Health crisis exacerbates downside risks to FLCs

‘Most of FLCs’ borrowers will not emerge unscathed from economic downturn’

The risk of a second coronavirus wave, together with weak borrower sentiment in an already fragile operating environment, would put further stress on Sri Lankan finance and leasing companies’ (FLCs) credit profiles, adding to existing pressures on asset quality and profitability, Fitch Ratings Sri Lanka said last week.

“These risks will test FLCs’ loss-absorbing capacity, but Fitch Ratings believes that the capital and profit buffers of most Fitch-rated standalone-driven FLCs’ (except for Bimputh, which will experience material capital erosion due to losses) will be adequate to cushion against moderate asset-quality shocks.

Fitch expects Sri Lanka’s real GDP to contract by 3.7% in 2020 due to the pandemic. The economic fallout has pressured the FLC sector’s asset quality with the six-months past due non-performing loans (NPLs) ratio spiking to 14.1% by end-June 2020 (1QFY21) (FYE20:11.4%). The sector’s return on assets turned negative to -2.3% in 1QFY21 (FYE20:1.9%) due to high credit costs.

“Sector’s growth challenges are worth watching. A prolonged restriction on vehicle importation and the resultant surge in second-hand vehicle prices are likely to hamper Sri Lankan FLCs’ medium-term growth prospects. The sector’s loans contracted by 0.2% yoy in 1QFY21 (CAGR of 12% FY15-FY20), and leasing and hire purchases accounted for 55% of the sector’s lending (FYE15:60%)”.

Referring to asset quality risk after moratorium, Fitch Ratings said, “We expect underlying asset-quality pressure that has been building up due to the pandemic to manifest from 3QFY21 and extend to FY22, as regulatory relief in the form of loan-repayment moratoriums has temporarily halted the recognition of credit impairments for much of this year. We believe that most of the FLCs’ borrowers will not emerge unscathed from the economic downturn because they are largely sub-prime”.

“Weak earnings due to rising credit costs and slow loan growth will weigh on FLCs’ internal capital generation. We view this risk as more acute for small FLCs which already have weak profitability buffers, with credit costs consuming more than 70% of their pre-impairment operating profits”.

“A deadline extension to meet capital requirements and lower loan growth will ease near-term capital pressures for some companies. Out of 38 licensed finance companies in the sector, nine were non-compliant with minimum capital requirements at end-September 2020 and the Central Bank of Sri Lanka (CBSL) has granted an extension to rectify the non-compliance.

“Banks’ diminished appetite to lend to the FLC sector could hurt small-to mid-sized FLCs in particular, hampering their financial flexibility. Small entities tend to rely more on bank funding, while large FLCs’ better domestic franchises will underpin their liquidity profiles”, Fitch Ratings said.