Fenghui Leasing Co., Ltd.

Transcription

1 Fenghui Leasing Co., Ltd. Rating Report Credit Drivers Summary Category Rating Report Location China Industry Leasing GICS 4020 Issuer rating B+ Outlook Stable Date 4AUG2017 Strengths Solid profitability Improving funding diversity Adequate capital position Weaknesses High reliance on short-term funding Aggressive asset growth rate High borrower concentration in a few industries Insufficient loan loss provisioning Rating Description Dagong HK assigns its global scale long-term issuer credit rating of B+ to Fenghui Leasing Co., Ltd. (hereinafter referred to as Fenghui or the company ). Contacts Irene Chan, CFA Associate Director (852) irene.chan@dagonghk.com The issuer credit rating of b+ reflects Fenghui s solid profitability, improving funding diversity and adequate capital position. The rating is constrained by the company s high reliance on short-term funding, high borrower concentration in a few industries, insufficient loan loss provisioning and aggressive asset growth rate over the past 3 years. The rating outlook is stable. Feihua Zhou Deputy Rating Director (852) feihua.zhou@dagonghk.com

2 Rating Outlook The stable outlook reflects our expectations that Fenghui would likely maintain its capital adequacy and access to funding over the next 12 months. The stable outlook is also based on our assumption that Fenghui s asset quality would not weaken materially in the next 12 to 18 months. Downgrade Scenario We may downgrade Fenghui if its asset quality deteriorates substantially on weakening economic condition or if the company s capital position worsens materially on unrestrained debt-financed asset growth. The rating would also be downgraded if the company s liquidity position or profitability were to weaken substantially on tightening funding condition. Upgrade Scenario While rating upgrade is unlikely in the near term, we may upgrade the company if its industry and borrower concentration has been lowered substantially, or if its liquidity gap has been narrowed significantly as a result of a higher proportion of long-term funding. Rating Rationale Wealth Creation Capability Analysis Industry Background There are three types of finance leasing companies in China, 1) financial leasing company, 2) foreign-funded finance leasing company ( shareholder registered offshore), and 3) domestic-funded finance leasing company. Financial leasing companies, as non-bank financial institutions, are generally backed by financial institution shareholders and are regulated by China Banking Regulatory Commission (CBRC), while foreignfunded and domestic-funded finance leasing companies are under the supervision of Ministry of Commerce (MOFCOM). Supported by favorable regulatory and policy environment in China, the finance leasing industry experienced rapid growth over the past 3 years, with remaining contract amount of the industry increased at a CAGR of 29% from 2014 to 2016, according to China Leasing Association. As of the end of March 2017, there were a total of 7,626 finance leasing companies in China, among which 7,346 (96%) are foreign-funded, 217 are domestic-funded, and 63 are financial leasing companies, according to China Leasing Association and Tianjin Binhai Financing Leasing Research Center. The dominant share of foreign-funded finance leasing companies in the industry was due to a much smaller amount of registered capital requirement and a lowerlevel of government approval. Competitive Position Fenghui has insignificant market share in finance leasing business in China. It is the fifth largest domesticfunded finance leasing company in China, in terms of registered capital as of the end of December Nonetheless, Fenghui left out of the top 20 (in terms of registered capital) when including foreign-funded and financial leasing companies, according to data from China Leasing Association and Tianjin Binhai Financing Leasing Research Center. In our view, the business nature of the company is similar to a collateralized lending institution. Fenghui s major business includes finance leasing, entrusted loans and receivable financing services, which accounted for 73%, 25% and 2%, respectively of its risk assets as of the end of December In line with the industry, a majority of Fenghui s finance leasing business is sale-and-lease back transaction (94%), in which lessee sells an existing assets to the company and pays rent to the company till the end of the contract. The remaining leasing assets are direct finance lease, in which the company purchases an equipment designated 2

