COLOMBO – Sri Lanka’s finance and leasing companies (FLCs) would be hurt further from the risk of a ‘second wave’ of coronavirus while import controls would hurt their growth, but most have capital to absorb losses, Fitch Ratings said.
“Weak earnings due to rising credit costs and slow loan growth will weigh on FLCs’ internal capital generation,” it added..
“We view this risk as more acute for small FLCs, which already have weak profitability buffers, with credit costs consuming more than 70 percent of their pre-impairment operating profits,” the rating agency said, forecasting Sri Lanka’s gross domestic product to contract 3.7% in 2020.
Sri Lanka is now in the middle of a spike in coronavirus with at least one large cluster and a mini-cluster in Kuliyapitiya.
“The risk of a second coronavirus wave, together with weak borrower sentiment in an already fragile operating environment, would put further stress on Sri Lankan finance and leasing companies’ (FLCs) credit profiles, adding to existing pressures on asset quality and profitability,” Fitch Ratings said.
“These risks will test FLCs’ loss-absorbing capacity, but Fitch Ratings believes that the capital and profit buffers of most Fitch-rated standalone-driven FLCs1 (except for Bimputh, which will experience material capital erosion due to losses) will be adequate to cushion against moderate asset-quality shocks.
Amid the economic downturn had already raised loans six months in arrears to 14.1% by June 2020 and return on assets fell to 2.3%.
Meanwhile an import restriction on cars will stunt the growth of the sector, Fitch warned.
Key areas to watch
Sector’s Growth Challenges: A prolonged restriction on vehicle importation and the resultant surge in second-hand vehicle prices are likely to hamper Sri Lankan FLCs’ medium-term growth prospects.
The sector’s loans contracted by 0.2% yoy in 1QFY21 (CAGR of 12% FY15–FY20), and leasing and hire purchases accounted for 55% of the sector’s lending (FYE15:60%).
Asset Quality Risk After Moratorium: We expect underlying asset-quality pressure that has been building up due to the pandemic to manifest from 3QFY21 and extend to FY22, as regulatory relief in the form of loan-repayment moratoriums has temporarily halted the recognition of credit impairments for much of this year.
We believe that most of the FLCs’ borrowers will not emerge unscathed from the economic downturn because they are largely sub-prime.
Weakening Internal Capital Generation: Weak earnings due to rising credit costs and slow loan growth will weigh on FLCs’ internal capital generation. We view this risk as more acute for small FLCs which already have weak profitability buffers, with credit costs consuming more than 70% of their pre-impairment operating profits.
Regulatory Relief: A deadline extension to meet capital requirements and lower loan growth will ease near-term capital pressures for some companies. Out of 38 licenced finance companies in the sector, nine were non-compliant with minimum capital requirements at end-September 2020 and the Central Bank of Sri Lanka (CBSL) has granted an extension to rectify the non-compliance.
Heightened Liquidity Risk: 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