Business Times

BOC backing retains Fitch 'BBB(lka)' for Merchant Credit

The local office of Fitch Ratings recently announced finance company, Merchant Credit of Sri Lanka (MCSL), would retain its 'BBB(lka)' standing. The largest stake of the company (51%) is held by Merchant Bank of Sri Lanka (MBSL) while 49% is owned by state-owned Bank of Ceylon (BOC), of which MBSL is also a 72% subsidiary.

According to the announcement, the status is a direct result of "implied support from MCSL's main shareholder and Sri Lanka's largest bank - state-owned Bank of Ceylon (BOC; 'AA(lka)'/Stable). Fitch believes that support is likely to be available to MCSL from BOC should it be necessary, in view of BOC's predominant shareholding in MCSL, its association with the BOC franchise and resulting reputation risk, as well as BOC's demonstration of support to subsidiaries".

However, it was also noted that "MCSL's rating reflects the implied support assumed to be available from BOC, in the absence of which its stand-alone rating would be lower". With its core business in vehicle finance through hire purchase (40% of its business) and leases (20%), MCSL had instead chosen to grow its portfolio by 16.7% through increased loans, due to its participating in "some relatively large loan syndications". As a result, the company's loans business had increased from 29% during the 2008 financial year to 40% in 2009. However, according to Fitch; "asset quality remained weak, reflecting a legacy of poor credit risk management".

Further, MCSL's "gross [non performing loans] ratio (defined by Fitch as advances in arrears for three months or above) was 23.6% in [the first half of 2010] from 28.1% at [during the financial year ending 2009]". As such, the agency suggested MCSL's asset quality could be "challenged" since "recovery of its customer base is likely to lag that of the overall economy".

On the other hand, Fitch also stated: "MCSL's profit after tax increased significantly in FY09, largely driven by higher non-interest income during this period. Consequently, its profitability measured by return on asset (ROA) increased to 2.1% in FY09 (FY08: 1.4%), although its core profitability (ROA adjusted for non-recurring gains) increased marginally to 1.6% in the year".

Fitch also indicated MCSL's profitability could be "constrained by credit costs", even though MCSL had "successfully leveraged its association with the BOC franchise to mobile deposits, amply demonstrated by the surge in deposits in FY09 by 45%". MCSL's concentration of depositors had also been highlighted due to the fact that its 10 largest deposits accounted for 16% of total deposits in the first half of the 2010 financial year, compared to 27% in the financial year ending 2009.

Also revealed was that MCSL "is a small registered finance company (RFC) accounting for 2% of total RFC assets [during the financial year ending 2008]", while its "assets represented 0.7% of BOC's consolidated assets as at end-March 2010".

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