The global economy has been fraying at the seams, which has tested the durability of finance company earnings and the quality of their assets. Funding markets have also cooled toward global finance companies over the past 12 months. Indeed, for many speculative grade issuers, unsecured wholesale term funding has all but dried up over the past six to 12 months. Against this difficult market backdrop, S&P Global Ratings expects funding and liquidity to be a key ratings risk for most of the sector in 2023.

The risk will be most pronounced for issuers that rely heavily on short-term funding, or that have funding that is due to mature within the next 12 months. Although secured and securitized funding markets have slowly recovered and now operate relatively smoothly, global finance companies (fincos) often rely on high-yield unsecured bond markets to generate stable funding. These markets have been choppy since mid-2022 and are likely to remain so throughout 2023.

Compared with other global financial institutions, fincos are particularly sensitive to changes in market sentiment toward them. In particular, shifts in sentiment can cause funding and liquidity to dry up, precipitating a solvency squeeze for lenders. We saw all of this play out in the Mexican finco market during 2022. In February 2022, a default by one of Mexico's largest domestic fincos, Credito Real, caused international bond markets to close to other Mexican lenders--by the end of January 2023, this had triggered a further two defaults in the sector.

Despite the deteriorating operating and macroeconomic environment, 80% of our ratings in the global finco sector still have a stable outlook (see chart 1). We rate global fincos using our "Financial Institutions Rating Methodology," published on Dec. 9, 2021, because, in our view, these firms face a host of risks commonly associated with bank-like entities. To this end, our analysis incorporates our opinion of their strategic position, tangible capital, asset quality and risk management, and funding and liquidity. The sector is especially diverse and includes a host of lending specialties such as leveraged lenders, consumer finance companies, vehicle lessors, and commercial and retail mortgage lenders.

Chart 1

2023 Will Test The Foundations Of Our Ratings On Global Fincos

As inflation remains elevated and global growth slows, we anticipate that major global economies will teeter on the edge of, or tip into, recession (see table 1). For fincos, the effect of the global monetary policy response to this environment will be mixed. Rising rates will bolster income from interest, but will also increase the cost of the wholesale-funded liabilities that form the bedrock of most finco balance sheets.

Table 1

Although asset quality at most fincos has been stable to date, which should bolster their resilience, we expect difficult conditions to begin to erode the performance of most loan books. Furthermore, where a loan is secured, we anticipate that the value of the collateral may be undermined in a default situation.

Mexico 2022: Sounding A Warning For Global Fincos

The past two years have seen Mexico's largest fincos come under protracted stress. By Jan. 31, 2023, three had defaulted (see chart 2).

Credito Real S.A.B. de C.V. SOFOM, E.N.R. was the first to come under pressure. A diversified commercial lender, it was one of Mexico's largest fincos and had about $3.7 billion in assets at the time of its default. Despite its scale and diversification, Credito Real's capitalization, profitability, and asset quality deteriorated rapidly over 2021. Its nonperforming assets more than doubled in the first quarter of 2021 alone.

The sharp deterioration in performance prompted management to implement a series of initiatives intended to raise liquidity and arrest the declining performance. These initiatives proved unsuccessful. By February 2022, the approaching maturity of a bond was creating overwhelming pressure for the group to raise liquidity. Ultimately, it was unable to do so, prompting first the nonpayment of a Swiss franc (CHF) 170 million secured loan note on Feb. 9, 2022, and then a general default of the group.

In the wake of this default, and as international funding for Mexico's fincos dried up, Unifin Financiera S.A.B. de C.V.'s balance sheet came under sustained pressure. At the time, UniFin was the clear leader in Mexican leasing, representing more than a third of S&P Global Ratings-rated Mexican nonbank financing company assets coming into 2022. Through the first half of the year, the group successfully raised short-term funding in domestic markets and expanded its banking relationships. Nevertheless, the diversity and stability of its funding had worsened. Ultimately, management elected to default in August 2022 because the group's funding prospects had become unsustainable. It had been operating for over 25 years and had nearly $5 billion of assets when it defaulted. Subsequently, we withdrew our ratings on Unifin.

