COVID-19 intensifies pressure on finance companies: Fitch

• Expects companies to face multiple challenges including muted loan growth, margin compression, higher loan impairment charges
• Loan moratorium expected to worsen profitability pressures, mask extension of asset quality deterioration
• CB measures will give breathing space but unlikely to resolve challenges sector was facing before virus
• Earnings for 2020 likely to be weaker than last year’s projections

The coronavirus outbreak and the resultant prolonged business disruptions will put additional pressure on Sri Lankan Finance and Leasing Companies’ (FLCs) earnings and asset quality, Fitch Ratings said in a statement yesterday.

The ultimate economic and financial market implications of the outbreak are unclear, while Fitch considers the risks to NBFIs’ credit profiles to be clearly skewed to the downside.

Fitch expects Sri Lankan FLCs to face multiple challenges in the near team, including muted loan growth, margin compression amid lower interest rates, and rising loan-impairment charges due to asset quality pressures.

“We believe that there could be a fall in loan growth in 4QFY20 (ending 31 March 2020), with growth already sluggish up to end-3Q20 (y-o-y decline of 0.9% in gross loans). The degree of recovery in FY21 will depend largely on the duration and severity of the virus outbreak.”

The Central Bank of Sri Lanka (CBSL) has announced further relief for COVID-19-affected businesses, and individuals are to be offered similar relief by FLCs as those offered to customers of banks, including a debt moratorium. Fitch believes that these have mixed implications for FLCs.

A one- to six-month debt moratorium, depending on the type of credit line, will have negative first-order implications for FLCs, but a reduction of the liquid-asset requirement for deposits and borrowings could reduce near-term liquidity shocks stemming mainly from non-payment of loan rentals.

Furthermore, Fitch believes the debt moratorium will exacerbate pressure on FLCs’ profitability, which is already weakened, and is likely to mask the extent of asset-quality deterioration.

In addition, the timeline to comply with enhanced minimum core capital and minimum capital-adequacy ratio requirements has been extended by one year. This will provide some breathing space to FLCs that have not met the relevant thresholds due to dislocation of the capital markets, while significant near-term earnings pressure may weigh on FLCs’ capital buffers. Out of the Fitch-rated FLCs, five had not met the minimum core capital requirements of Rs. 2 billion ($11 million) by 1 January 2020.

The Sri Lankan FLC sector had been struggling with rising non-performing loans, weakening profitability due to rising credit costs and muted loan growth, even before the coronavirus outbreak. This was due mainly to the sluggish economic growth and restrictions on the importation of vehicles to defend the local currency – which hit growth prospects for vehicle finance, the key business segment of Sri Lankan FLCs.

“Our expectations of earnings and asset quality weakening for 2020 now far exceed what was contemplated in late-2019 (see ‘Sri Lankan Finance and Leasing Companies Dashboard,’ published 13 November 2019).”

Fitch expects to complete a review of its ratings on the Sri Lankan FLCs in the near term, as with the banks, considering the likely impact of recent developments.

“Fitch has already revised the banking sector outlook to Negative as the coronavirus pandemic poses increased risks to the anticipated expansion in the economy and credit demand (see ‘Fitch revises Sri Lanka’s banking sector outlook to Negative on coronavirus; rating outlook Negative,’ published 26 March 2020).”