Fitch affirms five small and mid-sized Lankan banks

Fitch Ratings Lanka has affirmed the national long-term ratings on five small and mid-sized Sri Lankan banks. The banks are Nations Trust Bank PLC (NTB), Pan Asia Banking Corporation PLC (PABC), Union Bank of Colombo PLC (UB), SANASA Development Bank PLC (SDB) and Amana Bank PLC (Amana).   

The affirmations follow Fitch’s periodic review of small and mid-sized Sri Lanka banks and are driven by the banks’ intrinsic profiles. Fitch expects the banks’ capitalisation to remain thin in the medium term, as they are likely to sustain a strong increase in loans. PABC, SDB and Amana infused capital to meet their respective minimum regulatory core capital levels. The impact of the implementation of SLFRS 9 in 2018 could also significantly reduce the banks’ capital positions.  

The banks’ absolute non-performing loans (NPLs) increased in 1H17, in line with Fitch’s expectations. Fitch believes asset-quality risks are greater for these banks due to their greater exposure to retail and small and medium enterprise (SME) customer segments, which Fitch sees as more susceptible to economic downturns.   

Key rating drivers, national ratings and senior debt 
NTB’s ratings reflect its declining capitalisation, modest franchise and high product concentration. NTB’s capitalisation has come under pressure due to strong loan expansion (12.9 percent in 1H17 and 23.5 percent in 2016), which exceeded internal capital generation. Its Fitch Core Capital (FCC) and Tier I capital ratios continued decreasing to 10.7 percent and 10.6 percent, respectively, at end-1H17, from 12.2 percent and 12.1 percent at end-2015.   

NTB is a mid-size licensed commercial bank that had a modest market share gain to 2.5 percent of banking sector assets at end-1H17. Its current account, saving account (CASA) base decreased to 25.5 percent of deposits at end-1H17, from 32.5 percent at end-2015, similar to the trend seen across the sector.  

Product concentration remains high against peers, as leasing and credit cards accounted for 20.0 percent and 10.0 percent, respectively, of NTB’s gross loans at end-1H17. Its gross NPL ratio decreased to 2.5 percent at end-1H17, from 2.8 percent at end-2015, despite an increase in absolute NPLs.   

PABC’s rating reflects further deterioration in its asset-quality metrics during 1H17 relative to higher-rated peers, which has put pressure on the bank’s improved capitalisation following its Rs.2.1 billion rights issue in March 2017. The rating also reflects potential profitability pressure stemming from lower loan growth and higher credit costs. PABC’s gross NPL ratio rose to 6.3 percent at end-1H17 from 4.7 percent at end-2016, due to a 32 percent growth in absolute NPLs stemming from high loan-growth periods. Its loan book expanded by just one percent in 1H17 as the bank focused on strengthening its book quality.  

PABC requires a further Rs.1.3 billion to meet the minimum regulatory capital level of Rs.10 billion by January 1, 2018. Fitch expects the bank to achieve this through retained profits in 2017, as further capital infusions are not expected. The bank’s Tier I capital ratio increased to 10.8 percent at end-1H17, from 8.4 percent at end-2016.   

PABC’s outstanding senior debentures are rated at the same level its national long-term rating as they rank equally with the claims of its other senior unsecured creditors. 

The outlook on UB’s rating remains positive to reflect the shift in UB’s risk profile, which is driven by structural changes in its loan book composition that could support better asset quality. This stems from more diversified customer exposures, which are similar to higher-rated peers. However, UB has continued to sustain a rapid increase in loans that could pressure asset quality if not managed prudently. 

In addition, NPLs stemming from subsidiary, UB Finance Co. Ltd (32 percent of total NPLs at end-1H17) remains a significant drag on the group’s total NPLs. However, the bank’s gross NPL ratio improved to 2.6 percent at end-1H17, from 3.6 percent at end-2015.  

UB’s rating reflects its small franchise, weaker profitability and higher capitalisation relative to higher-rated peers. The bank accounted for just one percent of banking sector assets at end-1H17. Its profitability has been constrained by low net interest margins (NIM) and high-cost structures. Fitch believes the bank is likely to focus on increasing exposure to more profitable customer segments and income generation to improve profitability. UB’s FCC ratio fell to 19.4 percent at end-1H17, from 21.2 percent at end-2015, with sustained high loan growth of 14.4 percent in 1H17 and 38 percent in 2016. Fitch expects capitalisation to decline to levels similar to peers in the medium-term alongside continued rapid loan expansion.  

