TEXT-S&P downgrades Financiera Independencia to 'B+' from 'BB-'
Overview -- Asset quality deterioration at Mexico-based consumer finance company Findep has resulted in higher loan loss provisions that continue to pressure its bottom-line results and in profitability metrics that aren't in line with the risk it underwrites. -- We are lowering our global scale rating on Findep to 'B+' from 'BB-' and national scale ratings to 'mxBBB/mxA-3' from 'mxA-/mxA-2'. -- The stable outlook reflects our expectation that Findep's stricter underwriting and adjustments to collection practices could improve the quality of its loan portfolio in the long term, gradually strengthening its internal capital generation. Rating Action On Dec. 3, 2012, Standard & Poor's Ratings Services lowered its counterparty credit ratings to 'B+' from 'BB-' on global scale and to 'mxBBB/mxA-3' from 'mxA-/mxA-2' on national scale on Financiera Independencia S.A.B. de C.V. SOFOM E.N.R. (Findep). At the same time, we lowered our rating on Findep's $200 million senior unsecured notes to 'B+' from 'BB-'. The outlook is stable. Rationale The downgrade follows the deterioration of Findep's financial performance, which is no longer consistent with a 'BB-' rating. A more competitive environment, which resulted in higher indebtedness for Findep's target clients, and the reliance on external agents for collections management increased charge-offs and the default probability of its loan portfolio since late 2011. As Findep has been cleaning-up its loan portfolio, loan loss provisions (LLPs) have risen in recent months, hurting its profitability metrics. New loan originations have slowed down in 2012 due to stricter underwriting standards, and the company has enhanced its collection strategies. These measures could gradually strengthen Findep's internal capital generation in the long term, but we don't expect its historical profitability ratios to return. The ratings on Findep reflect rising charge-offs and weaker profitability, the possible deterioration of its financial flexibility, and the highly competitive market in which it operates. We continue to consider the company's satisfactory liquidity risk management, adequate funding structure, and geographic and client diversity as positive rating factors. We currently view Findep's asset quality as its major rating weakness. Although nonperforming loans (NPLs; loans 60 days or more past due) have started to improve recently, net charge-offs continue increasing mainly as a result of the loan portfolio clean up. NPLs represented 9.4% of the total loans at the end of September 2012, compared with 10.0% at September 2011, while net charge-offs as of the third quarter reached their peak of 21.5% for the past 12 months. Most of the charge-offs correspond to individual loans from Findep's traditional business. We view improved reserve coverage for NPLs as a partly mitigating factor. As of September 2012, reserves covered 84.4% of NPLs, up from 72.7% as of the same quarter in 2011 and the 71.9% average of the past three fiscal years. In our opinion, Findep remains challenged to improve the risk profile of its loan portfolio. LLPs continue pressuring Findep's bottom-line results, despite the positive trend in revenue generation. Operating revenues grew 18.7% in the past 12 months due to a higher net interest margin, while efficiency (noninterest expenses/operating revenues) has remained relatively stable, at 64.9% as of September 2012, despite the increase in personnel expenses and the expansion strategy of its subsidiaries, Financiera FINSOL, S.A. de C.V. SOFOM E.N.R. (Finsol) and Apoyo Economico Familiar (AEF). Nonetheless, LLPs, as proportion of operating revenues, have risen to cover for loan losses and the higher probability of default of the portfolio. At the end of September 2012, LLPs represented 34.8% of operating revenues, up from 28.4% as of September 2011 and the 27.9% average of the past three fiscal years. As a result, at the end of the third quarter of 2012, Findep's net profit was MXN3.9 million, resulting in a return on average assets of 0.05%, which we consider is not in line with the risk it underwrites. We expect Findep to improve its asset quality to strengthen bottom-line results in the long term; however, we don't expect that profitability will return to historical levels. We currently evaluate Findep's adjusted capitalization as adequate for the rating level. The 4% growth rate of the loan portfolio in the past 12 months has helped maintain capitalization levels, despite the practically nil internal capital generation during 2012. Findep's adjusted capitalization was 14.5% at the end of the third quarter of 2012, similar to 14.0% as of September 2011. Nonetheless, this ratio is much lower than the 26.7% level for 2010, prior to the acquisition of AEF and Apoyo Financiero Inc. (AFI), which generated a significant amount of goodwill that Findep hasn't compensated through internal capital generation. In our calculation of adjusted capitalization, we deduct all intangibles and the deferred tax asset portion related to tax loss carryforwards. The company's strategy of cleaning up its loan portfolio and following stricter origination practices should help maintain capitalization around these levels or even marginally improve as Findep's internal capital generation recovers. We also view as positive the absence of dividend payments in the medium term in order to preserve the capital base. In our opinion, Findep's funding profile is adequate for its profile. The company has been successful in diversifying its funding structure, and currently maintains a good balance between market and bank debt. Bond issuances allowed to extend the duration of the company's liabilities and represented 57% of its total funding as of September 2012. We consider that the short-term nature of its loan portfolio benefits its liquidity management. Without assuming a further deterioration of the company's asset quality, we expect collections from Findep's loan portfolio to sufficiently cover its liabilities during the next 18 months, although a higher funding cost might reduce the positive gap. Findep's loan portfolio has good geographic and client diversification, which in our opinion partly mitigates the high-risk profiles of its customers. Due to the nature of this business, the company's loan portfolio was highly fragmented among nearly 1.4 million clients as of the third quarter of 2012. Its loans originate from the entire country, with no state representing more than 10% of the total. The company has also started to build a presence in the northern Brazil, and to a lesser extent, in the U.S., through Finsol, AEF, and AFI, but we expect that most of Findep's credit exposure will remain in Mexico. Our base-case scenario assumes that Findep's loan portfolio growth will remain relatively flat in 2013 or even slightly decrease. We expect NPLs to hover around 9%-10%, with an 80%-85% reserve coverage, while we expect charge-offs to decrease to 20% or less in 2013. A high net interest margin, of around 55%, and lower LLPs should allow the company to post net profits and maintain adjusted capitalization around 14% in the coming 12-18 months. Outlook The stable outlook reflects our expectation that Findep's stricter underwriting and enhanced collection practices should improve the quality of its loan portfolio in the long term, gradually strengthening its internal capital generation. However, we don't expect the company to return to historical profitability metrics. If Findep's profitability does not start to improve, as a result of lower LLPs for charge-offs, or if loan growth is not compensated with an improved internal capital generation, we could take a negative rating action. Specifically, continued net losses or a combined ratio of NPLS and charge-offs above 30% could lead us to revise the ratings. We don't expect an upgrade in the next 12-18 months. Related Criteria And Research Rating Finance Companies, March 18, 2004 Ratings List Downgraded; Outlook Action To From Financiera Independencia S.A.B. de C.V. SOFOM E.N.R. Counterparty Credit Rating Global Rating Scale B+/Stable/-- BB-/Negative/-- Caval - Mexican Rating Scale mxBBB/Stable/mxA-3 mxA-/Negative/ mxA-2 Senior Unsecured B+ BB-