Fitch assigns MBSL first-time National Long-Term Rating of ‘BBB+(lka)

Fitch Ratings last week announced it assigned Merchant Bank of Sri Lanka & Finance PLC (MBSL) a first-time National Long-Term Rating of ‘BBB+(lka)’. The Outlook is Stable.
MBSL is 84.5 percent owned by Bank of Ceylon (BOC, A(lka)/Stable) and other BOC group entities. BOC is the largest banking group in the country.

“MBSL’s rating is driven by our view that the parent, BOC, would provide extraordinary support to MBSL, if required. BOC’s ability to support MBSL is reflected in its credit profile, which is underpinned by its standalone strength. 

“We believe that any required support for MBSL would be manageable relative to BOC’s financial capacity,” Fitch said in a statement.

The assessment by Fitch also takes into consideration BOC’s majority shareholding in MBSL, increasing product offerings by MBSL that are complementary to those provided by BOC, the parent’s oversight of MBSL’s policies and strategy through board representation and the usage of the BOC brand by MBSL in its business operations, which raises reputational risk for BOC should MBSL default.

MBSL is rated two notches below BOC, due to its limited importance to the group. MBSL mainly serves high-yielding, under-banked segments that have limited overlap with BOC’s core customer base but this is partly offset by BOC’s focus on increasing merchant banking via MBSL to strengthen group fee-based revenue. 

MBSL made up 0.8 percent of BOC’s consolidated assets at end-September 2023 and makes negligible contribution to group profitability. MBSL also has considerable management independence and there is limited operational integration between the entities.

Fitch said it assesses MBSL’s standalone credit profile as being weaker than its support-driven rating because of its small franchise with 1.8 percent market share of sector loans, evolving business model and weak financial profile, which is reflected in its poor asset-quality metrics, weak profitability and high leverage. 

MBSL focuses on vehicle leasing and gold and property-backed loans. It has a high-risk profile stemming from its significant exposure to borrower segments that are highly susceptible to economic and interest rate cycles.
The company’s loans that are more than three months past due were high at 25.3 percent of total loans at end-September 2023 (end-2022: 24.3 percent) due to its high-risk profile. Nonetheless, MBSL’s focus on bad debt recovery has resulted in a decline in the non-performing loan ratio from a much higher level in previous years. It expects a pick-up in borrowers’ business activity and declining interest rates to aid loan collections in the medium term.

MBSL’s pre-tax profit/average asset ratio was low at 0.9 percent in 9M23 and -0.9 percent in 2022, primarily due to the sharp reduction in its net interest margin and increase in operating costs on lower business volumes. 
“We expect MBSL’s profitability to improve in the near to medium term, though it will likely remain weaker than that of peers, as its lending operations pick up, borrowing costs decline and bad debt recovery improves.”