OREANDA-NEWS. Fitch Ratings has placed the long-term foreign and local currency Issuer Default Ratings (IDRs) and national scale ratings for Prestaciones Finmart S.A.P.I. de C.V. Sofom E.N.R. (Finmart) on Rating Watch Negative. A full list of rating actions follows at the end of this press release.

The Rating Watch Negative reflects Finmart's significant and unexpected operating and net losses recorded during 2015, as well as the continued pressure on its asset quality metrics that have resulted in a weakening of its loss absorption capacity and overall credit profile. Additionally, it reflects the entity's above average risk appetite and the poor execution of its previous structured asset sale strategy that resulted in reporting losses over the past three quarters.

KEY RATING DRIVERS - IDRs AND NATIONAL RATINGS

Finmart's ratings take into account its adequate franchise in the payroll deductible loans sector in Mexico, the relative flexibility of its business model that could allow the entity to adapt its business strategy to changing conditions as well as its recent efforts to strengthen its loan loss provisioning practices. The ratings also acknowledge the growing operational and financial synergies with its ultimate parent, EZCORP Inc. (NASDAQ: EZPW; not rated by Fitch) which are enhancing supervision and risk management practices.

Prior to 2013, Finmart's business model was focused on attaining balance sheet growth both organically and inorganically. During the fourth quarter of 2013 and across 2014, Finmart modified its model to incorporate more frequent non-recourse structured asset sales in order to accelerate income recognition, enhance its liquidity and decrease its reliance on traditional funding sources. As of December 2014, Finmart had privately securitized roughly 50% of its portfolio and at the time, planned to continue with this strategy.

During 2015, Finmart determined it would no longer pursue the recurrent structured asset sale strategy and would return to its previous business model, focusing on balance sheet growth. Its financial performance deteriorated rapidly since the first quarter of 2015, as it started the year with a low level of loans receivables and given that the loan portfolio it retained on balance did not generate sufficient income to cover operating costs, resulting in net losses. Fitch considers the rapid shift in strategy to be the primary cause of losses, but that should progressively lead to more predictable results if Finmart recovers and grows its earning assets in the future.

Operating ROA and ROE stood at -6.1% and -22.7% as of September 2015, respectively compared to the 7.6% and 26.6% figures reported at the end of 2014. Fitch believes this significant and unexpected deterioration in profitability metrics, which contrasts with those of Finmart's peers, puts pressure on the company's present credit profile. Additionally, as Fitch has previously stated, profitability is overstated to a certain extent because the company is consistently under-reserved relative to non-bank financial institutions rated at the same level and because interest income is accrued for some loans overdue for more than 90 days.

Fitch believes asset quality continues to be one of Finmart's main challenges. Impaired loan ratios remain above peers', and loan loss reserve coverage below. Finmart's delinquency metrics deteriorated in 2014 as its portfolio was overly concentrated with underperforming loans after it sold a relevant portion of its loans receivable at year end; these have remained pressured through the current year. As of 3Q15, the impairment ratio as adjusted by Fitch stood at 23% (DEC14: 22.6%). Even though effective credit losses are not expected to be high as long as the borrower is still employed in the public entity, as evidenced by the manageable amount of written-off loans. Fitch believe the delayed collection period from the public entities represents a moderate liquidity risk.

Reserves represented a low 22.9% of impaired loans, in line with its four year historical average of 22.4%. As of October 2015, management stated reserves would increase to above 40% as a result of the recently changed loan loss reserve practices. Although Fitch views positively this transition toward more prudential loan loss provisioning, Finmart's reserve policies still lag behind best industry practices, mainly with respect to the timing of the provisioning and unreserved accounts receivable from public entities.

The company's tangible equity to tangible assets ratio stood at 11.4% as of 3Q15, down from the 23.6% registered as of the close of 2014. After adjusting for the under-reserved portion of NPLs as defined by Fitch, this ratio stands at -2%, a significant deterioration compared to the 16.6% registered at the end of 2014. In Fitch's opinion, this is indicative of limited loss absorption capacity and substantially decreases Finmart's financial flexibility.

On April 30, 2015 EZCORP announced it was undergoing a review limited to Finmart's operations specifically related to errors in a portion of its credit portfolio that would affect registered loan loss reserves and interest income in EZCORP's consolidated financial statements under U.S. GAAP. This review resulted in the restatement of EZCORP's financial statements that among other things resulted in more rigorous non-performing loans (NPLs) classifications and loan loss reserve requirements, in more conservative interest income recognition and in the consolidation of the five private securitization transactions that were previously considered true sales. Mexican GAAP allows for more discretion on the recognition of impaired loans for unregulated non-bank financial institutions such as Finmart. As a result, Finmart's statements under Mexican GAAP were unaffected; however, Fitch believes there is still room for improvement in terms of adherence to more prudential accounting practices that lead to transparency and comparability.

RATING SENSITIVITIES - IDRs AND NATIONAL RATINGS

Finmart's ratings could be downgraded within the next six months if the entity is not able to successfully implement and sustain its balance sheet reconstitution strategy that translates into a recovery of its ability to generate profits. Fitch expects that Finmart will continue its trend and post recurrent gains in upcoming quarters. Additionally, contained non-performing loans (NPLs) and enhanced provisioning practices which progressively restore the tangible equity-to-tangible assets ratio adjusted for the unreserved portion of NPLs as defined by Fitch to a minimum of 10%.

Rating upside potential is limited until Finmart proves it is able to sustain positive financial results and consistent strategic objectives that are successfully executed while also strengthening its asset quality and capitalization metrics and improving the flexibility of its funding mix.

Fitch has placed the following ratings on Rating Watch Negative:

Prestaciones Finmart, S.A.P.I. de C.V., SOFOM E.N.R.
--Long-term foreign and local currency IDRs 'B+';
--National-scale long-term rating 'BBB+(mex)';
--National-scale short-term rating 'F2(mex)'.

Fitch has affirmed the short-term foreign and local currency IDRs at 'B'.