3 by the lessee and leases to them. In a typical entrusted loan transaction, the company lends money to a borrower using banks as agents. In general, the company enters into finance lease transaction with companies that possess a certain number of equipment while signs entrusted loan contracts with companies that do not possess any equipment but are able to provide collaterals or guarantees. We consider Fenghui s portfolio to have a high level of industry and customer concentration. The company has a relatively high concentration of its finance lease and entrusted loan in manufacturing sector, which accounted for 53% of its risk assets (excluding receivables finance) as of the end of Other major industry exposure includes utility (19%), construction (10%) and real estate (6%). (EXHIBIT 1). The company also has a high concentration in its borrower exposure, with loans to its 20 largest clients representing around 51% of its gross risk assets as of the end of In terms of geographical exposure, Fenghui s portfolio is moderately diversified among different regions in China. As of the end of December 2016, approximately 25.4%, 13.2%, and 9.9% of its finance lease and entrusted loans were in Shandong, Beijing, and Hubei, respectively. The remaining 51.5% came from other regions in China, with each province accounting for less than 10% of the total. EXHIBIT 1 Industry Exposure of Finance Lease and Entrusted Loan as of the end of December 2016 Agriculture, Foresting & Fishing, 3% Others, 4% Health & Social Care, 5% Real Estate, 6% Construction, 10% Manufacturing, 53% Utility, 19% Source: Company data Risk Management We view Fenghui s risk management framework as satisfactory as compared to many of its peers in the finance leasing industry but insufficient as compared to all other financial institutions on a broader basis. Despite sharing similar characteristics with financial institutions, Fenghui is not regulated by CBRC and does not have to follow regulations imposed on financial institutions. Its financial statements were presented in corporate format, which reduced the transparency of its overall financial condition. The company started implementing loan classification system in 2015 for better disclosure of its delinquency data. In terms of credit risk management, the company has multi-level reviews for its finance leasing and entrusted loan projects and a two-tier credit committee process for project approval. It has clear procedures in place for project review, with separate departments responsible for preliminary assessment and ongoing monitoring of projects. While the company does not set any quantitative limits in industries for both finance lease and entrusted loan projects, its management sets a list of high-risk industries to avoid at the beginning of each year, according to the company. 3

4 Corporate Governance Fenghui s ownership structure is transparent, in our view. JinZhou Chihang Group Co., Ltd (JinZhou) became the major shareholder of Fenghui in November 2015 after acquiring 90% of its shares. The remaining 10% shares were held by Beijing Shou Tuo Rong Sheng Invest Co. Ltd, an asset management company. The company has 7 board members, of which only one of them is independent. There are currently 4 members representing JinZhou on the board. The chairman of the board, Mr. Wang Yang, also acts as the president of Fenghui and oversees the operation of the company. Apart from Mr. Wang, there is another board member from the management team. The company has set up remuneration and performance evaluation committee and risk management committee, which report directly to the board. Until now no internal audit committee is in place, but the company s listed major shareholder, JinZhou, conducts internal audit for the company on an annual basis. Profitability We view the company s profitability as satisfactory given its ability to charge higher interest rates on its finance lease and entrusted loan projects. The company categorizes its revenue from lending business into interest income and financial advisory income, with each of them contributing around half of its total lending income over the past three years. As a one-time charge to the borrower on initiation of a project, financial advisory income has historically boosted the return for the company. In 2016, Fengui s pre-provision income on total assets was 6.2%, which was relatively high compared to its peers. Without taking any deposits, Fenghui s cost of funding was higher than those of banks, but it managed to earn a positive net interest spread. Since 2015, the company has lowered its cost of funding via issuance of asset-backed securities (ABS), which have lower interest rates compared to bank loans and other forms of financing. We anticipate to see a slight increase in the company s funding cost in 2017 amid ongoing deleveraging in China, partially offset by increasing issuance of ABS. Fengui s return (net income) on average total assets was high (i.e. 4.8% in 2016), partly due to its efficiency in controlling operating cost and its under-provisioning for asset impairment, in our view. Its cost to income ratio was low at around 14% in 2016, with employee compensation being the largest component of operating cost (34%). However, we believe the company s deficiency in loan loss reserve could lead to larger writeoff, and thus lower return, should its asset quality deteriorate. Assuming a higher expense for loan loss provision, we project Fenghui s return on net income to decline to 4.2% in the next 12 months. Debt Servicing Capacity Analysis/ Financial Analysis Asset Quality Fenghui s asset quality looks satisfactory but is expected to weaken against the backdrop of rapid loan growth, in our view. The company experienced a remarkably high asset growth rates over the past 3 years, with its total assets increasing at a CAGR of 79% from 2014 to 2016, compared to 29% CAGR for remaining contract amount of the whole industry. In our view, the aggressive loan growth may lead to rapid deterioration of its asset quality if the economic condition worsens. Besides, with new loans accounting for more than half of the gross loans in 2016, we think the NPL ratio of 0.7% may not be highly indicative of Fenghui s asset quality. The NPL ratio was also reduced after the company sold some of its NPL at small losses before yearend of On the other hand, we view Fenghui s loan loss provision as insufficient, with loan loss reserve covering only 30% of NPL as of the end of December The company made partial provision for loans overdue for less than 3 years. We believe the weak buffer may lead to large operating loss when loan quality deteriorates as portfolio ages and loan growth slows. 4

