ECONOMYNEXT – Fitch Ratings has confirmed a domestic ‘BBB+(lka)’ rating of Sri Lanka’s Senkadagala Finance despite pressure on the operating environment, with the firm having lower bad loans than the industry.
Senkadagala Finance has reported gross non-performing loan ratio based on six-month arrears of 7.7 percent by June 2021 which could deteriorate further amid lockdowns.
The firm had set aside set aside loan-loss provisions of about 7.0 percent of gross loans in the fiscal year to March 2021 (FY21), with further provisions of around 1.6 percent of gross loans taken in the first quarter of the current financial year.
Senka’s regulatory six-month NPL ratio also remained lower at FYE21 (6.5 percent) compared with the industry average of 11.3 percetn.
The full statement is reproduced below:
Fitch Ratings – Singapore/Colombo – 01 Sep 2021: Fitch Ratings has affirmed Senkadagala Finance PLC’s (Senka) National Long-Term Rating at ‘BBB+(lka)’. The Outlook is Stable.
KEY RATING DRIVERS
NATIONAL LONG-TERM RATING
Senka’s National Long-Term Rating is underpinned by its standalone credit profile. It reflects the company’s moderate deposit franchise and higher-risk exposure to cyclically sensitive SME borrowers as a mid-sized finance company in Sri Lanka.
These features contribute to the company’s modest profitability and higher reliance on secured wholesale funding relative to peers. Nonetheless, Senka has generally retained a more consistent business strategy and risk appetite relative to lower-rated peers, and its adequately matched asset-liability maturity profile provides some protection against the risk of a liquidity squeeze.
The Covid-19 pandemic continues to exert significant pressure on the operating environment for Sri Lankan finance and leasing companies. Fitch projects a gradual economic recovery in 2021 and 2022 after a 3.6% contraction in 2020 GDP, but this forecast remains subject to considerable uncertainty as it depends on the trajectory of the pandemic.
We expect continued pressure on loan demand, asset quality and profitability in the near term in light of the challenging operating environment.
Senka’s regulatory reported gross non-performing loan (NPL) ratio (based on six-month arrears) remained elevated at 7.7% at end-June 2021, and we see a risk of continued deterioration in the near term if the current lockdown is extended.
Against this, the company set aside loan-loss provisions of about 7.0% of gross loans in the fiscal year to March 2021 (FY21), with further provisions of around 1.6% of gross loans taken in 1QFY22.
Senka’s regulatory six-month NPL ratio also remained lower at FYE21 (6.5%) compared with the industry average of 11.3%.
We expect credit-provisioning pressure to continue to weigh on profitability in the near term. Senka recorded a quarterly net loss in 1QFY22 as higher credit costs outstripped pre-provision profits. Nonetheless, Senka has remained profitable in the past year with pretax profit of around 2.8% of average assets in FY21 (FY17-FY20: 2.2%-5.0%), and profitability is likely to recover if current movement restrictions are eased.
Meanwhile, Senka’s leverage, as captured by debt/tangible equity, remains at the higher end of rated large and mid-sized finance companies, but improved to 4.7x by end-1QFY22 from 5.2x at FYE21 due to an infusion of equity capital by the major shareholders earlier in the year. The company has announced a subsequent rights issue of around LKR475 million, which should help to shore up the capital buffer further. Senka’s core capital adequacy ratio of 17.9% at end-1QFY22 provided a moderate buffer against capital impairment risk relative to the regulatory minimum requirement of 6.5%.
We view Senka’s funding profile as more confidence-sensitive than that of peers, due to its smaller deposit-funding franchise and greater reliance on secured wholesale funding. Deposits comprised a moderate 38% of total funding at FYE21 (large and mid-sized peers:
78%-94%). Its deposit base is also fairly concentrated, raising the risk of lumpy funding outflows. Against this, its longstanding market presence helps to anchor the stability of its large deposit relationships, and the company’s positive short-term liquidity gaps and considerable undrawn liquidity facilities help to offset the risk of a liquidity shock.
Senka’s Sri Lankan rupee-denominated subordinated debt is rated two notches below its National Long-Term Rating. This reflects Fitch’s expectation of high loss severity and poor recoveries in the event of default, per our Bank Rating Criteria.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
NATIONAL LONG-TERM RATING
Positive rating action is unlikely in the near term in light of the difficult operating environment. An upgrade is only possible in the medium to longer term if the company is able to diversify its funding profile and strengthen its deposit franchise and profitability materially, closer to that of larger peers, while maintaining leverage towards the lower end of its peer group.
Any positive action on Senka’s National Long-Term Rating will lead to similar action on its subordinated debt.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
NATIONAL LONG-TERM RATING
Fitch may take negative rating action in the event of further persistent asset quality deterioration that results in in material capital impairment, funding pressure or an increase in asset encumbrance.
The ratings on Senka’s subordinated debt would be downgraded in the event of a downgrade of its National Long-Term Rating.
Senka, founded in 1968, is a mid-sized finance company in Sri Lanka. It held a market share of roughly 2.7% of industry assets and 1.5% of industry deposits at end-March 2021.