June 24, 2013 / 12:06 PM / 4 years ago

RPT-Fitch Downgrades Sri Lanka's NDB to 'AA-(lka)'; Outlook Stable

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June 24 (Reuters) - (The following statement was released by the rating agency)

Fitch Ratings has downgraded Sri Lanka-based National Development Bank PLC’s (NDB) National Long-term rating to ‘AA-(lka)’ from ‘AA(lka)'. The Outlook is Stable. The agency has also downgraded the bank’s outstanding subordinated redeemable debentures to ‘A+(lka)’ from ‘AA-(lka)'.‘AA’ category National Ratings denote expectations of very low default risk relative to other issuers or obligations in the same country. The default risk inherent differs only slightly from that of the country’s highest rated issuers or obligations.

KEY RATING DRIVERS

The downgrade reflects Fitch’s expectation that NDB’s risk profile will materially increase as a result of its changing business model, from being a well-capitalised, specialised project lender to a new entrant in a highly competitive domestic commercial banking sector. Project loans have reduced as share of total loans to 14% in 2012 from 58% in 2005. Its shift towards SME and retail lending will, in Fitch’s opinion, materially alter the bank’s risk profile, notwithstanding the diversification benefits provided by growth in these sectors.

Fitch believes NDB is still lagging its larger commercial banking peers, specifically in terms of its franchise in lending and deposits, and that it may face challenges in gaining critical mass across key product segments. For example, NDB has a 3% market share in deposits whereas most incumbents’ market share is in the low double-digit range. NDB’s current and savings accounts ratio (CASA) was 24% and loans to deposits ratio (LDR) was 111% at end-2012, while it has high deposit concentrations. Comparatively the median ratios for CASA and LDR in the ‘AA(lka)’ rating category, were 39% and 91% respectively.

These risks are counterbalanced by the bank’s satisfactory risk management policies, its prudent approach to provisioning, as well as by its satisfactory track record as a project lender. Its historical track record as a project lender allows it to benefit from longer-term wholesale funding. Other present attributes from its current business, such as high capitalisation and a low non-performing loan (NPL) ratio, are likely to diminish as NDB increasingly shifts to SME and retail lending.

The downgrade of NDB’s subordinated debentures reflects a one-notch differential that Fitch maintains from the issuer rating. This reflects the instrument’s gone-concern loss absorbing feature, and its subordination to senior unsecured creditors in the event of liquidation.

Core tier 1 capital adequacy ratio (CAR) was strong at 18.8% at end-2012 (2011: 14.4%), bolstered by a one-time capital gain on the disposal of its insurance subsidiary. However, Fitch expects this ratio to reduce in the long-term in line with expected asset growth, but to remain satisfactory for the current ratings. NDB’s asset quality is strong compared with its rated peers. Its regulatory non-performing loan (NPL) ratio stood at 1.31% at end-2012, compared with a peer median of 3.1%.

RATING SENSITIVITIES

A solid track record in developing and maintaining a commercial banking franchise with commensurate credit metrics would be considerations for an upgrade. The Stable Outlook, however, indicates this as a remote prospect over the next one to two years.

Sustained and substantial weakening in asset quality, stemming from aggressive loan growth, or a substantial weakening in capitalisation and provision coverage could result in a downgrade.

The subordinated debt rating is primarily sensitive to changes in NDB’s National Long-term rating.

NDB was established in 1979 as a specialised bank and transformed into a licensed commercial bank in 2005. The government of Sri Lanka indirectly held over 30% of NDB’s voting shares at end-March 2013, through various state-owned institutions.

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