Fitch affirms UB Finance at ‘BB’; Outlook stable

Fitch Ratings has affirmed UB Finance PLC’s (UBF) National Long-Term Rating at ‘BB(lka)’. The Outlook is Stable.

Fitch cited the following drivers for its rating decision.

Shareholder support underpins rating: UBF’s National Long-Term Rating is driven by our expectation of extraordinary support from Union Bank of Colombo PLC (UB, BBB-(lka)/Stable) to UBF, if required. Our view is based on UB’s 89.9% ownership of UBF, its record of ordinary support, board representation and common branding between the bank and UBF.

Relative size a constraint: UBF’s rating is constrained by our view that any support required may be more of a burden relative to UB’s modest balance sheet size, compared with other Fitch-rated financial leasing companies owned by larger banks. UBF’s assets accounted for 7% of UB’s consolidated assets and 14% of equity as of end-2023. UB’s smaller capital base also limits the amount of funding it can provide to UBF in times of need due to the regulatory limit on the bank’s single-borrower lending. At end-3QFY24 UBF held no debt from UB, with only modest historical borrowings on record. Limited importance to group: We rate UBF two notches below its parent’s rating given its limited importance to the UB group. UBF’s main products, including leasing and gold lending, account for 5.3% of the group’s gross loans and are not core products of the group due to limited scale, in Fitch’s view. Furthermore, synergies are limited between the bank and UBF, given minimal overlap between UB’s and UBF’s target customer profiles. UBF’s low contribution to group profitability due to a weak performance record, despite the 13% contribution in 2023, also limits its importance to the group.

Weak standalone profile: We believe UBF’s intrinsic credit profile is weaker than its support-driven rating. UBF has a small franchise, with market share of below 1% as of end-2023. Fitch views UBF’s risk appetite as high while its poor asset quality, weak earnings, thin capital buffers and significant deposit concentration underpin its weak financial profile.

Thin capital buffers: We expect the proposed rights issue to bridge UBF’s regulatory capital shortfall. However, the capital buffer could be thin against the regulatory minimum capital of Rs. 2.5 billion and may fall below the regulatory requirement should there be any unforeseen losses. UBF’s debt/tangible equity stood at 2.9x at end-3QFY24 and we expect this to increase in the medium term as UBF pursues aggressive growth.

Loan book to expand: We expect UBF to pursue rapid growth in the near to medium term, supported by improving economic activity and easing interest rates. We believe vehicle financing and gold-backed lending, which contributed 75% of loans at FYE23, to remain UBF’s core product offerings, while its legacy property exposures (11% of FYE23 loan book) is likely to decline.

Asset quality to improve: We expect UBF’s gross stage 3 loan ratio to moderate in the near to medium term, due to higher loan growth, increasing recovery efforts and less pressure on the existing borrowers due to improved economic conditions and declining interest rates. The gross stage 3 loan ratio marginally improved to 30% as of end-3QFY24 (FYE23: 33%) due to declining stage 3 loans, but remains considerably higher than the industry average of 18%.