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Vehicle import ban depresses sector growth prospects – Fitch

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Higher second-hand vehicle prices due to limited new vehicle supplies have reduced affordability and will most likely dampen future demand for vehicle financing and the prospects for sector earnings. The higher prices have supported loan recoveries from repossession in the near term, but may expose FLCs to unexpected sharp price corrections.

The sector’s direct exposure to vehicle financing through leases was around 53% of total loans by end-June 2021 (1QFY21) (FYE19: 55%), but actual exposure would be much higher as a significant share of term loans are backed by vehicle collateral.

The Covid-19 pandemic continues to exert significant pressure on the operating environment (OE) for Sri Lankan FLCs. Fitch Ratings projects a gradual economic recovery in 2021 and 2022, after a 3.6% contraction in 2020 GDP. However, this forecast remains subject to considerable uncertainty depending on the trajectory of the pandemic. The outlook on the OE remains negative and reflects significant downside risks from the ongoing pandemic and Sri Lanka’s sovereign credit profile (CCC).

What to Watch Pressure on Risk Profiles: The FLC sector loan book contracted for the fifth consecutive quarter in 1QFY22 with a yoy decline of 2.2% (FY21 growth: -3.1%), affecting revenue generation and asset quality ratios. This may push FLCs to assume more risk by diverting lending to products outside their core expertise to sustain business volumes, as similarly occurred in FY15-FY17.

Impairments to Peak in FY22: Fitch-rated FLCs’ regulatory non-performing loans (NPL), based on six-month arrears ratios, rose in FY21 despite a debt moratorium, reflecting the severe stress in the economy. The extent of borrower distress may not yet be fully visible in reported NPL ratios due to the moratorium affording flexibility. So we expect NPL ratios to peak in FY22 before easing in FY23 on slower accumulation of bad loans and slower loan growth over the past two years.

Ongoing Pressure on Profitability: FLCs’ profitability is likely to remain depressed owing to weak revenue generation and high credit costs. We do not expect the FLCs’ profitability to revert to higher historical averages within the next 12-18 months, as we believe it will take longer for revenue streams to fully recover and for FLCs to resolve asset-quality problems.

No Immediate Threat on Capital and Liquidity: Sluggish loan growth and acceptable balance sheet liquidity should relieve the near-term burden on rated FLCs’ capitalisation and liquidity profiles.

However, pressure on capitalisation is likely to emanate from further asset-quality deterioration, particularly through equity exposure to unprovisioned NPLs.

The CBSL tightened its monetary policy stance on 19th August by 50 bps, becoming the first central bank in the region to do so. Accordingly, money market rates, bond yields, and prime lending rates rose.

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