Fitch Downgrades Sinhaputhra Finance PLC to 'B(lka)'

Fitch Ratings Lanka has today downgraded Sinhaputhra Finance PLC's (SFL) National Long-term rating to 'B(lka)' from 'BB-(lka)'. The Outlook is Negative. Although liquidity pressure faced by the company has waned, Fitch notes the significant increase in the regulatory six-month NPLs and consequent deterioration in the net NPL/equity ratio, and depressed profitability.

The cash flows of SFL's customer base which consists of the SME segment were significantly impacted by the slowing economic environment witnessed since FY08. This, together with SFL's focus shifting away from recoveries towards maintaining liquidity in the first half of 2009, resulted in a sharp increase in NPLs particularly under the regulatory six-month classification. Fitch is concerned by the six-month net NPL/equity ratio of 34.6% at end-December 2009 (sector average of 2.8% at end-September 2009), given SFL's low provision coverage on NPLs and weak internal capital generation. The sector includes 11 registered finance companies (RFC; excluding companies related to the Ceylinco Consolidated group), which accounted for 56% of total non-Ceylinco RFC assets as at end-September 2009. The agency notes that an equity infusion is essential to stabilise the company's financial profile.

Fitch notes that although deposit outflows experienced by SFL and the wider RFC sector subsequent to the collapse of an unregulated 'deposit taking institution' in end-2008 were arrested by mid-2009, the company only fully complied with the regulatory minimum liquidity requirement in February 2010. However, SFL's holding of liquid assets in relation to fixed deposit liabilities at 15% at end-May 2010 is comfortably above the revised 10% regulatory requirement.

SFL's loan book grew by 10.7% yoy at end-March 2009 (FYE09), though it declined by 0.7% at FYE10. The bulk of growth was derived from hire purchase agreements (HP) for vehicle finance, changing the portfolio mix with leases, HP, and loans accounting for 27.8%, 24.6% and 47.5%, respectively, at FYE10 (FYE08: 43.8%, 7.8% and 48.4%, respectively). The loans primarily consist of working capital loans, which are secured against property mortgages. Fitch expects SFL's loan growth to remain low in FY11, as recovery of its customer base is expected to lag the current improvements in macro conditions.

Rising funding costs and suppressed yields as a result of the rising six-month NPLs (where interest ceases to be accrued) resulted in a continued deterioration in net interest margins (NIM). NIM was a low 3.8% at end-June 2009 from 7.1% at end-March 2008 (sector 9.2% at end-September 2009). Effective tax rates spiked at 62% at FY09 as tax benefits through capital allowances on leasing were substantially reduced. This is because SFL switched its portfolio from this product towards HP. Hence, audited return on assets was low at 0.3% at FYE09 (FYE08: 1.5%). Fitch notes that despite a sharp reduction in sector-wide deposit rates since the last quarter of 2009, SFL's profitability would continue to be constrained unless NPL accretion, particularly at the six-month level, is not contained.

SFL, established in 1978, is a registered finance company, regulated by the non-bank financial institutions department of the Central Bank of Sri Lanka. The company listed on the Colombo Stock Exchange on 02 June 2010, however, the current Managing Director Mr. Ravana Wijeyeratne continues to maintain control, holding 52% of SFL's equity. SFL operated through three branches and three service centres at FY10.