ECONOMYNEXT – Fitch affirmed licensed non-bank lender UB Finance Company Ltd’s national long-term rating at ‘BB(lka)’. The outlook is stable.

The rating is driven by Fitch’s expectation of extraordinary support from Union Bank of Colombo PLC, which owns 89.9 percent of UB Finance.

“UBF’s rating is constrained by our view that any support required may be more of a burden relative to UB’s modest balance sheet size, compared with other Fitch-rated financial leasing companies owned by larger banks,” Fitch said in its assessment.

The rating agency expects the proposed rights issue to bridge UBF’s regulatory capital shortfall. “However, the capital buffer could be thin against the regulatory minimum capital of LKR2.5 billion and may fall below the regulatory requirement should there be any unforeseen losses.”

The share closed down at 0.70 on Monday.

The full statement is reproduced below:

Fitch Ratings – Colombo – 26 Apr 2024: Fitch Ratings has affirmed UB Finance PLC’s (UBF) National Long-Term Rating at ‘BB(lka)’. The Outlook is Stable.

Key rating drivers

Shareholder Support Underpins Rating: UBF’s National Long-Term Rating is driven by our expectation of extraordinary support from Union Bank of Colombo PLC (UB, BBB- (lka)/Stable) to UBF, if required. Our view is based on UB’s 89.9% ownership of UBF, its record of ordinary support, board representation and common branding between the bank and UBF.

Relative Size a Constraint: UBF’s rating is constrained by our view that any support required may be more of a burden relative to UB’s modest balance sheet size, compared with other Fitch-rated financial leasing companies owned by larger banks. UBF’s assets accounted for 7% of UB’s consolidated assets and 14% of equity as of end-2023. UB’s smaller capital base also limits the amount of funding it can provide to UBF in times of need due to the regulatory limit on the bank’s single-borrower lending. At end-3QFY24 UBF held no debt from UB, with only modest historical borrowings on record.

Limited Importance to Group: We rate UBF two notches below its parent’s rating given its limited importance to the UB group. UBF’s main products, including leasing and gold lending, account for 5.3% of the group’s gross loans and are not core products of the group due to limited scale, in Fitch’s view. Furthermore, synergies are limited between the bank and UBF, given minimal overlap between UB’s and UBF’s target customer profiles. UBF’s low contribution to group profitability due to a weak performance record, despite the 13% contribution in 2023, also limits its importance to the group.

Weak Standalone Profile: We believe UBF’s intrinsic credit profile is weaker than its support-driven rating. UBF has a small franchise, with market share of below 1% as of end2023. Fitch views UBF’s risk appetite as high while its poor asset quality, weak earnings, thin capital buffers and significant deposit concentration underpin its weak financial profile.

Thin Capital Buffers: We expect the proposed rights issue to bridge UBF’s regulatory capital shortfall. However, the capital buffer could be thin against the regulatory minimum capital of LKR2.5 billion and may fall below the regulatory requirement should there be any unforeseen losses. UBF’s debt/tangible equity stood at 2.9x at end-3QFY24 and we expect this to increase in the medium term as UBF pursues aggressive growth.

Loan Book to Expand: We expect UBF to pursue rapid growth in the near to medium term, supported by improving economic activity and easing interest rates. We believe vehicle financing and gold-backed lending, which contributed 75% of loans at FYE23, to remain UBF’s core product offerings, while its legacy property exposures (11% of FYE23 loan book) is likely to decline.

Asset Quality to Improve: We expect UBF’s gross stage 3 loan ratio to moderate in the near to medium term, due to higher loan growth, increasing recovery efforts and less pressure on the existing borrowers due to improved economic conditions and declining interest rates. The gross stage 3 loan ratio marginally improved to 30% as of end-3QFY24 (FYE23: 33%) due to declining stage 3 loans, but remains considerably higher than the industry average of 18%.

Rating Sensitivities

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

UBF’s rating is sensitive to changes in UB’s credit profile, as reflected in UB’s National Long Term Rating as well as Fitch’s opinion around UB’s ability and propensity to extend timely extraordinary support. Developments that could lead to a negative rating action include:

– a material increase in UBF’s size relative to the parent that makes extraordinary support more onerous for the parent;

– further reduction in the parent’s ownership, control or influence that could weaken its propensity to support UBF;

– prolonged weak performance of UBF that we believe will weaken the parent’s propensity to support the subsidiary;

– a notable decline in UBF’s capital buffers, indicating reduced timeliness in financial support to support growth or meet regulatory norms;

– insufficient or delayed support from UB relative to UBF’s needs, which hinders UBF’s ability to meet its obligations in a timely manner.

Such developments could significantly reduce shareholder support prospects and, if severe, may lead to a multi-notch downgrade.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

An upgrade would most likely result from a positive rating action on UB’s National Long Term Rating, which would reflect its strengthened ability to support UBF.

A significant increase in UBF’s strategic importance to UB along with closer integration with UB across broader functional areas may lead to positive rating action. However, we do not expect such a change in the near term.

Issuer Disclosure on Regulatory Action

A temporary deposit cap of LKR7.5 billion was imposed on the company starting from December 2023, due to the unimpaired core capital falling marginally below the Central Bank of Sri Lanka’s threshold of LKR2.5 billion. This cap is anticipated to be lifted upon the completion of the proposed rights issue of LKR 0.25 billion, aimed at augmenting the core capital of the company. The rights issue is scheduled to conclude in June 2024.

The “Issuer Disclosure on Regulatory Action” subheading was provided by the issuer and is included pursuant to applicable regulatory requirements. Fitch Ratings Lanka is not responsible for the contents of such information.

References for substantially material source cited as key driver of rating

UBF ratings are driven by UB’s National Long-Term Rating.