ICRA Lanka revises outlook of Merchant Bank

ICRA Lanka Ltd. affirmed the rating of Merchant Bank of Sri Lanka and Finance PLC (MBSL) at BBB+, revising the outlook to “Stable” from “Negative”.

The outlook revision reflects the improvement of the capital profile of the company from the rights issue which was completed in September 2021. The outlook revision also factors in the improvement of the profitability indicators of the company and the improvement in the solvency ratio. The outlook may be revised to “Negative” in case of further deterioration in the company’s asset quality levels or weakening profitability. The outlook may be revised to “Positive” in case of an improvement in the asset quality indicators of the company.

When it comes to the outlook revision factors in the improvement of the capital profile, improved profitability, and improvement in the solvency of the company, MBSL raised Rs. 2,152 million through a rights issue on 16 September 2021. Furthermore, the outlook revision also factors in the improvement of the solvency ratio of the company amidst the improvement of the networth.

Subsequently, on 18 October 2021, the Central Bank of Sri Lanka (CBSL) removed the lending cap of Rs. 35 billion (imposed on March 2019) and deposit cap of Rs. 23 billion (imposed on May 2019). ICRA Lanka also noted the improvement in the profitability in CY2021 amidst improvement in the core margins of the company. MBSL reported a profit after tax (PAT) of Rs. 140 million for H1CY2021 vis-à-vis loss of Rs. 460 million for H1CY2020.

However, ICRA Lanka takes cognisance of the stretched asset quality indicators in terms of gross non-performing assets (GNPA), which stood at 16.44% as at June 2021 against 12.99% for the licensed finance companies (LCF) sector.

The company also fell short of the minimum core capital requirement of Rs. 2,000 million in December 2020. After several attempts to enhance the capitalisation profile, the company recently completed a rights issue on 16 September 2021 raising Rs. 2,152 million. ICRA Lanka envisages the CAR to improve by about 700 bpp from this capital infusion. MBSL is also now in a comfortable position to meet the next regulatory minimum core capital requirement of Rs. 2,500 million, which is to be met by 31 December 2021. Subsequent to the completion of the rights issue, the CBSL has also removed the above-mentioned lending and deposit caps placed on the company. ICRA Lanka also expects a sharp improvement in the company’s gearing levels from the high 18.44 times as of June 2021.

Amidst a few large ticket facilities falling into NPA in CY2019 and the high slippages in the personal loans portfolio in CY2020, the GNPA ratio peaked at 18.14% in June 2020 vs. the LCF sector at 14.31%. However, ICRA Lanka also noted that the contraction of the overall portfolio, due to the lending cap, has also contributed to the high GNPA ratio. The company has managed to improve the GNPA ratio to 16.44% in June 2021 amidst improved recoveries in Q1CY2021.

However, ICRA Lanka envisages the asset quality of the company to remain under pressure in the immediate term due to the effects of the third and fourth waves of the Covid-19 pandemic, although some improvement in the ratio is expected in the short to medium term from the growth in the lending portfolio amidst the removal of the regulatory caps. The solvency measured in terms of net NPA/net worth has remained high for the company over the past two years, mainly due to the weak capital profile (162% in December 2020), but is expected to significantly improve with the recent capital infusion. Going forward, MBSL’s ability to control the new slippages and recoverability of the legacy NPA portfolio would be a key rating sensitivity.