RAM assigns BB+/NP rating to Swarnamahal Financial Services

RAM Ratings Lanka has assigned respective long- and short-term financial institutions ratings of BB+ and NP to Swarnamahal Financial Services Ltd (“SFSL” or “the Company”); the long-term rating has a stable outlook. The ratings are premised on the strong credit quality of the Company’s loan portfolio and its healthy capitalisation.

The ratings are also supported by SFSL’s well-known name, primarily underscored by its sister company, Swarnamahal Jewellers (Pvt) Ltd (“Swarnamahal Jewellers”). Nevertheless, the ratings are constrained by SFSL’s small size, as well as the Company’s short track records on profitability and improved corporate governance under its new management team.

Incorporated in 2004, SFSL is part of the EAP Group of Companies (“EAP Group” or “the Group”), a well-established, diversified family business with interests that include entertainment, jewellery, leisure and finance. However, the Company is a relatively small registered finance company (“RFC”), accounting for only 1.53% of the industry’s assets as at end-September 2010.

Historically, SFSL has faced regulatory pressure due to related-party transactions; meanwhile performance had been in the red. Notably, the Company underwent a major management restructuring in 2009, following which it has turned around while strengthening its corporategovernance framework.

SFSL is predominantly focused on the pawn-broking business, which entails low delinquencies. As a result, its asset-quality indicators have remained healthy. The Company’s gross non-performingloan (“NPL”) ratio was well below its peers’ at 0.61% as at end-FYE 31 March 2010 (“FY Mar 2010”). This eased further to 0.55% as at end-September 2010, mainly driven by its expanding loan base. Moreover, the Company has also trimmed its exposure to real estate and related-party loans; these accounted for a respective 8.32% and 0.79% of its total assets as at end-September 2010 (end-FY Mar 2009: 21.58% and 12.17%). Going forward, SFSL’s portfolio expansion is expected to stay robust, primarily driven by its pawn-broking business via the enlargement of its branch network.

On a separate note, SFSL’s performance has been improving. The Company’s net interest margin (“NIM”) widened to 7.79% as at end-September 2010 (FY Mar 2009: 3.60%), propelled by the expansion of its high-yield pawn-broking segment and declining funding costs, in line with the environment of receding interest rates. Consequently, SFSL returned to profitability in FY Mar 2010 after 2 consecutive years of losses; its pre-tax profit amounted to LKR 23.39 million for the year. The strong performance carried through to 1H FY Mar 2011, with a pre-tax profit of LKR 32.76 million.

Meanwhile SFSL’s funding is dominated by deposits, which accounted for 86.73% of its total funding needs as at end-September 2010. The Company’s deposit base has been charting strong growth in recent years, supported by its expanding branch network and the relatively high deposit rates offered. However, we note that SFSL’s liquidity position had weakened in tandem with the rapid expansion of its loan portfolio. As such, the Company’s statutory liquidity ratio declined from 12.23% as at end-March 2010 to 10.27% as at end-September 2010, i.e. just above the regulatory minimum of 10%.

Notably, the Company’s capital cushioning remained healthy; its tier-1 and overall risk-weighted capital-adequacy ratios (“RWCARs”) clocked in at 14.04% and 20.35%, respectively, as at end- September 2010 - well above the corresponding regulatory minimums. Going forward, SFSL’s capitalisation is expected to be bolstered further by a LKR 55 million capital infusion from its listing on the Colombo Stock Exchange (“CSE”), coupled with stronger internal capital generation.