Fitch Ratings raises concerns on finance companies’ ability to withstand losses amid protracted stresses triggered by pandemic

• Expects asset quality pains to manifest more acutely in Oct-Dec. quarter and extended through FY22
• Says nine out of 38 licensed companies non-compliant with minimum capital requirements at end-Sept.

Joining in the bandwagon of issuing cautionary signals on the country’s finance leasing company (FLC) sector, Fitch Ratings yesterday said the pandemic induced pressures on asset quality and profitability would test the companies’ loss absorption capacity while noting that most companies have the capital and profit buffers, sufficient enough to cushion against moderate asset quality shocks. 

The rating agency expects the sector’s asset quality pains, which have been aggravated by the pandemic, to manifest more acutely from the October-December quarter and extend through the financial year 2022 as regulatory relief afforded in the form of moratoriums, temporarily halted the recognition of credit impairments for much of this year.

The gross non-performing loans ratio, a key measure of the sector’s asset quality, slumped to 14.1 percent by end-June, from 11.4 percent in March. 

The rising credit costs and the slow growth in loans will also weigh on the sector’s ability to generate internal capital as the dual impact dampens profits. 

The sector’s return on assets turned negative 2.3 percent in the April-June quarter from 1.9 percent in the year ended March 2020, Fitch 
Ratings data showed.   3 

The finance and leasing companies are mostly expected to lose out to the banks which became more aggressive in capturing lending markets since the onset of the pandemic as they were part of the Rs.180 billion Central Bank-driven refinance scheme while they had the scale and the liquidity, sufficient enough to offer loans, mostly at mid or higher single digits for wider 
swaths of borrowers. 

Meanwhile, vehicle leasing and hire purchase business, which accounted for 55 percent of the sector’s lending, as estimated by Fitch, came under severe pressure due to prolonged restrictions on vehicle importation and the resultant surge in second-hand vehicle prices. 

“These risks will test FLCs’ loss-absorbing capacity, but Fitch Ratings believes 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 Ratign said in a report on the sector released yesterday. 

In view of providing regulatory relief at the height of the pandemic to support the sector to navigate through the crisis with less pain, the Monetary Board extended reprieve on capital and liquidity to the sector. 

While these reliefs and the lower loan growth will ease near term pressures for some companies, Fitch said, 9 out of 38 licensed companies were non-compliant with the minimum capital requirements at end-September, and “the Central Bank of Sri Lanka has granted an extension to rectify the 
non-compliance”.  

Early this week, First Capital Research, an independent research house, estimated Rs.20 billion capital hole in the entire sector, of which Rs.11.1 billion due by December 2020 and the balance by December 2021, for companies to stay in line with the extended minimum 
capital requirements.  However, big cap companies, numbering approximately 15, are already in compliance with the minimum capital levels due by 
both year-ends. 

On liquidity, Fitch Ratings said, “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,” the rating agency added.