SDB’s rating captures its high-risk appetite in terms of substantial exposure and rapid loan growth in the retail and lower-end SME segments. Fitch believes this could pressure the bank’s capitalisation in the absence of capital raising, despite its Rs.1.4 billion capital infusion in May 2017, as internal capital generation may be insufficient. SDB’s profitability, as measured by return on assets, remained low due to its high operating and credit costs. This is despite a high NIM compared with peers, which reflects its target market segment.   

SDB’s reported gross NPL ratio increased to 2.2 percent at end-1H17, from 2.1 percent at end-2016. Fitch expects asset quality to deteriorate as loans season.   

Amana’s rating reflects its small and developing franchise and high risk appetite stemming from its predominant exposure to SME and retail segments. Amana began operations in 2011 and accounted for 0.6 percent of banking sector assets at end-1H17. There has been a large increase in the bank’s capitalisation following a July 2017 rights issue to meet the higher 2018 regulatory minimum capital requirements. Fitch expects Amana’s capitalisation ratios to moderate in the medium term from the estimated post-rights issue FCC ratio of 22.7 percent as the loan book expands.   

Amana’s asset-quality metrics remain better than those of peers despite deterioration in the bank’s gross NPL ratio to 1.5 percent at end-1H17 from 0.9 percent in 2016. Fitch expects asset-quality pressure to increase as the loan book seasons due to the bank’s high SME and retail segment exposure of 75 percent of gross loans at end-2016.   

Amana remains mainly deposit funded and has maintained a stable CASA base relative to peers of over 50 percent. We expect the bank’s profitability metrics to improve in the medium term relative to better-rated peers as it capitalises on the existing infrastructure and enhances its franchise, leading to a lower cost/income ratio, despite potentially higher credit costs from asset-quality pressure and SLFRS 9 implementation.   

Subordinated debt  
The Basel II compliant Sri Lanka rupee-denominated subordinated debt of NTB and PABC are rated one notch below the banks’ national long-term ratings to reflect subordination to senior unsecured creditors.  

Rating sensitivities, national ratings and senior debt 
NTB’s rating could be downgraded if there is a continued decline in capitalisation seen through sustained strong loan expansion in the absence of capital raisings. Increased capital impairment risk through continuous asset-quality deterioration could also result in a downgrade. An upgrade is contingent upon lower product concentration, a significant increase in capitalisation and a more stable funding profile alongside progress in building a stronger commercial banking franchise. The upgrade of UB’s rating is contingent upon its ability to manage risks from continued high loan growth, despite structural changes to its loan composition, which would be reflected through sustained asset-quality improvement. The improvement in UB’s financial profile to levels similar to higher-rated peers could also support an upgrade. Capital impairment risks stemming from sustained rapid loan expansion or asset-quality deterioration could pressure UB’s rating. SDB’s rating could be downgraded if there is a continued deterioration in capitalisation, either through aggressive loan growth or greater unprovided NPLs. An upgrade would be contingent upon moderation of its risk appetite and sustainable improvements in asset quality and profitability.  Fitch does not see upside potential for PABC’s ratings in the near term, as the bank may face difficulty is sustaining adequate capital buffers similar to higher-rated peers. PABC’s rating would be downgraded if loss-absorption buffers further deteriorate, either through a greater share of unprovided NPLs, aggressive loan-book growth or weaker internal capital generation. A rating upgrade for Amana is contingent upon the expansion of the bank’s franchise and improved and sustained financial profile, in particular, achieving profitability levels that are similar to higher-rated peers. Deterioration in loss-absorption buffers, either through excessive growth above management forecasts or a greater share of unprovided NPLs, could put downward pressure on Amana’s rating.  

Senior debt ratings will move in tandem with the banks’ national long-term ratings.   

Subordinated debt  
Subordinated debt ratings will move in tandem with the banks’ national long-term ratings.  
The rating actions are as follows:

Nations Trust Bank PLC national long-term rating affirmed at ‘A(lka)’; stable outlook, Basel II-compliant subordinated debentures affirmed at ‘A-(lka)’. Pan Asia Banking Corporation PLC national long-term rating affirmed at ‘BBB-(lka)’; stable outlook, senior debenture rating affirmed at ‘BBB-(lka)’, subordinated debenture rating affirmed at ‘BB+(lka)’.   

Union Bank of Colombo PLC national long-term rating affirmed at ‘BB+(lka); positive outlook. SANASA Development Bank PLC national long-term rating affirmed at ‘BB+(lka)’; stable outlook. Amana Bank PLC national long-term rating affirmed at ‘BB(lka)’; stable outlook.