost all loan providers have relaxed their conditions auto financing, i.e., reduced down payments to 10-15 percent of the car price, and extended installment periods up to 72 months. This has resulted in higher risks in lending due to rising loans and longer installment periods, which lead to the outstanding principal exceeding market prices of cars throughout the tenure of the loan. Over the first three years of lending, creditors will have to bear risks of late payments in loans.

Under these circumstances, the auto financing market will remain a buyer's market. Despite evidently rising interest rates in the financial system, tougher rivalry will likely pressure increases in lending rates for auto loans, in comparison to rising costs for deposits over the latter half of this year after a long period of low rates throughout last year to early this year. Short-term deposit rates for less than one-year maturity at large commercial banks have climbed from 1 percent to 1.5-2.25 percent, while deposit rates for 2-3 year tenors have risen from 1.25-1.5 percent to 2-3.25 percent.

Meanwhile, auto-financing interest rates are still pegged low. The auto-financing rate for most new cars is around 2.9 percent per annum, normally, on a 20 percent down payment and an installment period of not more than 48 months, which is therefore an effective rate of only 5.5 percent over the term of the loan. That is considerably cheaper than the MLR lending rates of large commercial banks, at 6.0 percent. Meanwhile, the cost of fund is only beginning to rise and remains much lower than the inflation rate.

Therefore, rivalry for market share in the auto loan market at present is fraught with interest rate risk which stems from the inability to raise lending rates to conform with the cost of deposits and from the mismatch of capital structures and loans extended. As auto financing has a typical duration of 4 years, on average, and the interest rate is fixed for the entire contract period. But most of this capital funding comes from short-term deposits of not more than one year. This has resulted in the possibility that margins in this business have begun to drop during H2/2005.

Moreover, these factors may also lead to the risk of higher NPLs, even though NPLs among auto loan providers in finance company system are at present still low at only 1-2 percent. However, KRC still views that such loan extension must be conducted more carefully by not being too lenient in reducing loan conditions. Capital must be managed to match loans extended to create a quality auto financing loan market that can compete freely.

Financial Markets