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Sri Lanka finance companies pressured by Coronavirus: Fitch

ECNOMYNEXT – Sri Lanka’s Finance and Leasing Companies (FLCs) which had seen a spike in bad loans would be further pressured by Coronavirus, with a low loan growth and margin pressure, Fitch Ratings said.

Sri Lanka’s rupee collapsed in 2018 after rates were cut in April just as the credit system was recovering and liquidity injections were made by the central bank in April and July/August 2020.

From February 2020 the central bank has made unprecedented liquidity injection and the rupee is again under pressure.

Sri Lanka Non-Bank Finance Institutions (NBFIs) had seen higher bad loans after the currency collapse than commercial banks.

“Fitch expects Sri Lanka FLCs to face multiple challenges in the near team, including muted loan growth, margin compression amid lower interest rates, and rising loan-impairment charges due to asset-quality pressures” the rating agency said.

“The ultimate economic and financial market implications of the outbreak are unclear, while Fitch considers the risks to NBFIs’ credit profiles to be clearly skewed to the downside.”

Sri Lanka’s central bank has announced relief to Covid-19 affected businesses.

“A one- to six-month debt moratorium, depending on the type of credit line, will have negative first-order implications for FLCs, but a reduction of the liquid-asset requirement for deposits and borrowings could reduce near-term liquidity shocks stemming mainly from non-payment of loan rentals,” the rating agency said.

“Furthermore, we believe the debt moratorium will exacerbate pressure on FLCs’ profitability which is already weakened, and is likely to mask the extent of asset-quality deterioration.”

Coronavirus Intensifies Pressure on Sri Lanka Finance Companies

Thu 02 Apr, 2020 – 21:40 ET

Fitch Ratings-Colombo-02 April 2020: The coronavirus outbreak and the resultant prolonged business disruptions will put additional pressure on Sri Lankan finance and leasing companies’ (FLCs) earnings and asset quality, says Fitch Ratings.

The ultimate economic and financial market implications of the outbreak are unclear, while Fitch considers the risks to NBFIs’ credit profiles to be clearly skewed to the downside.

Fitch expects Sri Lanka FLCs to face multiple challenges in the near team, including muted loan growth, margin compression amid lower interest rates, and rising loan-impairment charges due to asset-quality pressures. We believe that there could be a fall in loan growth in 4QFY20 (ending 31 March 2020), with growth already sluggish up to end-3Q20 (yoy decline of 0.9% in gross loans). The degree of recovery in FY21 will depend largely on the duration and severity of the virus outbreak.

The Central Bank of Sri Lanka (CBSL) has announced further relief for COVID-19-affected businesses, and individuals are to be offered similar relief by FLCs as those offered to customers of banks, including debt moratorium.

We believe that these have mixed implications for FLCs.

A one- to six-month debt moratorium, depending on the type of credit line, will have negative first-order implications for FLCs, but a reduction of the liquid-asset requirement for deposits and borrowings could reduce near-term liquidity shocks stemming mainly from non-payment of loan rentals. Furthermore, we believe the debt moratorium will exacerbate pressure on FLCs’ profitability which is already weakened, and is likely to mask the extent of asset-quality deterioration.

In addition, the timeline to comply with enhanced minimum core capital and minimum capital-adequacy ratio requirements has been extended by one year. This will provide some breathing space to FLCs that have not met the relevant thresholds due to dislocation of the capital markets, while significant near-term earnings pressure may weigh on FLCs’ capital buffers. Out of the Fitch-rated FLCs, five had not met the minimum core capital requirements of LKR2 billion (USD11 million) by 1 January 2020.

The Sri Lankan FLC sector had been struggling with rising non-performing loans, weakening profitability due to rising credit costs and muted loan growth, even before the coronavirus outbreak. This was due mainly to the sluggish economic growth and restrictions on the importation of vehicles to defend the local currency – which hit growth prospects for vehicle finance, the key business segment of Sri Lankan FLCs. Our expectations of earnings and asset-quality weakening for 2020 now far exceed what was contemplated in late-2019 (see “Sri Lankan Finance and Leasing Companies Dashboard”, published 13 November 2019).

Fitch expects to complete a review of its ratings on the Sri Lankan FLCs in the near term, as with the banks, considering the likely impact of recent developments. We have already revised our banking sector outlook to negative as the coronavirus pandemic poses increased risks to the anticipated expansion in the economy and credit demand (see “Fitch Revises Sri Lanka’s Banking Sector Outlook to Negative on Coronavirus; Rating Outlook Negative”, published 26 March 2020).