Fitch Ratings has downgraded Sri Lanka's Union Bank of Colombo Plc by one notch to 'BB(lka)' on rising non-performing loans.
The outlook was revised to stable from negative at the lower rating.
"The downgrade reflects the deterioration in UB's credit profile, in terms of its asset quality and capitalisation," the rating agency said.
"Fitch has taken into consideration UB's increasing risk appetite, which can be seen in its rapidly expanding operations despite delays in implementing a core banking system.
"Fitch believes that although UB is on track to resolve operational weaknesses, it is likely to take some time until tangible benefits from stronger risk management and more robust internal reporting feed through."
Union Bank has increased loan growth 16 percent in the first nine months of the year above the sector 5.2 percent rate. Non-performing loans had increased 27 percent increasing NPLs to gross loans ratio of 13 percent from 12 percent at the end of 2012.
Its subsidiary UB Finance accounted for 41 percent of group NPLs. At bank level the NPL ratio had grown to 8.4 percent of gross loans at the end of the third quarter from 6.9 percent at end 2012 mostly from gold backed loans.
The full statement is reproduced below:-
Fitch Downgrades Union Bank of Colombo to 'BB(lka)'/Stable Ratings Endorsement Policy
18 Dec 2013 5:06 AM (EST) Fitch Ratings-Colombo/Hong Kong-18 December 2013: Fitch Ratings Lanka has downgraded Sri Lanka-based Union Bank of Colombo PLC's (UB) National Long-Term Rating to 'BB(lka)' from 'BB+(lka)'. The Outlook has been revised to Stable from Negative.
KEY RATING DRIVERS
The downgrade reflects the deterioration in UB's credit profile, in terms of its asset quality and capitalisation. Fitch has taken into consideration UB's increasing risk appetite, which can be seen in its rapidly expanding operations despite delays in implementing a core banking system. Fitch is of the view that UB's exposure to mostly SME customers renders it susceptible to economic cycles.
The rating captures UB's weak financial profile and small franchise relative to other licensed commercial banks. Fitch believes that although UB is on track to resolve operational weaknesses, it is likely to take some time until tangible benefits from stronger risk management and more robust internal reporting feed through.
Fitch expects UB's newly extended loans to continue to exert pressure on capitalisation as they season. UB posted loan growth of 16% in 9M13, well above the 5.2% for the sector. The NPLs increased by 27% in the first nine months of 2013, bringing the ratio of NPLs to gross loans to 13% at end-3Q13, from 12% at end-2012. The NPLs at its subsidiary UB Finance Limited accounted for 41% of the group's total NPLs. The increase in the NPL ratio, excluding the NPLs at UB Finance Limited, to 8.4% of gross loans at end-3Q13 from 6.9% at end-2012 stemmed largely from pawning (gold-backed) advances.
Having accumulated unprovided NPLs of 45% of equity at end-3Q13 (end-2012: 31%, end-2011: 30%) UB's capital remains vulnerable to further loan deterioration. UB's Fitch core capital ratio decreased to 14.5% at end-3Q13 (end-2012: 16.2%), mainly due to loan growth.
In addition, the decline in UB's consolidated regulatory core capital adequacy ratio to 13.7% at end-3Q13 from 17.7% at end-2012 reflects losses from the consolidation of Serendib Capital Limited to comply with new accounting standards in Sri Lanka. UB transferred its non-performing assets to Serendib Capital Limited, a special purpose vehicle, in 2003. UB's investment in Serendib Capital Limited is in the form of a deeply discounted bond that the latter issued in 2003 as part of UB's recapitalisation. The bond is guaranteed by Sampath Bank Plc (AA-(lka)/Stable).
UB recorded deposit growth of 21% in 9M13 resulting in a decrease in its loans/deposits ratio to 88.8% at end-3Q13 from 92.5% at end -2012. Fitch believes that the share of current and savings deposits in UB's total deposit base is likely to continue to be smaller than that of its more established peers.
RATING SENSITIVITIES
Continuously aggressive loan growth or loose underwriting standards may result in a rating downgrade if they were to lead to further significant capital erosion or materially hamper the group's liquidity.
An upgrade is contingent on ongoing improvements to UB's risk management processes and systems, which should provide the bank with a more robust framework to manage its expansion and enable it to maintain adequate loan quality and capitalisation.
UB is a small licensed commercial bank accounting for less than 1% of the Sri Lankan banking sector's assets. Vista Knowledge Limited and Select Gain Limited, which are companies associated with Malaysia's Genting Berhad, together hold 25.2% of UB's equity while Sampath Bank PLC holds a further 7.5%. The bank had 45 branches at end-3Q13. UB's subsidiaries include UB Finance Limited) and National Asset Management Limited.
Sri Lanka's Union Bank downgraded to 'BB(lka)
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