Sour loans mount at finance firms with adoption of riskier business models

The deteriorating asset quality appears to be a common phenomenon with Sri Lanka’s banks and non-banks but the intensity of the problem of the latter suggests that the ailment runs deep. 

Sri Lanka’s highly dispersed and untidy non-bank sector reported a higher gross non-performing loans (NPL) percentage of 5.8 percent by March 31, 2018, up from 4.9 percent in December 2017.

According to Fitch Ratings, this was a result of the change in the business mix of the finance companies to a more challenging one from the easier vehicle 
leasing business.

It was only yesterday Mirror Business reported that the banking sector gross NPL ratio had weakened to 3.3 percent by end-May, from 3.0 percent at the beginning of the year and loans worth Rs.65 billion had fallen into the non-performance category during the first five months. 

Sri Lanka’s finance companies were forced to shift their business mix to segments they did not have experience to stem the competition from banks on its vehicle finance business.

“Competition in leasing from banks and a deceleration in vehicle financing has pushed finance companies to look beyond their core businesses and venture into term financing, microfinance and lending against gold,” Fitch Ratings said.

The rating agency this week affirmed the ratings of nine large and mid-sized finance companies and downgraded the rating of one company.

Since of late, Sri Lanka’s finance companies have been diversifying their product portfolio to offset the revenue losses from the highly competitive vehicle leasing business. 

But the portfolio risk has increased in tandem due to the absence of poor-quality collateral, challenges in recoverability in collateral and the lack of experience in the new segments, 
Fitch noted. 

Sri Lanka operated with 51 non-bank finance companies with assets of Rs.1,355 billion by end-2017, representing 7.9 percent of the financial system. 

The credit expansion in the sector slowed down to 9.8 percent in 2017, from 21 percent in 2016, as the sector could not overcome the challenges stemming from higher interest rates, taxes and macro-prudential limits on credit. 

Meanwhile, Fitch Ratings downgraded Melsta Regal Finance Limited’s national long-term rating to ‘B’ from ‘A+’ with a Stable outlook.

The plunge in the rating of Melsta Regal comes after its former parent Melstacorp PLC, the owners of Distilleries Company of Sri Lanka PLC, shed its entire stake in the company in March. 

Fitch said that they cannot rely on Fairfax Financial Holdings Limited, the new parent of Melsta Regal, with effective control of 70 percent via Bluestone1 (Private) Limited—an SPV established for the acquisition—to provide support, when needed. 

“The resolution of the ‘Rating Watch Evolving’ and downgrade of Melsta Regal Finance’s rating to reflect its standalone profile is because the agency views that support from the parent, Fairfax Financial Holdings Limited (Fairfax), cannot be relied upon,” the rating agency said.

Fitch believes Fairfax’s stake in Melsta Regal Finance is part of its portfolio of investments and does not have a strategic significance.  

“As such, MRF’s standalone profile is characterized by an evolving business model and small franchise (0.5 percent of sector assets at end-March 2018). The rating also captures potential pressure on MRF’s asset quality from its unseasoned loan book.”