Fitch Ratings has assigned LB Finance PLC (LB) a national long-term rating at ‘A-(lka)’ with a stable outlook.
LB’s national long-term rating reflects its established franchise among licensed finance companies (LFC), whose higher yielding exposures have supported sound profitability. The rating also captures its relatively higher risk appetite as indicated by its exposure to gold-backed loans. Fitch views LB’s capital as satisfactory taking into account the entity’s good revenue generation.
LB’s leading 11 percent deposit market share among LFCs, as well as its extensive branch network has supported the company’s funding position. At the same time, it also exposes LB to higher liquidity risk compared with peers in particular as gross loans reached 90 percent of assets at end 1HFY16 which is higher than the industry. Meanwhile, its share of liquid assets (as a percent of total assets) declined to 9 percent. Mitigating factors include its moderately concentrated deposit base and un-utilised backup facilities.
Fitch sees LB’s product exposure to gold-backed loans (17 percent of gross loans at end 1HFY16) as being a potential risk to its asset quality due to the volatility of gold prices even though the focus is on short tenure facilities (almost all under six months). This concentration is unique in the LFC peer group. LB’s business focus remains on vehicle financing (75 percent of the loan book at end 1HFY16) with motor cars and three-wheelers accounting for 26 percent and 24 percent of the total at end-1HFY16. About 60 percent of its motor car and three-wheeler loans comprise unregistered vehicles, which is a positive as they are newly imported and are of a better credit quality.
Fitch expects LB’s net incremental non-performing loans (NPLs) to increase in the medium term in line with the entity’s projected loan growth. Its 90 days overdue loans are higher than peers’. Reported NPLs at a five-month level improved to 4.6 percent at 1HFY16 from 5.2 percent in FY15, the latter being, however, mostly a function of solid loan growth (1HFY16: 12.6 percent, FY15: 15.1 percent). Revision of its impairment policy in FY15 resulted in a significant improvement in its provision coverage.
LB’s pre-impairment profit to average total assets stood at 8.5 percent at end-1HFY16 (FY15: 8.8 percent, FY14: 6.8 percent), similar to higher rated peers. Its cost to income ratio remained the lowest among peers at 36 percent at end 1HFY16 on the back of greater scale. Higher net interest margins (NIMs) reflect relatively higher risk products such as gold-backed lending and three-wheeler leasing, along with an increase in lower cost wholesale borrowings. However, Fitch believes that a potential increase in operating costs due to branch expansion and an increase in credit costs could hamper operating profitability and internal capital generation, in the medium term.
The rating reflects Fitch’s expectation that LB’s profitability remains sufficient to allow for growth, while maintaining capital ratios at the current level. The regulatory Tier-1 ratio stood at 16.0 percent at end-FY15.
An upgrade of LB’s rating is contingent upon the company achieving stronger capitalisation levels along with a moderation of its risk appetite demonstrated through lower exposure to risky assets. A more comfortable liquidity position would also support the rating.
Fitch would downgrade LB’s rating if the company fails to maintain its capital levels, weaker profitability or if there is a sustained deterioration of in asset quality. An increase in liquidity risk could also lead to a downgrade.