UB Finance Company Limited

ICRA Lanka reaffirms the issuer rating of UB Finance Company Limited

InstrumentRated Amount (LKR Mn)Rating Action
Issuer ratingN/A[SL]BB (Negative); Reaffirmed

Rating action

ICRA Lanka Limited has reaffirmed the issuer rating of UB Finance Company Limited (“UBF” or the Company) at [SL]BB (Pronounced SL double B). The outlook on the rating remains Negative.

Rationale

The rating factors in UBF’s weak capital profile and asset quality indicators as compared to the systemic average. The company reported a Networth of LKR 738 Mn in Mar-21 as compared to the regulatory minimum requirement of LKR 2,000 Mn. UBF’s capital profile deteriorated significantly since 2018 because of weak profitability and adjustments required as per the revised regulatory capital computation norms and very specifically due to the one-time IFRS-9 transition adjustment of LKR 430 Mn in FY2019. As a result, the Central Bank of Sri Lanka (“CBSL”) placed a lending cap of LKR 9.8 Bn and deposit cap of LKR 7.2 Bn on the Company, which was revised to LKR 8.1 Bn and LKR 5.8 Bn respectively in Aug-20. ICRA Lanka had factored in timely capital and liquidity support from Union Bank of Colombo PLC (UBC or the parent; rated [SL]BBB/stable). However, UBC did not infuse fresh capital in the last fiscal year, as UBF was in the process of raising a sizeable capital (in relation to its current net worth) from an external investor. The capital-raising process failed to close as a result of the pandemic. UBF is currently considering two options, one of which is via a potential strategic investor. ICRA Lanka also notes that, as the second option, the parent company, UBC has given an undertaking to infuse the required capital, in case option one does not materialize. ICRA Lanka will continue to monitor the development on the capital raising and future rating actions will be taken accordingly. If the Company fails to meet the minimum regulatory capital requirement, within a reasonable time period, it could lead to a correction in the rating.

ICRA Lanka also notes, UBF’s weak asset quality with its gross NPA ratio (GNPA) at 15.8% in Mar-21, higher than the Licensed Finance Company sector’s average of 11.3%. The GNPA improved in Mar-21 from 18.6% in Mar-20, as a result of the focus on collections and recoveries in 90 days plus buckets. The rating also notes some improvement in the overall risk profile of the lending portfolio, with exposure to risk product segments such as SME lending, moderating. However, the overall asset quality levels of UBF will be a key monitorable, going forward. 

Outlook: Negative

The Negative outlook reflects the weakened capital profile, which has resulted in the lending and borrowing restrictions and, its weak asset quality profile. The outlook may be revised to ‘Stable’ in case the Company is able to secure adequate capital in a timely manner and improve its asset quality. There could be a correction in the rating in case the capital infusion does not materialize.  

Key rating drivers

Credit challenges

Significant external capital requirement to comply with the regulatory minimum; UBF is a 73% subsidiary (81% by voting rights) of Union Bank of Colombo PLC (“UBC rated [SL] BBB/stable). The Bank along with the strategic partner Shorecap II Limited has infused close to LKR 1.4 Bn to UBF (“UB Finance Company Limited”/ “the Company”) since 2011. UBF continues to non-comply with the regulatory minimum Core Capital requirement since Mar-18 and capital adequacy requirements since Jan-19. The company, reported a Networth of LKR 738 Mn in Mar-21 as compared to the regulatory minimum requirement of LKR 2,000 Mn. The one-time IFRS 9 transition adjustment of LKR 430 Mn, adjusted for FY2019 had a significant impact on UBF’s overall capital position. As at Mar-21, regulatory Core Capital Ratio and the Capital Adequacy Ratio was 3.61% and 4.55%, respectively, as compared to the regulatory requirement of 6.50% and 10.50%. The lending cap of LKR 9.8 Bn and the deposit cap of LKR 7.2 Bn initially placed on the Company was revised in Aug-20 to LKR 8.1 Bn and LKR 5.8 Bn respectively. ICRA Lanka notes that UBF requires immediate minimum capital support of approximately LKR 1.85 Bn to meet the regulatory minimum requirement of LKR 2.5 Bn by December 31, 2021. The parent entity, UBC did not infuse fresh capital in 2018, as UBF was in the process of raising a sizeable capital from an external investor. ICRA Lanka takes cognizance of the on-going capital enhancement initiative via a potential strategic investor, and the commitment of the parent entity to infuse the required capital, if the former does not materialize. However, timely completion of the capital infusion is crucial from a rating point of view, as the company was consistently operating below the regulatory capital limits.

