Fitch assigns Asia Securities first-time rating of ‘BBB-’; Outlook Stable

Fitch Ratings said yesterday it has assigned Asia Securities Ltd. (ASPL) a National Long-Term Rating of ‘BBB-(lka)’. The Outlook is Stable. 

ASPL is a prominent equity brokerage in Sri Lanka. The company, which was founded in 1990, also offers broker credit services to its clients. 

The rating on ASPL reflects its franchise as one of the leading equity brokerages in Sri Lanka, simple yet generally effective risk management, adequate capitalisation relative to local regulatory requirements, and acceptable liquidity buffers as indicated by liquid assets and contingent liquidity coverage of short-term liabilities. 

The rating also incorporates limitations from the weaknesses of the industry’s operating environment, including a small and volatile equity market, still developing market infrastructure and regulatory framework, as well as ASPL’s narrower funding base and variable profitability due to its dependence on fluctuating stock-market revenues. “We believe ASPL’s lean management team leaves it susceptible to key-person risk, although this is mitigated by the stability of its senior leadership since an ownership change in 2015,” Fitch said.

ASPL’s revenues are primarily from equity brokerage and margin lending, with little direct investment risk. Credit risks in margin financing are mitigated by a 50% regulatory loan-to-value limit. ASPL applies an additional valuation discount on securities that it deems to be higher-risk, forming a further buffer against collateral risk. Meanwhile, upcoming sector enhancements to address settlement and other operational risks lag those of many markets in Asia, but should help to strengthen industry operations. 

ASPL’s reliance on volatile equity-market revenues weighs on its credit profile. Operating profitability has fluctuated widely over the past few years - although this partly reflected a number of one-off costs in FY19. Nonetheless, average operating profit to average equity was positive at around 41% over FY18-FY21 (calculated using provisional financial statements for FY21). 

Earnings have been strong in the past 12-18 months due to robust equity-market activity. Improvements to the cost base over the past few years should also help to support revenue retention and profitability, if sustained. However, we believe profitability is likely to remain unpredictable due to the nature of ASPL’s business. Ongoing challenges to the economy and sovereign credit profile also raise risks to funding conditions and equity-market performance, which could put pressure on ASPL’s profitability and funding over the next few years. 

Management is working to build more recurring revenue streams under the Asia Securities brand. These business lines are held separately from ASPL, but could help to strengthen the overall franchise if successful. However, execution of this strategy remains uncertain and the plans are likely to entail further investment, funded by loans from ASPL. This places an additional demand on ASPL’s resources, which Fitch incorporates in our assessment. 

Fitch also views ASPL’s funding profile as more confidence-sensitive than larger financial service organisations, such as major banks and finance and leasing companies. The company has raised adequate funding from banks and private investors despite challenging market conditions in the past several years, and expanded funding facilities provide additional flexibility as borrowing needs have risen alongside strong market activity in the past 12-18 months. Nonetheless, Fitch believes the company’s funding avenues remain relatively narrow, which presents concentration risk in times of stress. 

“We deem ASPL’s capitalisation to be adequate, with net adjusted leverage – defined as (tangible assets – reverse repurchase agreements – securities borrowed)/tangible equity – of 3.0x-5.5x over FY17-FY20,” Fitch said. ASPL’s client financing exposure is subject to a prudential limit of 3x regulatory adjusted net capital, and we expect the company to remain within this limit in the near to medium term (FY17-FY21: 0.7x1.9x regulatory adjusted net capital). 

In calculating net adjusted leverage, Fitch deducts ASPL’s exposures to related entities from tangible assets and equity. These are mainly investments in emerging business lines held apart from ASPL but under a common influence.