Fitch Downgrades Finmart to 'B-'; Rating Watch Evolving

Fitch Ratings has downgraded Prestaciones Finmart, S.A.P.I. de C.V., SOFOM E.N.R.'s (Finmart) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to 'B-' from 'B+'. In addition, the Long- and Short-Term National scale ratings were downgraded to 'BB-(mex)'/'B(mex)' from 'BBB+(mex)'/'F2(mex)'.

At the same time, the Rating Watch was revised to Evolving from Negative. A full list of rating actions follows at the end of this press release.

The downgrade of Finmart's IDRs and National ratings reflects the deterioration of its financial performance since 2015, as well as the continued limitation of its loss absorption capacity. It also reflects Fitch's opinion that there is limited adherence to international best accounting practices that lead to transparency and comparability of its financial reports. Finmart is a non-regulated financial institution that reports its financial statements under Mexican GAAP; however, it is not in line with the requirements set for regulated entities.

The Evolving Watch follows EZCORP Inc.'s (NASDAQ: EZPW; not rated by Fitch) announcement on May 10, 2016 of its intention to sell its 94% equity stake in Finmart as a result of a strategic review of this business.

KEY RATING DRIVERS - IDRs AND NATIONAL RATINGS

Finmart's ratings are limited by the continued pressure on its asset quality metrics, which adversely affects its loss absorption capacity and liquidity position.

As of first-quarter 2016 (1Q16), its non-performing loan (NPL) ratio as adjusted by Fitch stood at 30.4%, which is higher than the 24.5% registered in 2015 and which compares unfavorably to that of its peers. Fitch believes that Finmart's ongoing efforts to strengthen underwriting standards and risk controls are positive and that asset quality metrics should improve as a result in the medium term.

During 2013 and 2014, Finmart modified its business model to incorporate more frequent structured asset sales. As of December 2014, Finmart had sold roughly 50% of its portfolio and, at the time, planned to continue with this strategy. During 2015, the entity decided to revert back to its on-balance-sheet-growth model, which resulted in a rapid deterioration of its financial performance.

Under Fitch's approach, and considering more detailed information provided by the company, four out of the six transactions have recourse against Finmart. These assets are currently not consolidated in the company's financial statement under Mexican GAAP; however, EZCORP consolidates them under U.S. GAAP.

Fitch believes these transactions represent a relevant risk to Finmart because of the requirement to make up any cash if there is a shortfall in the collections. Currently, this shortfall has been approximately USD0.5 million per month. The pressure on these off-balance-sheet transactions' asset quality in addition to the fact that the maturity of the cash flows in the hedge is shorter than the contracts in the structured asset sales impairs their self-servicing ability. EZCORP has guaranteed the future cash outflows of these contracts.

Currently EZCORP is focused on selling the company. Finmart's ratings consider its moderate franchise, reflected in its position as the third most-important player in the payroll deductible loans sector in Mexico, which could benefit its sale prospects. They also reflect the company's proven ability to continue growing amid challenging conditions.

At the same time, Finmart is growing its loan portfolio organically, focusing on originating loans for public entities with an adequate payment track record and good credit quality in order to rebuild its revenue-generating base and reverse its negative financial performance, while decreasing administrative expenses and improving collection practices.

Operating ROA and ROE continue to be negative, but improved to -2.3% and -10.6% as of 1Q16. However, profitability is overstated to a certain extent because the company is consistently under-reserved and because interest income is accrued for some loans overdue for more than 90 days. The company's loss absorption capacity is limited, reflected in a tangible common equity-to-tangible assets ratio adjusted for the under-reserved portion of NPLs as defined by Fitch of -7.3% as of 1Q16. If the off-balance-sheet structured asset sales were consolidated on Finmart's financial statements, it would negatively affect capital metrics and historical profitability.

In Fitch's view, Finmart's liquidity position has benefitted from its parent's ordinary support. EZCORP provides two credit facilities to Finmart in order to finance growth. The flexibility of Finmart's funding mix is limited as it is composed mostly of secured facilities.

Fitch considers that in addition to traditional credit risks, Finmart is also exposed to operational, political, reputational and event risks.

RATING SENSITIVITIES - IDRs AND NATIONAL RATINGS

Fitch expects to resolve the Evolving Watch when the sale process is completed. The agency will evaluate the credit quality of the acquirer and the potential support it could provide to Finmart. Alternatively, Finmart's ratings could continue to reflect its standalone strength. In such a case, ratings could be downgraded if the company is not able to contain the deterioration of its asset quality or if it is not able to restore its adjusted tangible equity ratio to a minimum of 8%.

Upside potential is limited for Finmart's standalone ratings until it improves its adherence to more prudent accounting practices. It must also be able to sustain positive financial results and consistent strategic objectives while also strengthening its asset quality and adjusted capitalization metrics and improving the flexibility of its funding mix.

Fitch has downgraded the following ratings:

--Long-Term Foreign- and Local-Currency IDRs to 'B-' from 'B+'; Rating Watch Evolving;

--National scale Long-Term rating to 'BB-(mex)' from 'BBB+(mex)'; Rating Watch Evolving;

--National scale short-term rating to 'B(mex)' from 'F2(mex)'; placed on Rating Watch Evolving.

Additional information is available at 'www.fitchratings.com'.

Adjustments to Financial Statements: Pre-paid expenses were reclassified as other intangibles and deducted from Tangible Equity. Fitch reclassified all loans that are overdue or that exhibit partial payment for more than 90 days as NPLs. Fitch has also reclassified the total value of account receivables from public entities as loans, with those that are overdue 90 days or more categorized as impaired. Other income and expenses were classified as other operating income.

Applicable Criteria

Global Non-Bank Financial Institutions Rating Criteria (pub. 28 Apr 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=865351

National Scale Ratings Criteria (pub. 30 Oct 2013)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=720082

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1005523

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1005523

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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