The broad funding shutdown that began with Credito Real and precipitated Unifin's default has cascaded to other lenders:

• In August 2022, we downgraded Engencap Holding S. de R.L. de C.V. to 'B+' and Operadora de Servicios Mega S.A. de C.V. SOFOM E.R. (GFMega) to 'B' and have maintained a negative outlook on these ratings.
• In September 2022, we withdrew our ratings on Financiera Independencia S.A.B. de C.V. SOFOM E.N.R. (Findep).
• Early in January 2023, Mexarrend S.A.P.I. de C.V. announced that it would be unable to pay its upcoming maturities. Ultimately, it defaulted on a range of instruments during the week of Jan. 23. All of our ratings on it now sit at 'D'.

The transition of three major Mexican financing companies into default shows how even the most established fincos can be vulnerable to a rapid and protracted closure of domestic and international funding markets. Excluding those that have defaulted, we have assigned a negative outlook to all the independent Mexican NBFIs we rate, or placed them on CreditWatch with negative implications, because we expect conditions to remain tough in 2023.

Funding And Liquidity Sources Will Be Tough To Secure In 2023

All told, global fincos are facing up to a challenging year. The difficult macroeconomic backdrop will weigh on earnings and force management teams to work hard if they are to shore up their funding and retain sufficient liquidity. The stable outlooks on many global fincos are based, in part, on the resilience they demonstrated through the pandemic. However, as global economies struggle and funding conditions look set to remain tough through the year, pressure on this resilience will only ratchet up. In our view, the sector is very likely to see outlook revisions, or even rating transitions, in 2023.

Country Anchors

The anchor is the starting point of our ratings analysis for banks and fincos. We base it on our Banking Industry Country Risk Assessment (BICRA), which evaluates and compares the relative strength of different banking systems and highlights the economic and industry risks associated with a particular country's financial system.

For NBFIs, we adjust the anchor down to account for differences between the banking system and the various NBFI sectors. A preliminary anchor for each NBFI sector is established by reference to the bank anchor in the same country. We then may apply a country- or sector-specific adjustment, or an entity-specific adjustment, to arrive at the final anchor for an NBFI. The final anchor for an NBFI entity cannot be higher than the relevant bank anchor.

Table 2

Country Anchors: Rationales

Australia

Our 'bb+' anchor for nonbank financial lenders remains three notches below that for banks operating in Australia. This reflects nonbank lenders' lack of access to central banks, strong competition faced from banks, and higher-risk funding dynamics relative to banks.

Australia has a wealthy, open, and resilient economy that has performed relatively well following economic downcycles and external shocks. Financial institutions in Australia are exposed to economic risks resulting from rapid house price growth during 2019-2021 and high household debt. We forecast property prices will fall until mid- to late-2023 and thereafter grow slowly. Credit losses over the next two years should remain low, and close to pre-pandemic levels even as rate hikes erode debt serviceability for highly leveraged borrowers.

Brazil

Our starting point--or anchor--for our ratings on NBFI fincos in Brazil is currently 'bb', just one notch below the 'bb+' anchor for commercial banks operating only in the country. We consider in assessing industry risk that the central bank of Brazil and the National Monetary Council (CMN) closely regulate and monitor all financial entities in the country, including nonbank companies. In addition, these entities also have access to central bank funding, but in practice are less able to use this than banks.

Canada

Our starting point--or anchor--for our ratings on NBFI fincos in Canada is 'bbb-'. We initially set the anchor for fincos three notches below the anchor for banks in the same country to reflect the typical lack of central bank access, lower regulatory oversight, and higher competitive risk for fincos, relative to banks. NBFI companies in Canada have moderately higher funding risk than banks because of their lack of central bank access and relatively higher use of wholesale funding. NBFI companies also face increased competitive risks compared with banks in Canada, without substantial barriers to entry to offset the increased competition. While there are some federal regulations as well as provincial laws, Canadian NBFIs face less prudential regulation than banks in Canada, resulting in moderately higher risk relative to banks. As with banks, the Canadian fincos' anchor reflects the country's competitive economy, which is tempered by a substantially indebted household sector and outsize real growth in house prices since 2000.