5 Mitigating factors are the company s tiered vetting process for leasing and loan projects and regular riskmonitoring. The company set a maximum LTV ratio of 70% (compared to net asset value of leased assets) for sale-and-leaseback transaction and a maximum LTV ratio of 90% (compared to purchase price) for direct lease assets. Nonetheless, some of the collateralized assets under its finance lease contracts are illiquid, which the company may find difficult to sell if its customer defaults. Capital We view Fenghui s capital adequacy as moderate. The company s capital growth was much in line with its asset growth over the past three years (3 year CAGR of 87% for shareholders equity vs. 97% for total assets), which helped contain its leverage. Fenghui s capital growth was underpinned by shareholder s capital injection as well as an increase in its retained earnings. In 2014, 2015, and 2016, Fenghui s shareholders injected capital amounted to RMB 700 million, RMB 1 billion and RMB 500 million, respectively into the company. The capital increment represented 47%, 36% and 12%, respectively of its each yearend s shareholders equity. According to its major shareholder, JinZhou s announcement, JinZhou would increase Fenghui s share capital by 60% to 4 billion in 2017 to cope with the company s business growth. In our view, the company s capital position would weaken if it continues the current pace of asset growth, in the absence of corresponding increase in external capital contribution. As of the end of December 2016, Fenghui s leverage ratio (shareholders equity/ total assets) was 16.8%, down from 23% in Given the aggressive asset growth and under-provisioning for NPL, we believe an abrupt increase in loan losses caused by deteriorating macro-economic environment may erode the company s capital. Modifiers Debt Structure and Financial Policy Our Debt Structure Assessment indicated a two-notch downward adjustment from the base rating of Fenghui owing to the company s debt maturity concentration. As of March 31, 2017, approximately 81% of Fenghui s total debt would be due by the end of Fengui relies heavily on short-term funding to finance its business growth, which may lead to liquidity shortfall on tightening credit market, in our view. The mismatch between the company s asset and liabilities duration also implies a liquidity gap. As of the end of December 2016, more than half of Fenghui s debt (56%) would mature within one year, while the company s finance lease projects generally have terms ranging from 3 to 5 years. Fenghui s funding channels include bank loans, bonds, asset-backed securities (ABS), private placement to asset management companies and borrowing from trust companies and other financial institutions. As of the end of March 2017, private placement to asset management companies represented 50% of its interest-bearing debt, with most maturing in several months to 2 years. Most of these private placement pledge of its assets. The company has improved its funding diversify in recent years by issuing ABS and offshore USD bond. By pledging some of its leasing projects as collateral, Fenghui s ABS issuance generally have lower interest rates and longer maturity (5 years) as compared to other existing funding sources. As of the end of March 2017, around 58% of Fenghui s interest-bearing debts are pledged with assets, and restricted assets accounted for 31% of the company s total assets. Fenghui has RMB19.9 billion of total reported debt outstanding as of March 31st, EXHIBIT 2 lists the maturity schedule of the company s outstanding debt. 5

