ICRA Lanka assigns B- rating for TKS Finance

ICRA Lanka Ltd., subsidiary of ICRA Limited, a group company of Moody’s Investors Service, has assigned the issuer rating of [SL] B- (Pronounced SL B minus) with a stable outlook to TKS Finance Ltd. 

Rationale

The rating considers TKS’s modest scale and franchise, weak asset quality indicators, poor earnings and constrained resource profile. ICRA Lanka takes note that the company is under CBSL’s restriction on borrowings (deposit and other borrowings caps at Rs. 4.9 billion and Rs. 123 million respectively) since January 2018 and lending since June 2018, due to non-compliance of the minimum core capital requirement. TKS’s core capital as in June 2018 stood at about Rs. 0.5 billion, below the regulatory requirement of Rs. 1 billion for Licenced Finance Companies (LFCs). Further, TKS’s total capital adequacy ratio at 6.2% as of July 2018 was below the regulatory requirement of 10% and the gearing stood high at 14.7 times as of June 2018. ICRA Lanka notes that, sizeable further external capital infusion (about Rs. 2.0-2.5 billion over the period FY2019-FY2021) would be required as internal generation is likely to remain modest. Going forward, timely capital infusion would be crucial to meet regulatory capital requirement.

Outlook: Stable

TKS’s ability to raise capital to meet the regulatory requirement on a timely basis would be a key rating sensitivity. The outlook may be revised to “Positive” based on TKS’s ability to grow its portfolio and improve its earnings profile and asset quality indicators while maintaining a healthy capital profile. The outlook may be revised to “Negative” in case of TKS continuing to fail in meeting regulatory capital requirement going forward or in case of further deterioration in its overall financial risk profile.

Key rating drivers Credit challenges

nSmall scale of operations and modest competitive position: TKS is a relatively small player in the NBFI industry with a portfolio of about Rs. 4.9 billion as of June 2018. Presently, the company is operating with restrictions on lending (since June 2018) and borrowings (since January 2018), imposed by CBSL, because of non-compliance of the minimum core capital requirement of Rs. 1 billion, currently. As of Jun-18, the portfolio consisted of loans, leasing and HP, and microfinance lending which accounted for about 85%, 12% and 3% respectively. The loan segment largely consists of property loans (37% of total portfolio), working capital finance loans (about 16%), personal loans (about 16%) and loan (about 10%) granted to a group company, AFL Asset Management Ltd. The leasing portfolio mainly consists of lending for passenger vehicles (cars, vans, jeeps) which accounted for about 8% of total portfolio and lorries which accounted for about 2% of the total portfolio in Jun-18.

nWeak asset quality indicators: TKS recorded a high gross NPA ratio of 22.0% in June 2018 (19.2% in March 2018) largely on account of working capital financing backed by post-dated cheques and property backed loans to SME clients. The working capital financing portfolio (about 16% of the total portfolio in June 2018) recorded a gross NPA ratio of 63.7% and property loans (about 37%) recorded a gross NPA ratio of 21.6%. The high slippages were primarily because of stress faced by the SME segment due to macro-economic challenges, and inadequate credit evaluation and monitoring. The top 20 NPA accounts constituted about 17% of the total NPAs as of June 2018. TKS’s ability to curtail further slippages and recover loans extended to AFL and from current NPAs would be a key rating monitorable going forward.

nSizeable external capital required: TKS’s core and total capital adequacy ratios stood at 6.2% as of July 2018. While TKS is complying with the minimum core CAR requirement of 6.00%, its total CAR is below the regulatory threshold of 10.00%. Further, according to the CBSL direction for LFCs, TKS’s core capital was required to be increased up to 1.0 billion by January 2018 and each year thereafter by Rs. 500 million until it reaches Rs. 2.5 billion by January 2021; the company’s core capital stood at about Rs. 0.5 billion in June 2018, below the threshold. ICRA Lanka estimates that the company would require further external capital support of about Rs. 2.0-2.5 billion over the period FY2019-FY2021 to meet the subsequent requirements (with adequate buffer). Further, TKS’s solvency ratio2 stood high at about 119% as of Jun-18 because of the asset quality weakness and high gearing (14.7 times in June 2018). TKS’s ability to raise capital on a timely basis would be a key rating monitorable going forward.

nLimited funding diversity: Since January 2018, TKS has a cap imposed by CBSL on public deposits at Rs. 4.9 billion and other borrowings at Rs. 123 million. Total borrowings of TKS stood at about Rs. 4.5 billion and about 98% of it as public deposits, consisting of fixed deposits (about 94%) and savings deposits (about 4%) in June 2018. The borrowings from banks accounted for the remaining 2%.

nPoor profitability indicators: TKS has been reporting net losses since FY2017 and the net loss for Q1FY2019 was Rs. 78 million (net loss of Rs. 124 million for FY2018). The earnings profile is characterised by high credit costs of 6.0% in June 2018 (4.5% in March 2018 because of higher provisioning for slippages in the SME portfolio. Going forward, it is crucial for TKS to improve its asset quality and keep credit cost under control as business expands.