Fitch Affirms Alliance Finance Company's Rating at 'BB+(lka)'
At the same time Fitch affirmed AFC's outstanding senior unsecured debentures at 'BB+(lka)' and outstanding subordinated debentures at 'BB(lka)'.
KEY RATING DRIVERS
NATIONAL RATING AND SENIOR DEBT
AFC's rating reflects its established but modest franchise and weaker capitalisation given its growth track record. This is balanced against recent improvements in risk controls. Execution of management's strategic plan to expand its loan book and adherence to sustainable growth targets underpin the Stable Outlook, and meaningful deviation from the plan may place downward pressure on AFC's ratings.
Fitch expects AFC to expand at a pace commensurate with its current capitalisation levels over the medium term, led by growth in vehicle financing and other term loans. Consequently, Fitch expects AFC's capital ratios to remain at current levels, with capital being supported by gains from planned asset disposals and a planned LKR72m rights issue.
AFC's loan book expanded by 28% in the financial year ended 31 March 2016 (FY16), in line with the industry. However, aggressive loan growth, beyond management's current growth targets, will exert pressure on AFC's financial profile as it could further weaken capitalisation and asset quality as well as erode its liquidity and funding position.
AFC's internal capital generation has been constrained by low profitability and continued dividend payouts. The Fitch Core Capital ratio, which includes the revaluation reserve (17% of equity), declined to 12% at FYE16 (FYE15: 14%).
AFC's reported gross non-performing loan (NPL) ratio for loans in arrears for at least six months reduced significantly to 2.5% at FYE16 from 8.3% at FYE15 primarily due to the sale of repossessed vehicles and gold articles from its matured pawning book. Fitch believes that rapid loan growth in a challenging operating environment would still exert pressure on asset quality, despite strengthened credit risk management.
AFC's ROA improved to 1.9% in 1QFY17 (FY16: 1.8%, FY15: 1.1%) largely due to better revenue generation and relatively lower credit costs, but remains low compared to higher-rated peers. Rapid branch expansion during the last three years and increased investment in staff have led to a high cost-to-income ratio relative to peers. Fitch believes that an increase in credit costs could hamper operating profits and internal capital generation in the medium term.
Fitch expects projected balance-sheet expansion to also put pressure on AFC's funding as it is likely to outstrip deposit growth and push AFC to rely more on wholesale funding. Liquidity remains stretched as high loan growth resulted in its loan-to-deposit ratio increasing to 192% in 1QFY17 (FY16: 188%).
AFC's outstanding senior debentures are rated at the same level as AFC's National Long-Term Rating as they rank equally with the claims of the company's other senior unsecured creditors.
The outstanding subordinated debentures are rated one notch below AFC's National Long-Term Rating to reflect their subordination to the claims of senior unsecured creditors.
An increase in risk appetite, which will be evident from aggressive loan book growth above management forecasts, could lead to a downgrade of AFC's rating if capitalisation continues to weaken, asset quality deteriorates significantly and funding and liquidity are eroded.
Conversely, an upgrade of AFC's rating is contingent upon the company achieving a sustained improvement in its capitalisation commensurate with its loan growth, and a moderation of its risk appetite through better underwriting standards and risk controls to help sustain improvements in asset quality.
SENIOR AND SUBORDINATED DEBT
The debt ratings will move in tandem with changes in the AFC's National Long-Term Rating.
In accordance with Fitch's policies the issuer appealed and provided additional information to Fitch that resulted in a rating action which is different than the original rating committee outcome.