6 EXHIBIT 2 Fenghui Leasing Debt Maturity Profile as of March 31 st, 2017 Debt Maturity Profile Amount (RMB Million) Until the end of , , , , , and after Total 19,907.4 Source: Company data The following EXHIBIT 3 shows Fenghui s adjusted financial highlights from fiscal year 2014 to fiscal year 2016: EXHIBIT 3 Fenghui Leasing Three-Year Adjusted Financial Highlights Three Year Adjusted Financial Highlights Fenghui Leasing Co., Ltd. Fiscal year as of 31-Dec Dec Dec-2014 (Millions of RMB, Adjusted Financials) Interest Income 1, Interest Expense 1, Net Interest Income Financial advisory income 1, Pre-provision Income 1, Net Income Gross Loans 19, , ,132.3 Gross Debt 19, , ,889.3 Total Assets 25, , ,985.9 Shareholder's Equity 4, , ,500.6 Adjusted Financial Ratios NPLs/Gross Loans (%) n.a. Loan Loss Coverage (%) n.a. Net Interest Margin (%) Pre-provision Income/ Loan Loss Provision (%) 9, , Pre-provision Income/ Average Total Assets (%) Net Income/Total Assets (%) Source: Company data, Dagong HK estimates Company Description Established in October 2009, Fenghui Leasing Co., Ltd. is a Chinese finance leasing company based in Beijing, China. Fenghui Leasing provides finance leasing, entrusted loans and receivable financing services to its clients across different regions in China. The company engages in finance leasing activities associated with sales-leaseback and direct leasing businesses, while sales-leaseback business accounted for about 90% of the financial leasing revenue over the past three years. As of December 2016, the company s registered capital amounted to RMB4.0 billon, whereas the paid-in capital was RMB2.5 billion. In November 2015, Jinzhou Cihang Group Co., Ltd., a Chinese jewelry manufacturer listed on the Shenzhen Stock Exchange, acquired 90% shareholding of Fenghui and became its parent company. Remaining 10% shareholding was held by Beijing Shou Tuo Rong Sheng Investment Co., Ltd. Fenghui had a total revenue of RMB2.4 billion and total assets of RMB25.5 billion at the end of year

7 Peer Comparison We select Fenghui Leasing s peers based on the industry in which it operates finance leasing. Both Universal Medical Financial & Technical Advisory Services Co., Ltd. ( Universal Medical ) and Far East Horizon Ltd. ( Far East Horizon ) are subject to the supervision of MOFCOM, while CCB Financial Leasing Co., Ltd. ( CCB Financial Leasing ) and China Development Bank Financial Leasing Co., Ltd. ( CDB Financial Leasing ) are non-bank financial institutions regulated by CBRC (EXHIBIT 4). Fenghui Leasing has smaller size than most of its peers (except Union Medical, a medical equipment leasing company in China) despite having higher asset growth rates. Fenghui s total assets grew at a CAGR of 79% from 2014 to Such a rapid asset growth rate makes the company more vulnerable to event risks as compared to its peers, in our view. Fenghui Leasing s profitability, as indicated by pre-provision income to average assets of 6.2% and return on average assets of 4.8% in 2016, was higher than those of its peers, given the relatively higher interest rates it charged on loan projects. On the other hand, the company had a higher cost of funding compared to its peers. Having banks as major shareholders, its financial institution peers (CCB Financial Leasing and CDB Financial Leasing) are able to borrow at lower costs given their access to China s interbank market. In terms of asset quality, Fenghui Leasing s NPLs ratio was in line with most of its peers in 2016, but its loan loss coverage was the lowest among its peers, reflecting the company s under-provisioning practice and indicating higher risks to its profitability and capital adequacy, in our view. EXHIBIT 4 Finance Leasing Industry Peers Peer Comparison Fenghui Leasing Universal Medical Far East Horizon CCB Financial Leasing CDB Financial Leasing Fiscal year as of 31-Dec Dec Dec Dec Dec-2016 (Millions of RMB, Adjusted Financials) Interest Income 1, , , , ,363.8 Interest Expense 1, , , ,805.6 Net Interest Income , , , ,558.2 Pre-provision Income 1, , , , ,469.2 Net Income , , ,561.3 Liquid Assets 1, , , , ,789.1 Gross Loans 19, , , , ,860.1 Total Assets 25, , , , ,512.1 Shareholder's Equity 4, , , , ,301.7 Adjusted Financial Ratios Liquid Assets/Total Assets (%) NPLs/Gross Loans (%) Loan Loss Coverage (%) Net Interest Margin (%) Pre-provision Income/ Loan Loss Provision (%) 9, , Pre-provision Income/ Average Total Assets (%) Net Income/Total Assets (%) Shareholder s Equity/Total Assets (%) Source: Company data, Dagong HK estimates 7

