Sri Lanka’s Central Finance rating confirmed at ‘A+(lka)’ amid NPL spike
ECONOMYNEXT – Fitch Ratings said it was confirming an ‘A+(lka)’ rating of Central Finance Plc, Sri Lanka’s fourth largest finance company, amid a spike in bad loans, with one of the strongest capital buffers in the sector.
“CF’s rating reflects its high-risk appetite, evident from asset quality that is weaker than the sector’s, stemming from its customer segments that are vulnerable to economic and interest rate cycles,” the rating agency said.
“This is partly mitigated by CF’s healthy capitalisation.”
CF’s regulatory six-month non-performing loan ratio increased to 9.3 percent by the end of the financial year to March 2020 from 5.6 percent a year earlier.
The impaired-loan ratio (based on stage III loans – mostly 120 days past due) spiked to 14.7 percent by end March 2020 from 10.5 percent a year earlier.
The economic disruptions from a Coronavirus pandemic may not be fully captured due to an ongoing moratorium, Fitch said.
Credit costs have cost 108 percent of its pre-impairment operating profit by first quarter of the 2021 financial years, which was higher than the 38 percent reported last year.
Fitch expected credit costs to steady from the third quarter of 2021 as the economy will recover but profits were likely to be lower than last year.
“We expect CF to maintain lower leverage ratios than its local peers, underscored by better capitalisation despite pressure from asset-quality deterioration,” Fitch said.
“CF’s regulatory Tier I capital ratio of 27.7 percent at FYE20 was the highest among rated peers and also higher than that of the sector’s 11.2 percent, reflecting better loss-absorption capacity.”
The full statement is reproduced below:
Fitch Affirms Central Finance at ‘A+(lka)’; Outlook Stable
Fitch Ratings – Colombo – 11 Sep 2020: Fitch Ratings (Lanka) Limited has affirmed the National Long-Term Rating of Central Finance Company PLC (CF) at ‘A+(lka)’. The Outlook is Stable.
KEY RATING DRIVERS
CF’s rating reflects its high-risk appetite, evident from asset quality that is weaker than the sector’s, stemming from its customer segments that are vulnerable to economic and interest rate cycles.
This is partly mitigated by CF’s healthy capitalisation. The rating also captures CF’s established franchise, which is underpinned by a solid market share and a long 62-year operational record in the domestic market.
We expect CF’s asset-quality metrics and the corresponding provisions to increase due to a weakened operating environment, exacerbated by the coronavirus pandemic.
CF’s regulatory six-month non-performing loan ratio increased to 9.3% by the end of the financial year to March 2020 (FYE20) from 5.6% at FYE19 and the impaired-loan ratio (based on stage III loans – mostly 120 days past due) spiked to 14.7% by FYE20 from 10.5% at FYE19.
Nevertheless, we believe the asset-quality deteriorations have not captured the full impact of the economic disruptions from the pandemic.
Regulatory relief in the form of a moratorium on loan repayments or restructuring for affected borrowers has halted the recognition of credit impairments for now.
CF’s earnings and profitability are likely to come under pressure due to weaker income generation and higher credit costs in the near term. Its pretax net income-to-average total asset ratio further slumped to -0.7% by end-June 2020 after declining to 6.3% at FYE20 from 8.7% at FYE19.
CF’s credit costs have absorbed 108% of its pre-impairment operating profit by 1QFYE21, which is significantly higher than the 39.8% reported in FYE20. We expect CF to remain profitable in FY21 as the credit cost will normalise from 3QFY21 and the economy will recover gradually, but the profitability is likely to be significantly lower than that of FYE20.
We expect CF to maintain lower leverage ratios than its local peers, underscored by better capitalisation despite pressure from asset-quality deterioration. CF’s debt/tangible equity is a relative strength at 1.4x at FYE20, the lowest among peers rated by Fitch (peer median 4.0x). CF’s regulatory Tier I capital ratio of 27.7% at FYE20 was the highest among rated peers and also higher than that of the sector’s 11.2%, reflecting better loss-absorption capacity.
CF’s financial flexibility remains better than that of its peers, underpinned by an established deposit franchise. Deposits remain CF’s main source of financing and their share of total financing increased to 88% by 1QFYE21 from 82% at FYE20. We do not expect a significant change in the funding mix in the medium term. CF’s regulatory liquidity thresholds continued to remain well above the required minimum thresholds.
CF is the fourth-largest financial and leasing company in Sri Lanka, accounting for 7.5% of total sector assets and 7.3% of sector deposits at FYE20. Its business model revolves around vehicle financing, which accounted for around 94% of total loans at FYE20.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
CF’s rating could be upgraded if there is a material strengthening in its franchise and its risk appetite moderates relative to that of its domestic peers, which Fitch does not expect in the medium term.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
CF’s rating could be downgraded if leverage were to rise or capital buffers were to be substantially eroded due to weakening asset quality and prolonged rapid growth in the more vulnerable customer segments.