Fitch rates Multi Finance ‘B+(lka)’; Outlook Stable

Fitch Ratings Lanka has assigned the Multi Finance Company Limited (MFCL) a National Long-Term rating of ‘B+(lka)’. The Outlook is Stable.

MFCL’s rating reflects its small size, weak franchise, modest capitalisation and low profitability in its core business. The rating factors in the company’s rapid loan growth since its takeover by Entrust Limited in March 2008, and the resulting improved product diversity.

The rating may face downward pressure if there is a significant structural change in MFCL’s balance sheet, which could impede future profitability. Such a change in its balance sheet could arise from, among other things, its potential merger with the finance company - The Standard Credit Lanka Ltd (SCLL). A significant and sustained weakening of its capitalisation or liquidity could also have a negative rating impact. Conversely, an increase in MFCL’s scale of operations without a significant compromise on asset quality, as well as a sustained improvement in its core profitability could result in a ratings upgrade.

In March 2011, MFCL’s parent - Entrust Limited - was appointed as managing agent of SCLL (a failed company of the Ceylinco Group). SCLL is being restructured; Entrust’s management intends to merge SCLL with MFCL post-restructuring. Fitch notes that such a merger could significantly alter MFCL’s balance sheet, with a higher proportion of real estate and other slow or non-yielding assets on its books. As such, Fitch will closely monitor changes that could arise to MFCL’s balance sheet post merger and assess its asset composition and quality commensurate with its rating as more information becomes available.

Aided by equity injections in the financial year ended March 2008 (FY08) and FY09, MFCL was able to meet the regulatory minimum capital requirement of Rs. 200m for registered finance companies (RFCs) and increased its asset base to Rs. 681m by end-H1FY11 (FYE07: Rs. 150m). MFCL’s lending portfolio is its main asset, comprising mainly vehicle financing through leases and hire purchase (FYE10: 89% of advances) for commercial vehicles. MFCL’s loan quality is high, with gross non-performing advances (NPAs; advances in arrears in excess of three months) accounting for just 4.2% of advances at end-H1FY11 (1% at the regulatory six-month level), which is considerably lower than peers’. However, Fitch notes that this portfolio is still new and as such NPAs could increase as the loan book seasons.

MFCL’s profitability is constrained by its high cost structures, although its net interest margins (NIMs) benefit from a high proportion of equity-funded assets. The company’s operating costs, which accounted for 11.2% of average assets in H1FY11 (FY10: 13%), are considerably higher than other RFCs’ rated by Fitch (FY10: 5.8%). This is partly driven by the fact that MFCL is still in early stages of growth and yet to benefit from expenses incurred on branch expansion and systems improvements. However, Fitch notes that as MFCL expands and the proportion of equity-funded assets decreases, its NIMs will continue to narrow and therefore cost structures would need to improve so as to maintain core profitability.

As MFCL is still in the early stages of growth, the proportion of equity, although decreasing, is a major component of its funding base (37% of assets at end-H1FY11 from 71% at FYE09). Deposits funded just 23% of assets (over 60% for peers), with parent company borrowings funding 30% at end-H1FY11. Fitch observes that MFCL is exposed to some degree of refinancing risk on this borrowing. Although deposit growth of 28% in H1FY11 (FY10: 118%) was higher than the sector, this growth was on a very small base and did not match loan growth of 69% in H1FY11 (FY10: 65%) - partly owing to its limited deposit franchise. However, branch expansion undertaken and current marketing efforts should support higher deposit growth in FY12.

MFCL was established as an RFC in 1974. It was a closely held company before it was acquired and restructured by Entrust Limited - an investment holding company. Entrust is in turn held by Pacific Trust (Pvt) Limited, a holding company owned by a consortium of investors.