India’ Mahindra and Mahindra backing helps Sri Lanka’s Ideal Finance rating

ECONOMYNEXT – Fitch Ratings said it was confirming a ‘BB-(lka)’ rating of Sri Lanka’s Ideal Finance Limited, with a Rating Watch Positive after India’s Mahindra & Mahindra Financial Services Limited injected captial amid a fallout from a Coronavirus pandemic.

MMFSL had injected 1.1 billion rupees of capital in February 2020.

“This has strengthened the company’s financial profile and bolstered its loss-absorption buffers against Sri Lanka’s challenging operating environment,” the rating agency said.

“Ideal’s rating also takes into account its high-risk appetite, aggressive growth, exposure to more-vulnerable customer segments and its still-developing franchise, which is reflected in its small market share and limited operating history.”

“We believe the challenging operating conditions exacerbated by the pandemic have elevated funding and liquidity risks for Ideal.

Ideal Motors, which is linked to Ideal Finance is the agents for Mahindra and Mahindra in Sri Lanka.

Fitch said, Mahindra will invest 2 billion rupees to get a 58.2 percent stake in Ideal Finance in three tranches up to 2021.

Ideal Finance’s bad loans had risen to 5.2 percent from 3.2 percent in the 2019 financial year.

“We expect Ideal’s asset quality to be further weakened by the economic fallout from the pandemic,” Fitch said.

The full statement is reproduced below:

KEY RATING DRIVERS

Ideal’s rating reflects its improved capitalisation following the introduction of new capital by an initial LKR1.1 billion investment in February 2020 from India’s Mahindra & Mahindra Financial Services Limited (MMFSL). This has strengthened the company’s financial profile and bolstered its loss-absorption buffers against Sri Lanka’s challenging operating environment.

Ideal’s rating also takes into account its high-risk appetite, aggressive growth, exposure to more-vulnerable customer segments and its still-developing franchise, which is reflected in its small market share and limited operating history.

The RWP reflects Fitch’s belief that Ideal’s rating could benefit from the change in shareholding and increased probability of support once MMFSL’s effective control is established, in light of MMFSL’s potentially stronger credit profile.

As part of this process, MMFSL will progressively invest LKR2 billion (approximately USD11 million) to acquire a 58.2% stake in Ideal in three tranches up to 2021.

Fitch expects the minimum regulatory capital requirement of LKR2.5 billion for finance companies to be met at the end of the transaction, at which point we expect MMFSL to have acquired effective control of Ideal.

We believe the challenging operating conditions exacerbated by the pandemic have elevated funding and liquidity risks for Ideal. The company’s financial flexibility in terms of unsecured debt / total debt remains low and its deposit base remains small and highly concentrated.

We expect Ideal’s asset quality to be further weakened by the economic fallout from the pandemic. Its reported NPL ratio (greater than 180 days overdue) increased to 5.2% in FY20, from 3.2% in FY19, but was still below the average ratio for the sector.

Ideal’s leverage in terms of debt/tangible equity has been supported by the capital infusions, but we expect it to increase in the medium-term as the company builds scale. Profitability, measured by pre-tax net income/average assets, dropped to 5.2% in FY20, from 6.0% in FY19, and is likely to remain under pressure due to rising credit costs.