Lankan Leasing Firms vulnerable to economic pressure

Fitch Ratings observes that the underlying risks of Sri Lanka’s specialised leasing company (SLC) sector have increased in light of the highly inflationary and rising interest rate environment that has prevailed since end-2006, according to a comment published today.

Fitch notes that the three large SLCs that it rates - Lanka Orix Leasing Company PLC (LOLC, A(lka)/Stable), People’s Leasing Company Limited (PLCL, A-(lka)/Stable), and Commercial Leasing Company PLC (CLC, A-(lka)/Stable), which accounted for 56% of the SLC sector at end-2007 - are relatively more resilient to a continued deterioration in macro economic conditions, given their stronger risk management controls and systems, and better access to liquidity lines from commercial banks.

However Fitch believes that the underlying risk profile could deteriorate disproportionately for the 17 smaller SLCs that make up the remaining 44% of the sector. As such, the ratings of the three smaller SLCs rated by Fitch - Ceylease Financial Services (BBB-(lka)/Stable Outlook), People’s Merchant Bank PLC (BBB-(lka)/Stable Outlook), and Seylan Merchant Bank (BB+(lka)/Stable Outlook) - could be more vulnerable, but are enhanced by the implicit support deemed to be available from their higher-rated majority shareholders.

In addition to the escalation of market risk, credit and liquidity risks (which were hitherto of lesser significance) have also become concerns.

Delinquencies within the lease and hire purchase loan portfolio of the three larger SLCs have progressively increased between 31 March 2006 FYE06) and 30 June 2008 (Q109).

Although the percentage of vehicles seized or returned through voluntary submissions between FY06 and FY08 remained fairly static, legal proceedings were initiated on 24.2% of such contracts in FY08 compared to 17.3% in FY06, as SLCs are increasingly unable to recover overdues via the sale of such repossessed assets.

This is attributed to the slowdown in demand for used vehicles.

Fitch recognises that the extent and frequency of such shortfalls incurred on the sale of repossessed assets is likely to increase for lease and hire purchase loans as an asset class across the wider financial sector, if macro economic pressures were to continue.

Fitch observes that SLCs that carry more seasoned portfolios, and those that maintain low exposures to the value of the underlying asset on incremental loans will be better positioned to absorb a possible further decline in the market value of used vehicles over the medium term.

Although the observed sample of SLCs is well capitalised as indicated by a median equity/asset ratio of 16.4% at end-Q109, liquidity is a growing concern.

The ratio of equity funded cash and equivalent liquid assets (liquid capital) to outstanding principal net of provisions on loans that are more than 90 days past their due date progressively tightened to 10% at FYE08 from 43% at FYE05.