Fitch affirms Merchant Credit rating

Fitch Ratings Lanka has affirmed Merchant Credit of Sri Lanka Ltd’s (MCSL) National Long-term rating at ‘BBB(lka)’, reflecting the implied support assumed to be available from its main and ultimate shareholder, Bank of Ceylon (BOC, ‘AA(lka)’). The outlook is stable.

The agency takes considerable comfort from BOC’s strength and its effective ownership of 88% of MCSL’s equity, as well as board influence through common directors.

However, MCSL’s rating is constrained by its weak asset quality and low capitalisation which has resulted in poor solvency.

MCSL’s core business is the provision of vehicle finance in the form of finance leases and hire purchase (HP) which together represented 75% of its asset base at FYE07.

Historically, asset quality has been weak on account of poor monitoring.

Reflecting the impact of the challenging macroeconomic environment, the gross NPL ratio (NPLs are defined by Fitch as advances in arrears for more than three months) rose to 32.5% at FYE07 from 20.0% at FYE06 (14.5% at FYE07 from 9.9% at FYE06 at the six-month regulatory threshold). Consequently, net NPLs/equity declined to 169.7% at FYE07 from 127.9% at FYE06 (46.0% at FYE07 from 39.7% at FYE06 at the six-month level).

Following the institution of fresh management and an increased focus on recoveries beginning from H208, the gross NPL ratio improved to 28.5% (14% at the six month regulatory threshold) and the net NPL/equity ratio improved to 142.4% (43.3% at the six month level) at August 2008 from the respective ratios at FYE07.

The company’s profitability, as measured by ROA, increased to 2% in FY07 from 1.7% in FY06.

This was supported by an expansion in net interest margins, reflecting the shift in the portfolio in favour of HP, but is still constrained by the NPL drag and high operating costs.