Fitch affirms Central Finance at ‘A+(lka)’

Fitch Ratings-Colombo/Hong Kong/Singapore-13 November 2012: Fitch Ratings Lanka has affirmed Central Finance Company PLC’s (CF) rating at ‘A+(lka)’. The Outlook is Stable. Simultaneously, Fitch has affirmed CF’s senior unsecured debt at ‘A+(lka)’, subordinated debt at ‘A(lka)’ and commercial paper at ‘F1(lka)’.

CF’s ratings factor in its strong franchise and capitalization supported by robust profitability. CF’s franchise developed over its 55-year operating history. At end-2011, CF was the largest licensed finance company (LFC) holding 13% of LFC assets in Sri Lanka.

An upgrade of CF’s rating is contingent upon greater product and funding diversity together with better funding flexibility commensurate with higher category peers. Conversely, a sustained weakening in capitalization due to a deterioration in asset quality or profitability could result in a downgrade.

CF has been successful in sustaining its strong capitalization ratios in the face of high growth. Its equity/asset ratio of 23.0% at end-September 2012 was higher than that of peers and was supported by robust profitability and high capital retention. Its statutory Tier 1 capital adequacy ratio of 22.4% also compared well with local peers.

Profitability remained strong with ROA increasing to 5.2% in FY12 (FY11: 4.4%) despite a narrowing of net interest margins (NIMs) during the year. This was mainly due to lower taxes (because of a reduction in the corporate and financial value added tax rates from FY12) but CF also benefitted from improved operating efficiency (as the company leveraged on newly opened branches) and lower credit costs (owing to better asset quality). NIMs were squeezed in FY12 by rising funding costs in the latter half of the year. However, Fitch expects NIMs to widen in FY13 as the effect of revised lending rates feeds into higher yields.

CF’s deposit growth of 13.9% in FY12 did not keep pace with strong loan growth of 38.1% during the year, which led the company to opt for increased institutional borrowings. Due to the strength of its franchise CF has in the past been able to mobilize deposits at a considerably lower cost than peers. However, balancing increased funding requirements while managing funding costs could be challenging in FY13.

CF adopts a conservative risk profile with a credit portfolio expansion of 11% in H113 (FY11-FY12: two-year compound annual growth rate of 34%). Although high, this level of growth was significantly lower than that of large peers (two-year CAGR above 50%). Growth stemmed from both leasing and hire purchase (HP) portfolios, with LFCs meeting pent up credit demand, as well as satisfying the excess demand from banks due to a regulatory credit ceiling imposed on banks in 2012.

Asset quality has been improving supported by an enhanced credit environment and greater recovery efforts. CF’s gross three-month non-performing loan ratio stood at 4.9% at end-H113 (FYE12: 4.1%), down from 7.0% in FY11. Maintaining these ratios could be challenging given a gradually slowing macroeconomy and rising interest rates. Fitch believes NPLs could rise in FY13 unless greater efforts are taken to prevent NPL slippage as the loan book seasons.