Fitch downgrades Senkadagala Finance's National rating to 'BBB(lka)', Removes RWN.

Fitch Ratings has downgraded Sri Lanka-based Senkadagala Finance PLC's (Senka) National Long-Term Rating to 'BBB(lka)' from 'BBB+(lka)'. The Outlook is Stable. Fitch has also downgraded Senka's subordinated debt rating to 'BB+(lka)' from 'BBB-(lka)', and removed the Rating Watch

Negative (RWN) from all of Senka's ratings.

KEY RATING DRIVERS

Weakened Asset Quality Drives Downgrade: Senka's exposure to more economically vulnerable borrowers has led to greater asset-quality deterioration in recent years, against its better-than-peer performance in the past. Its reported 90-day past-due loan ratio climbed to 19.8% in 1QFY24 (financial year end-March) amid weakened borrower repayment capacity, and we expect asset-quality pressure to persist for some time even as

the economy gradually recovers.

Still, Senka's higher capitalisation than the industry and longer-tenor funding structure support its credit profile.

RWN Resolved: The removal of the RWN reflects our view that further downside to Senka's ratings is less imminent following the completion of the local-currency portion of the sovereign's domestic debt optimisation (DDO), which addresses one element of risk to sector funding and liquidity.

The operating environment will remain weak in light of strained household finances and fragile investor confidence, but should stabilise on a gradual economic recovery with easing inflation and interest rates.

Eased macroeconomic risk will temper the pressure on the sector's operating performance and liquidity profile although the pace of recovery may vary depending on individual entities' business mix and franchise strength.

Fitch expects sector growth to remain weak with lingering asset-quality pressure in FY24, but this may improve in FY25 as economic growth recovers. Declining interest rates should ease pressure on funding costs but could hit asset yields for lenders with shorter asset-repricing cycles.

Modest Franchise in Vehicle Financing: Senka is a mid-sized finance and leasing company (FLC) with about 2% share of sector assets and 1% of deposits. Its main business is in vehicle financing with a higher exposure than peers to commercial vehicles, such as buses, lorries and tractors.

These segments are more susceptible to economic weakness and have driven greater asset-quality deterioration for Senka in recent years.

Senka also focuses on lower- to middle-income self-employed individuals, and small- to mid-sized enterprises. Management has developed...