Fitch Ratings Lanka has assigned Mercantile Investments and Finance PLC (MIF) a national long-term rating of ‘BBB-(lka)’. The outlook is stable. The agency has also assigned the company’s outstanding senior unsecured debentures a national long-term rating of ‘BBB-(lka)’.

MIF’s rating reflects its modest franchise stemming from its long operating history, satisfactory capitalisation and loan-book exposure to less risky customer segments relative to peers. However, its ratings also capture its high risk appetite, which is evident in its substantial exposure to equity investments, low profitability metrics relative to peers and greater reliance on concentrated and short-term funding.

Equity investments accounted for 16.8 percent of total assets at the end of the financial year to March 2015 (FYE15), much higher than the level at similarly rated peers, leaving the company vulnerable to market risk. In addition, MIF is in breach of the regulator’s rule that limits equity investments to 25 percent of capital funds for non-bank financial institutions, with equity investments at 52.2 percent of capital funds at FYE15.

MIF’s ROA has declined to 1.9 percent at end-1HFY16 from 3.2 percent at FYE13 largely due to weak net interest margin (NIM) and high impairment charges relative to peers. Fitch believes that a potential increase in operating costs due to branch expansion and an increase in credit costs could hamper operating profitability and internal capital generation.

Fitch views MIF’s concentrated deposit base and high negative maturity mismatches as risks to its funding profile. Deposits are the main source of funding for MIF, but its deposit base is highly concentrated compared with similarly rated peers.

MIF’s negative mismatches of assets and liabilities of less than one year are higher than that for similarly rated peers. It amounted to 47 percent of equity at end-October 2015, 50 percent at FYE15 and 65 percent at FYE14. Unutilised credit lines covered 52 percent of the negative mismatches at end-October 2015. Funding lines sourced by MIF by pledging its assets could help to reduce such mismatches.

MIFs regulatory Tier 1 capital adequacy ratio decreased to 19.6 percent at end-1HFY16 from 21.7 percent at FYE15 (FYE14: 22.5 percent). The loan book increased by 21 percent in FYE15 (FYE14: 17 percent), in line with the industry. Fitch expects a further dilution in capitalisation due to MIF’s expanding operations, but believes that capitalisation should remain satisfactory for its current rating.

Fitch believes that MIF’s higher exposure to less risky assets, such as motor cars (40 percent of total advances at FYE15) has supported its asset quality. MIF’s gross regulatory NPL ratio (FYE15: 4.2 percent) has historically remained below that of the industry.

MIF’s outstanding senior debentures are rated at the same level as MIF’s National Long-Term Rating, as the issue ranks equally with the obligations to the company’s other senior unsecured creditors.

The company was established in 1964, and is majority owned by the Ondaatjie family, who directly hold 57 percent of MIF’s equity. At end-June 2015, MIF accounted for 3.3 percent of non-bank financial institution sector assets in Sri Lanka. MIF mainly provides vehicle financing through lease and hire purchase.