Chile

The anchor for Chile-based NBFIs is 'bb+', reflecting the standard three notches below the bank anchor. Fincos do not have central bank access and rely mostly on wholesale funding. Although fincos that issue market debt are regulated by the Financial Market Commission (CMF) and are required to report their financial statements following international standards on a quarterly basis, we do not believe they have the same prudential standards as banks. We believe fincos face strong competition from banks and other fincos, with low barriers to entry. We currently see negative pressures on the NBFIs anchor in Chile, reflecting downside risks from the ongoing constitutional amendments, pension system reform, and social discontent on economic growth and investment

China

We believe that finance companies operating in China face higher risks than banks. These risks include their lack of access to the central bank; significant reliance on wholesale funding; and, for many, less-comprehensive prudential supervision and regulation.

Finance companies are not subject to pricing controls and face fewer market distortions because of state ownership than banks. However, these companies are more susceptible to business cycles, leading to more-volatile revenue. Compared with banks, finance companies generally have higher financing costs. For all these reasons, the anchor (the starting point of our rating assessment) for a finance company operating in China is 'bb-', two notches below that for banks.

In our view, the tightened scrutiny on microfinance companies, leasing companies, and other companies should be credit positive for finance companies in China. This will improve the sector's governance and risk management capacity and limit risk-taking activities. In turn, these improvements support system stability. Nevertheless, the regulatory framework on financial companies is generally more relaxed. That said, a few financial companies are licensed or supervised by the China Banking and Insurance Regulatory Commission (CBIRC) under similar prudential regulations to banks.

Chinese Asset Management Companies

We see asset management companies (AMCs) in China as a distinct and specialized subsector within the finance company sector. Our starting point--or anchor--for our ratings on AMCs in China is currently 'bb-', which is two notches below the anchor for banks operating in the same country. This mainly reflects AMCs' typical lack of access to central bank funding, significant reliance on wholesale funding, and lower regulatory oversight.

Regulatory barriers to entry ensure that AMCs face less competitive risk than fincos. In China, only licensed AMCs can acquire nonperforming assets from financial institutions in the primary market. So far, five national AMCs and 59 local AMCs have been licensed in China and we do not anticipate a rapid increases in the number of licenses over the next two years.

The four largest national AMCs benefit from a positive entity-specific adjustment to their anchors. The one-notch adjustment indicates that these companies are subject to much stricter prudential regulatory oversight than other AMCs. Over the years, regulations on the "Big Four" national AMCs have been strengthened, especially in areas such as capital and leverage requirements, and risk management frameworks.

Colombia

Our starting point--or anchor--for our ratings on NBFI fincos in Colombia is currently 'b+', which is three notches below the anchor for banks operating in the same country. This reflects NBFIs' typical lack of access to the central bank's credit lines, higher competitive risks than among banks, and lower regulatory oversight. Furthermore, Colombian fincos rely on wholesale funding sources, including commercial and multilateral credit facilities. Now that international debt markets are partly closed, this has gained increased relevance. Moreover, these entities usually face strong competition from banks, so their margins are more susceptible to competitive pressure and their revenue is more volatile than the average for the banking system. On the other hand, Colombian NBFIs are not subject to the significant prudential regulatory oversight, as opposed to banks. For example, fincos are not required to hold minimum capitalization levels as banks do.

Finland

Our anchor for NBFI fincos in Finland remains at 'bbb-', three notches below that for banks operating in Finland. This reflects Finnish fincos' materially higher industry risk compared with domestic banks. Fincos do not have central bank access and are more dependent on market-sensitive funding, which limits their financial flexibility, particularly in times of stress. Moreover, they face strong competition from banks and from each other, and given their concentration in a few business lines, their revenue can be more volatile. In addition, fincos are generally not prudentially regulated and do not benefit from regulatory oversight.

India

Our starting point for rating fincos in India is 'bb-', which is two notches below the anchor for the banking sector in India. We believe that Indian fincos face greater industry risk than banks because fincos generally have no access to central bank funding. While the regulations for fincos are tightening further, we believe the sector remains subject to less onerous regulations, notwithstanding some requirements on capital adequacy, liquidity, and asset quality management. The Reserve Bank of India, the country's central bank, rolled out scale-based regulation for nonbank financial corporates from Oct. 1, 2022. In our view, large entities that are categorized in the "upper-layer" bracket under the regulations could be subjected to enhanced regulatory requirements. Several fincos in India have created strong niches, domain expertise, and economies of scale to support revenue stability and mitigate competitive pressure.

