Mercantile Investment and Finance’s Rs. 1 b listed debentures assigned BBB+/P2

RAM Ratings Lanka has reaffirmed Mercantile Investments and Finance PLC’s (MIF) respective long and short-term financial institution ratings at BBB+ and P2. Concurrently, the company has been assigned respective long and short-term ratings of BBB+ and P2 to the company’s proposed Rs. 1 billion Senior Unsecured Listed Debentures (2013/2018). Both long-term ratings carry a stable outlook.

The ratings are upheld by MIF’s good capitalisation levels. They are, however, tempered by its below average asset quality as a result of its high exposure to equity investments, its unseasoned loan portfolio given its recent rapid loan growth, and below-average performance.

MIF is a licensed finance company (“LFC”) that has been in operation for over 48 years and operates with a branch count of 14. Furthermore, MIF had channelled its funds towards lending in fiscal 2012, in contrast to previous years when funds were directed mainly to investments in equity. Consequently, its loan portfolio has expanded robustly in recent times.

MIF’s asset quality is deemed below average, weighed down by its high exposure to non-core assets, i.e. equity investments amounting to 70.27% of shareholders’ funds, which far exceeds the Central Bank of Sri Lanka’s (“CBSL”) stipulated limit of 25%. The heightened exposure to equity investments increases the company’s vulnerability to market risk. On the other hand, MIF’s loan quality indicators remained relatively unchanged, with its non-performing loans (“NPLs”) ratio clocking in at 2.81% as at end-December 2012 (end-March 2012: 2.94%). However, in absolute terms, the company’s gross NPLs weakened 20.07% from Rs. 309.85 million to Rs. 372.05 million as at end-December 2012 amidst a loan growth of 27.28%. The bulk of NPLs arose from leased vehicles. Given MIF’s credit assets growth of 27.28% during the same period, its loan book is deemed to be relatively unseasoned.

The company’s net interest margin (“NIM”) of 5.60% in 9M FY Mar 2013 compared weaker to that of its LFC counterparts, owing to its high equity exposure.

Fluctuations in returns on equity investments render MIF’s performance volatile; as such its high equity exposure is viewed negatively. However, the company’s interest income improved 76.02% (annualised) in 9M FY Mar 2013, backed by robust credit growth, thereby reducing its earlier reliance on equity investment gains.

MIF’s top line improved by an annualised 19.57%, thereby easing its previously high cost-to-income ratio (excluding equity gains) to levels on line with that of similarly rated LFC peers. The ratio, however, is expected to deteriorate in the short run as the company is expected to open five new branches. Supported by a better core performance, MIF’s return on assets and return on equity improved to 4.42% (annualised) and 14.94%, respectively in 9M FY Mar 2013 (FY Mar 2012: 3.28% and 9.66%). Overall, the company’s performance has been deemed to be below average.

Elsewhere, MIF’s funding comprised deposits and borrowings, which accounted for a respective 42.29% and 33.21% of its funding mix as at end-December 2012. The company’s securitised borrowings, which are longer-tenured (2-4 years), resulted in an easing of its maturity mismatches. Meanwhile, MIF’s loans-to-deposits ratio (LD) remained high at 177.53% (end-March 2012: 175.81%) due to its aggressive loan growth increasingly funded by borrowings, as credit growth surpassed deposit growth. On the other hand, deposits grew by 24.05% to Rs. 7.14 billion in 9M FY Mar 2013 (end-March 2012: Rs. 5.72 billion), backed by the company’s extended branch reach and promotional campaigns. MIF’s liquidity is viewed as adequate. Its statutory liquid-asset ratio stood at 12.64% as at end-December 2012 (end-March 2012: 12.76%) amid rapid loan growth and is presently in line with that of similar-rated peers. The company’s liquid assets to customer deposits and short-term funds ratio stood at 36.22% as at end-December 2012, better than similar-rated peers’.

Although MIF’s capitalisation moderated during the review period owing to the robust expansion of its loan book, its capitalisation is still good compared to its peers’. The company’s tier-one and overall risk-weighted capital-adequacy ratios (“RWCAR”) deteriorated to 19.53% and 22.87%, respectively as at end-December 2012, from 22.40% and 27.17% as at end-March 2012, amidst robust credit growth.

MIF does not have immediate plans to infuse capital into the company and intends to augment its credit assets by around 30% by end-December 2013. While the company opines that its capital cushioning will moderate further, resulting in an estimated overall RWCAR of around 17%, the ratio will still be better than most similar-rated peers’.