Fitch affirms Senkadagala Finance at ‘BBB+(lka)’; Outlook Stable

Fitch Ratings has affirmed Sri Lanka’s Senkadagala Finance Company Limited’s (SFC) National Long-term rating at ‘BBB+(lka)’. The Outlook is Stable.

SFC’s rating reflects its long operating history and good capital structure, as well as its relatively good credit control systems and processes. The rating is however constrained by SFC’s evolving economies of scale and market share in core operations in relation to some of its larger peers.

An upgrade of SFC’s rating is contingent upon the continued consolidation of its lending base and greater diversity of its funding sources, while sustaining healthy asset quality and profitability. Conversely, a downgrade could occur in the event of an unexpected and sustained weakening of SFC’s asset quality or profitability - however this is less likely over the medium-term.

SFC’s loan book grew by 8% in the six months to end-September 2010 (6M11) as macro-economic credit growth gradually picked up, in contrast to a 3% contraction in the fiscal period that ended in March 2010 (FYE10).

The company’s growth has been somewhat lower than most of its rating peers’, partly due to the smaller average ticket-size of its advances and smaller branch network. At end-6M11, close to 78% of SFC’s portfolio consisted of hire purchase contracts, while approximately 18% and 4% consisted of finance leases and working capital loans, respectively.

SFC has hitherto funded its loan growth largely through securitisations, where liabilities are matched to the cash repayments of the underlying assets, limiting liquidity risk to a great extent. However, given the relatively higher costs of such lines, the company expects to diversify its funding base towards retail deposits which cost less, to improve its competitive position. Fitch notes that this could increase SFC’s mismatches to a level that is more in line with industry peers.

SFC’s good credit controls, combined with its adequate pricing of advances on a risk-adjusted basis, have helped keep its asset quality and capital structure relatively healthy through the last economic cycle.

The company’s NPL ratio (defined by Fitch at the three-month-in-arrears level) has continued to improve during FY10 and 6M10, driven by improving economic conditions, concerted recovery efforts, and the write-off of fully provided NPLs on a periodic basis.

Due to SFC’s conservative provisioning policy, provisioning reserves exceeded NPLs at the six-months-in-arrears level (net NPL/equity at 6M10: -1.03%), eliminating any incremental hit on equity at this threshold.

SFC’s profitability improved in 6M10, with pre-tax return on asset (ROA) returning to an annualized 6.95% at end-6M10, compared to an average of 5.85% between FY03 and FY08, helped by better margins in a low-interest-rate environment and lower provisioning costs.

SFC’s ROA was depressed during FY09 and FY10, largely on account of higher NPLs and related provisioning costs in a weak economic environment, as well as due to its aggressive branch expansion during this period. Fitch expects SFC’s ROA to remain healthy over the medium-term, in line with its expectations for the company’s peers, as provisioning costs are likely to ease if the local economy continues to improve.

At FYE10, SFC accounted for an approximate share of 3% of registered finance company assets in Sri Lanka, and operates through a network of 30 outlets, employing over 200 staff. The company was established in 1968 by the Balasuriya family, who own 90% of SFC’s equity.