Korea

The 'bbb-' anchor for fincos operating in Korea is two notches below the bank anchor derived from our Banking Industry Country Risk Assessment for Korea. We believe fincos in Korea face incremental industry risks relative to banks because fincos are more dependent on market-sensitive funding and lack access to central bank funding. They also have volatile revenue bases and face competition from banks to some degree. The adequate regulatory supervision and oversight for fincos temper these weaknesses, to some extent.

Mexico

Our anchor for Mexican NBFIs is 'bb-', which is the standard three notches below the bank anchor derived from our BICRA. Our three-notch deduction reflects our view of the incremental risk of NBFIs relative to banks, which stems from a less comprehensive prudential regulation and weaker institutional framework. Additionally, Mexican NBFIs don't have central bank access and are highly dependent on wholesale funding, which limits their financial flexibility and increases their funding risk, particularly during times of financial stress and adverse economic conditions.

In our view, unlike previous periods of market turmoil, Mexican NBFIs won't benefit from the existence of government-owned development banks as these won't represent a stable funding source to the NBFI sector going forward. Additionally, we don't expect any support from the government to strengthen NBFI funding profiles in the next few years.

Mongolia

Our 'b-' anchor for fincos is two notches below the anchor for banks operating in Mongolia. We believe fincos in Mongolia face incremental industry risk relative to banks. Fincos are more dependent on market-sensitive funding and lack access to central bank funding. They also face more competition compared with banks due to lower barriers to entry. We believe regulatory oversight on the financial system in Mongolia is relaxed by international standards and the country's regulatory framework is relatively underdeveloped.

New Zealand

Our 'bb' anchor for fincos in New Zealand is the standard three notches below the bank anchor. The three notches reflect our view of the incremental industry risk for fincos in New Zealand relative to banks. Funding risk for fincos is higher than that for banks, in our view, because they typically lack central bank access. Compared with banks, fincos also operate under weaker regulatory oversight and a less-supportive institutional framework. They face higher competitive risks and revenue is typically less stable through economic cycles, in our view.

The New Zealand economy is open, prosperous, and flexible, drawing on decades of structural reforms. We believe New Zealand financial institutions are exposed to the risk of a sharp correction in house prices, which grew rapidly in 2020 and 2021. House prices have fallen in an orderly manner since their peak in late 2021 and we expect this trend to continue. Interest rate increases by the central bank, combined with a variety of government tax-related changes, rising housing supply, moderating demand in light of lower immigration levels, and falling consumer confidence have driven the decline in property prices.

Taiwan

Our 'bb+' anchor for fincos operating in Taiwan under the jurisdiction of the Financial Supervisory Commission (FSC) is two notches below our bank anchor. The FSC supervises most NBFIs in the country and we consider its prudential regulatory standards for NBFIs are less robust than those for banks.

For NBFIs regulated by the Ministry of Economic Affairs, the anchor is 'bb'. This reflects our view that these fincos operate under less comprehensive and less stringent regulatory requirements than fincos under the FSC's jurisdiction.

We generally assess profit margins at fincos as adequate and market shares for the leading players have been stable, which suggests that barriers to entry are sufficiently high to limit competition. However, funding risk for fincos is higher than for banks, in our view, because they are more reliant on market-sensitive wholesale funding.

U.K.

The 'bb+' anchor for nonbank finance companies is three notches below the domestic bank anchor. We believe that the main risk for NBFIs is industry risk. Finance companies do not have central bank access, which limits their financial flexibility, particularly during times of financial stress. They face strong competition from banks and from each other and, given their concentration in fewer business lines, revenue can be volatile. Finance companies in the U.K. are regulated by the Financial Conduct Authority, as opposed to the Bank of England's Prudential Regulatory Authority. In general, they have weaker regulatory requirements than banks and are subject to less intensive oversight.

U.S.