8 Rating Metrics EXHIBIT 5 shows the breakdown of the rating metrics of Fenghui. EXHIBIT 5 Fenghui Leasing Co., Ltd. Rating Metrics Rating Factors Weight Rating I. Operating Environment 6.0% aa II. Wealth Creation Capability 47.0% Market Opportunities 11.8% bbb+ Competitive Position 21.2% b- Profitability bbb Return on Average RWA 8.5% bbb Pre-provision Income/Loan Loss Provision 5.6% bbb Strategy & Corporate Governance neutral III. Debt Servicing Capacity 47.0% Non-Performing Loan Ratio 9.4% bb Leverage Ratio 6.1% bbb Tier 1 Capital Ratio 13.7% b Loan Loss Coverage 10.7% ccc Market Access (gov. 10-year rate) [%] 7.1% bb IV. Deviation Index bb V. Industry Risk bb Base bb VI. Modifiers Debt Structure and Finance Policy -2 Liquidity and Funding neutral Comprehensive Analysis neutral Stand-Alone Credit Assessment (SACA) 100.0% b+ VII. External Support Corporate Entity Support neutral Government Support Issuer Private Credit Rating (ICR) B+ neutral Source: Company data 8

9 Rating Methodology The principal methodologies used in Fenghui s rating are Dagong HK s Corporate Methodology and Financial Institutions Methodology published in March 2017, which can be found at the website We apply both Dagong Global s general corporate and financial institutions methodology for Fenghui Leasing s rating assessment. Taken into consideration that Fenghui Leasing shares some attributes of finance companies, some of the rating indicators from general corporate methodology may not be applicable to Fenghui, in our view. Therefore, we apply some rating indicators from financial institutions methodology instead to better assess the issuer s credit rating. As Fengui s financial statements were presented in corporate format, we prepared pro forma financial statements to calculate applicable financial ratios. The following indicators are used in assessing Fenghui Leasing s credit assessment and are from Dagong Global s financial institutions methodology. Under Wealth Creation Capability Competitive Position, We applied Risk Management (from FI methodology) instead of Product and Services (from General Corporate methodology) Under Wealth Creation Capability Profitability, We applied Return on Average RWA and Pre-provision Income/Loan Loss Provision (from FI methodology) instead of EBITDA Margin and Return on Assets (from General Corporate methodology) Under Debt Servicing Capacity, We applied Non-Performing Loan Ratio (from FI methodology) instead of Debt/Capitalization (from General Corporate methodology) We applied Leverage Ratio (from FI methodology) instead of (FCF Short-term debt)/equity (from General Corporate methodology) We applied Tier-1 Capital Ratio (from FI methodology) instead of Debt/EBITDA (from General Corporate methodology) We applied Loan Loss Coverage (from FI methodology) instead of EBITDA Interest Coverage (from General Corporate methodology) We applied Market Access (from FI methodology) instead of Quick Ratio (from General Corporate methodology) Under Modifiers, We applied Liquidity and Funding (from FI methodology) instead of Liquidity Assessment (from General Corporate methodology) 9

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