As sub-prime lenders, finance and leasing companies are critical because they lend to segments of the economy banks wouldn’t readily lend to. However, their high exposure to vehicle loans places them in a predicament due to a government ban on vehicle imports in a failing bid to avoid a balance of payments crisis.

The sector’s direct exposure to vehicle financing through leases was around 53% of total loans by end June 2021, but actual exposure would be much higher as a significant share of term loans are backed by vehicle collateral, Fitch Ratings said in a Sri Lanka Non-Bank Financial Institutions note in September 2021.

“Prolonged restrictions on vehicle importation could pose challenges to growth prospects of Sri Lankan finance and leasing companies,” Fitch says. It notes that 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 finance and leasing companies to unexpected sharp price corrections.

The Covid-19 pandemic continues to exert significant pressure on the operating environment for financing and leasing companies.

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 remains negative and reflects significant downside risks from the ongoing pandemic and Sri Lanka’s sovereign credit profile”.

The sector loan book contracted for the fifth consecutive quarter in the June quarter, down 2.2% from a year earlier. This is exerting pressures on revenue generation and asset quality and push finance and leasing companies to assume more risk by diverting lending to products outside their core expertise to sustain business volumes.

Fitch said that the companies it rated could see non-performing loans increase. NPLs, based on six-month arrears ratios, rose during the previous 2020/21 financial year 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, and we expect NPL ratios to peak in 2022 before easing in 2023 on a slower accumulation of bad loans and slower loan growth over the past two years,” Fitch noted.

The rating agency expects profitability to remain depressed owing to weak revenue generation and high credit costs. It does not expect profitability to revert to higher historical averages within the next 12-18 months, as it will take longer for revenue streams to fully recover and for finance and leasing companies to resolve asset-quality problems.