Our starting point--or anchor--for our ratings on NBFI fincos in the U.S. is currently 'bb+'. We initially set the anchor for fincos three notches below the anchor for banks in the same country to reflect the typical lack of central bank access, lower regulatory oversight, and higher competitive risk for fincos relative to banks. U.S. fincos typically rely on bank facilities, secured and unsecured debt, and other wholesale funding, whereas U.S. banks mainly rely on deposit funding. While consumer finance companies are generally subject to consumer protection laws, U.S. fincos are typically not subject to the significant prudential regulatory oversight of banks' capital and liquidity, which in our view is supportive of creditworthiness. While U.S. fincos may compete with banks, they often focus on higher-risk lending than banks and are subject to greater cyclical volatility. Like banks, the U.S. fincos' anchor reflects the country's diversified and high-income economy.

U.S. Business Development Companies

The starting point--or anchor--for ratings on business development companies (BDCs) is currently 'bb+'. The anchor is three notches below the U.S. bank anchor to reflect the lack of central bank access, lower regulatory oversight, and higher competitive risk relative to banks. BDCs are subject to some regulation, but they are not subject to the significant prudential regulatory oversight that banks' capital and liquidity are, which we view as generally supportive of creditworthiness. BDCs typically focus on higher-risk lending than banks and are subject to greater cyclical volatility.

U.S. Federal Home Loan Banks

Our anchor for our ratings on U.S. finance companies that we rate under our financial institutions criteria, including federal home loan banks (FHLBs), is 'bb+'. Because of FHLBs' public policy role and regulatory status, we apply a sector-specific anchor adjustment to raise the anchor for these entities by three notches to 'bbb+'. This is to account for the Federal Housing Finance Agency's regulatory oversight, the favorable funding FHLBs enjoy through their close relationship with the U.S. government, their strong competitive position alongside other housing-related government-sponsored enterprises (including Fannie Mae and Freddie Mac) in the U.S. housing finance market, and the statutory priority of liens in a bank wind-down situation.

Appendix

Deriving NBFI anchors from the Banking Industry Country Risk Assessment and bank anchors

The foundation of our bank and finco anchors is our BICRA, which reflects the economic and industry risks in a particular country's financial system.

For NBFIs, we adjust the anchor to account for differences between the bank and NBFI sectors, as well as potentially for country-, sector-, and entity-specific factors.

We establish preliminary anchors for NBFI sectors relative to the bank anchor in the same country. We then may apply a country- or sector-specific adjustment or an entity-specific adjustment to arrive at the final anchor for an NBFI. However, the final anchor for an NBFI entity cannot be higher than the relevant bank anchor.

The preliminary anchors for the NBFI sectors reflect the typical incremental risks that NBFIs face relative to banks. As such, in all countries, we set the preliminary anchor for fincos--including business development companies (BDCs)--three notches below the bank anchor, and the preliminary anchor for securities firms two notches below the bank anchor, subject to a floor at 'b-'.

The preliminary anchors for the finco sectors aim to reflect the additional risks that fincos face relative to banks. As an example, if the bank anchor in a given country is 'bb+', the preliminary anchor for fincos in that same country is 'b+'. In our view, the incremental industry and economic risks for NBFIs relative to banks typically include the following:

• Lack of access to central bank funding, which increases liquidity and funding risk relative to banks;
• Strong competition from banks, exacerbated by banks' lower cost of financing;
• Higher competitive risk, both among themselves and relative to banks, because of lower barriers to entry combined with more volatile or fragmented business conditions; and
• Limited regulatory oversight compared with banks, which heightens their sensitivity to changes in investor confidence.

Country-specific adjustments to the preliminary anchor

In some cases, a country- or sector-specific adjustment results in the NBFI anchor being higher or lower than the preliminary anchor. For an NBFI sector or subsector in a given country, we make a positive country- or sector-specific adjustment when we view the incremental risks relative to banks as materially lower than those identified in the preliminary anchor, and vice versa.

Examples of situations that may trigger a positive adjustment of one to three notches for fincos, or for specific subsectors within the finco sector, include:

• The NBFI sector or subsector benefits from a stronger institutional framework (government oversight) than is typical for such sectors. In some countries, fincos are regulated or have other supportive institutional framework elements.
• Funding is stronger for the specific NBFI sector or subsector than we typically observe for NBFIs. In some countries, for example, fincos have direct or indirect access to central bank funding, perhaps through government-sponsored development banks.
• Regulations preserve competitive position (and, hence, reduce competitive risk) for the sector or subsector. In some countries, government regulators restrict the number of licenses granted to NBFIs and these are required to undertake certain types of business.