Conglomerates with finance company subsidiaries could witness rating pressure from added leverage: Fitch

Sri Lanka’s conglomerates with finance company subsidiaries could face pressure on their leverage and thereby their credit ratings as the finance companies’ growth amid weak operating conditions may demand increased support from the parents, which may have to be met with fresh debt. 

According to a new report by Fitch Ratings, which looked at the companies with finance company subsidiaries, the rating agency said these parent companies would face a rise in Fitch Rating’s adjusted debt due to medium term asset growth in the current weak operating environment, which in turn pressure the parent company earnings. 

“An aggressively expanding financial service subsidiary in a weak operating environment such as Sri Lanka could increase a corporate parent’s adjusted debt and pressure the parent’s rating,” said Nadika Ranasinghe, co-author of the report. 

The rating agency took Singer Sri Lanka PLC, Abans PLC and Dialog Axiata PLC as parent companies with financial services subsidiaries as part of their study and assumed 10 percent growth in their assets in the medium term on average for a year. 

The ratings agency said while a growth in assets significantly above their expectations could pressure Singer’s and Abans’ ratings, Dialog’s rating should remain due to its higher debt headroom. 

“Singer is potentially the most affected as its financial services subsidiary, Singer Finance (Lanka) PLC, has a large asset base from strong loan growth in the last few years,” Fitch Ratings said. 

The rating agency forecasted 11 percent growth on average in their assets base from FY22 to FY25 compared with 9 percent annual average growth in the past three years. 

Fitch estimates this growth in assets amid the weak operating environment could add Singer Sri Lanka PLC an adjusted debt of around Rs.11 billion to Rs.12 billion to the parent’s corporate leverage ratio.

Fitch’s corporate rating criterion de-consolidates the financial services subsidiary from the parent when calculating the parent’s credit metrics.

However, for financial services operations, which are considered strategic to the corporate parent, the rating agency assumes a hypothetical capital infusion from the parent into the financial services subsidiary when calculating their adjusted leverage. 

“The capital infusion size is based on our assessment of the subsidiary’s self- sustaining capital structure, considering its asset-quality and funding risks, and its reported debt/tangible equity ratio”, Fitch added. 

Therefore, higher growth in assets than the expectations or the faster erosion of capital buffers due to the higher operating and credit costs amid a weak operating environment could increase the implied capital infusion required from the parent. 

Meanwhile, for Abans PLC, Fitch said the firm’s balance sheet is already stretched due to a real estate project and any additional burden from its finance company subsidiary could pressure their ratings. “However Abans’ leverage should ease if its plan to sell Abans Finance PLC materialises,” Fitch added. 

Last September, Softlogic group announced a plan to acquire Abans Finance and to merge with Softlogic Finance. 
Dialog Axiata PLC, on the contrary has more debt headroom should its finance company subsidiary, Dialog Finance PLC, requires support and therefore does not pose any pressure on its parent’s rating. 

Sri Lanka’s finance companies have been undergoing a period of low growth, higher non-performing loans and low profits compared to their banking sector counterparts, and their woes exacerbated since last year due to pandemic induced headwinds.