Fitch Affirms Central Finance at ‘A+(lka)’; Outlook Stable
Fitch Ratings – Colombo – 01 Sep 2021: Fitch Ratings (Lanka) Limited has affirmed the National Long-Term Rating of Central Finance Company PLC (CF) at ‘A+(lka)’. The Outlook is Stable.
KEY RATING DRIVERS
CF’s rating reflects the company’s high-risk appetite, evident from asset quality that is weaker than that of the sector. This stems from its customer segments, which are vulnerable to economic and interest-rate cycles, and is mitigated by CF’s healthy capitalisation. The rating also captures CF’s established franchise, which is underpinned by an acceptable market share and a long 63-year operational record in the domestic market.
The Covid-19 pandemic continues to pressure the operating environment for Sri Lankan finance and leasing companies. Fitch projects a gradual economic recovery in 2021 and 2022, after a 3.6% contraction in 2020 GDP, but this is subject to considerable uncertainty, depending on the trajectory of the pandemic.
We expect CF’s asset quality pressure to continue into the financial year ending March 2022 (FY22) due to the protracted slowdown in the country’s economic recovery, exacerbated by a third wave of the pandemic. CF’s regulatory six-month non-performing loan (NPL) ratio increased to 13.6% in FY21, from 9.3% in FY20, to be higher than the sector’s 11.3%. Similarly, its impaired-loan ratio, based on Stage III loans – mostly 120 days past due – spiked to 21.4%, from 14.7% at FYE20.
We attribute the significant deterioration in asset quality to the 16.5% sharp contraction in CF’s loan book, which further contracted by -3.0% in 1QFY22, and rising absolute NPLs. Loan impairment charges stayed high at 8.0% (annualised) at end-1QFY22, to be 4.3% of the average loan book at FYE21 (FY18-FY21: 3.3%). This underscores our expectation of a further increase in delinquencies in FY22. Total loan loss allowances were only adequate to cover 65% of NPLs (42% of impaired loans) at FYE21, reflecting CF’s reliance on collateral.
We expect CF’s profitability to remain under pressure in FY22 due to muted loan growth and high credit costs. Its pre-tax income/average assets ratio of 6.6% at FYE21 (FYE20: 6.4%) was below the four-year average of 8.9% in FY17-FY20, but comparable with the rated-large finance and leasing company (FLC) median of 6.6%. CF’s profitability ratio declined sharply to 3.7% in 1QFY22 as credit cost absorbed 58% of its pre-impairment operating profit.
We expect CF’s better-than-peer capitalisation to continue, despite pressure from asset-quality deterioration. Leverage, measured by debt/tangible equity, of 1.1x at FYE21 (1QFY22: 1.0x) was the lowest among Fitch-rated FLCs (large peer median: 3.1x), while its regulatory Tier I capital ratio of 32.4% was the highest among rated peers and also above the sector’s 14.3%, reflecting better loss-absorption capacity.
CF’s better-than-peer financial flexibility reflects its high share of deposits, which increased to 95.6% of total funding in 1QFY22, from 82.6% at FYE20 (FYE21: 94.3%). This followed the repayment of most of its long-term borrowings. We estimate a marginal decline in this ratio when CF resumes its loan growth, but it should remain better than that of peers. CF’s regulatory liquidity thresholds stayed well above the minimum thresholds.