"TFC's rating factors in its significant market share and deposit franchise in the registered finance company (RFC) sector, whilst constrained by its low capitalisation, moderate profitability, and risks inherent to the real estate market," Fitch Ratings said.
"The revision of the Outlook to Negative reflects the company's deteriorating profitability on account of rising funding costs and the lack of a commensurate increase in real-estate related income.
"Fitch will continue to monitor the company's efforts toward improving yields, enhancing recoveries and generating greater liquidity from its real-estate assets, particularly in a challenging economic environment."
Fitch also confirmed TFC's 'BBB-(lka)' rating on its subordinated debentures.
TFC is the largest finance company in Sri Lanka, with a 25 percent share of sector assets at end-December 2007.
Due to current macroeconomic conditions, TFC has tightened lending criteria and has focused on recovery since the end of the 2007 financial year.As a result, TFC's portfolio growth was just 9 percent in the 2008 financial year from 33 percent the year before while cash collection ratios improved to approximately 100 percent by September 2008 from 85 percent at April 2008.
TFC's portfolio was mainly vehicle financing. Leasing was 55 percent and hire purchase agreements 35 percent, respectively, at the end of the 2008 financial year. Personal loans accounted for 10 percent.
Real estate investments for sale and rent accounted for 18 percent of assets at the end of the 2008 financial year.
"Consequent to lower loan growth and lower yields in overall real estate investments and land sales, profitability was significantly affected by the rising cost of funds and increased credit costs (provisions)," Fitch said.
Return on assets (ROA) had declined to 1.9 percent at FY08 (and 0.4 percent in the first half of the 2009 financial year) from 2.7 percent in 2007.
While yields in hire purchase and leasing have increased, overall yields on land easy payments and land stock sales have failed to keep pace with the rising cost of funds over the last two years.
Fitch defines non performing loans (NPLs) as loans in arrears for over three months.
TFC's NPL to gross loans was high at 20.0 percent at the first half of the 2009 financial year from 17.7 percent at the end of the 2008 financial year.
Net NPL to equity was at 100 percent by the first half of 2009 compared to 89 percent at the end of the 2008 financial year.
However, NPLs at the regulatory level of over six months to gross loans was 7.2 percent by the first half of 2009 compared to 6 percent at the end of the 2008 financial year.
Net NPL to equity ratio was 30 percent by the first half against 23 percent at the end of the 2008 financial year.
"The latter ratio was high on account of 35 percent of NPLs having real estate collateral which did not attract any provisioning," Fitch said.
"However, even after adjustment for these NPLs, TFC's ratios were significantly above its peers."
TFC has the largest time and savings deposit base among registered finance companies and year-on-year growth was 31 percent at the end of the 2008 financial year.
These deposits accounted for 74 percent of funding by the first half of 2009 and are re-priced annually.
As such, TFC is exposed to high interest rate risks, Fitch said.
Rate sensitive assets covered 51 percent of rate sensitive liabilities in the 'less than one year' category at the end of the 2008 financial year against 52 percent at the end of the 2007 financial year.
TFC's equity to assets ratio was 9.8 percent by the first half of 2009, against 10.4 percent against the end of the 2008 financial year which was historically below peer averages.
TFC is a listed registered finance company and is part of the Ceylinco group, with an asset base of 42.2 billion rupees at the end of the first half of the 2009 financial year.
It has a network of 46 branches. Established in 1940, TFC has primarily undertaken vehicle financing and property development financing.
Corrected - reference to asset base in penultimate paragraph and clarifying financial year in references to vehicle financing portfolio and real estate investments.