Weak asset quality to persist in the short term: UBF reported a Gross NPA of 15.8% as in Mar-21 (18.6% in Mar-20) as compared to the Licensed Finance Company (“LFC”) sector’s gross NPA of 11.3% in Mar-21 (11.6% in Mar-20). Significantly weak asset quality indicators is partly due to depletion of the portfolio and weaker collections due to the challenging macro-outlook. ICRA Lanka notes that the company has recorded particularly high NPAs in its working capital and other business-related exposures, segments which the company intends to curtail.  The provision coverage ratio of the company stood at 49.5% in Mar-21 as compared to 45.1% in Mar-20 and 65.9% in Mar-19. The rating takes some comfort in improved collection levels in Dec-20 and Mar-21 quarters, however the impact of the third wave of the COVID outbreak is yet to be seen. Going forward, the company’s ability to arrest incremental slippages and reduce the NPAs by recovering some of the large ticket exposures are crucial from a rating point of view.

Modest scale of operations and limited franchise: UBF operates with a modest portfolio of LKR 7.7 Bn as in Dec-20 (LKR 8.5 Bn as in Mar-20 and LKR 10.0 Bn as in Mar-19). The Company offers lease and vehicle backed loans (49% as in Dec-20), working capital financing (17%), Fixed Deposits backed loans (9%), Gold loans (7%) and others (18%). Key asset classes in the lease and vehicle backed loan category includes cars, light commercial vehicles, lorry, van and bus which accounted for 29%, 9% 9%, 5% and 3% of the total portfolio as in Dec-20. Going forward, UBF is expected to focus on leasing and gold loans. Presently, the portfolio growth is constrained by lending cap placed by CBSL which was revised to LKR 8.1 Bn in Aug-20.

Subdued profitability: UBF’s Net margins improved in FY2021 due to the reductions in cost of funds with the sharp decline in systemic interest rates.  However, the RoA and RoE of the company further moderated to -0.47% and -5.46%, respectively in FY2021 as compared to 0.05% and 0.70% in FY2020 (0.18% and 2.07% in FY2019). The Net Interest Margin (“NIM”) of UBF rose to 6.76% in FY2021 as compared to 5.79% in FY2020 (6.48% in FY2019), on account of lower cost of funds due to the lower interest rate regime prevailing during the period. The operating expenses of the company reduced to 4.71% in FY2021 as compared to 4.78% in FY2020 (4.72% in FY2019) as the company has streamlined its operations, while the credit cost of the company increased to 2.43% in FY2021 as compared to 1.69% in FY2020 (1.92% in FY2019). Going forward, company’s ability to improve overall profitability by managing credit cost and operating expenses will be crucial, as the room for lending margin expansion will be limited.

Analytical approach: For arriving at the ratings, ICRA Lanka has applied its rating methodologies as indicated below.

Links to applicable criteria:  ICRA Lanka’s Credit Rating Methodology for Non-Banking Financial Institutions

About the Company:

UB Finance Company Limited (UBF) was formerly known as The Finance & Guarantee Co. Ltd. It was incorporated in 1961 and, operated as a Finance and Real estate development company. In 2011, Union Bank of Colombo (UBC) acquired majority stake in the Company with a capital infusion of LKR 600 Mn. The Company also received a capital infusion of LKR 500 Mn from a private equity investor- ShoreCap II Ltd.  As in April 2018, UBC and ShoreCap II Ltd held about 73% (81% voting rights) and 12% (13% voting rights) respectively in UBF. Initially, UBF was involved in real-estate development and financing. The Company still has some of its old loan portfolio, which is completely in the NPA category. Presently, the Company focuses on retail asset classes (vehicles loans/ leases) and gold loans.

During FY2021, UBF reported a Loss After Tax of LKR 41 Mn on a total asset base of LKR 8,187 Mn as compared to a PAT of LKR 5 Mn on a total asset base of LKR 9,350 Mn in FY2020.

Key financial indicators
LKR MnFY2019 (Audited)FY2020 (Audited)FY2021 (Audited)
Net Interest Income721593592
Profit after Tax205(41)
Net worth770768738
Loans and Advances (Net)8,7857,7396,901
Total Assets11,1279,3508,187
Return on Equity2.1%0.7%-5.5%
Return on Assets0.2%0.1%-0.5%
Gross NPA18.1%18.6%15.8%
Net NPA6.2%10.2%8.0%
Capital Adequacy Ratio5.7%2.6%4.6%
Gearing (times)13.110.89.8
Rating history for last three years:
Analysts
Sanduni Kankanamalage
+94-777478138
sanduni@icralanka.com  

Niraj Jalan
+91-33-71501146
niraj.jalan@icraindia.com

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