Fitch Ratings has affirmed the National Long-term rating of Union Bank of Colombo Limited (UBC) at ‘BB+(lka)’ reflecting the bank’s improved asset quality on a restructured loan book, constrained profitability and lack of a broad deposit base. The Outlook is revised to Positive from Stable.
The recent equity injections and the benefits expected, specifically to profitability and scalability of the bank’s business, is reflected in the revision of the Outlook to Positive.

Equity infusion in FY07, from existing as well as new shareholders, enhanced equity to LKR1.434 billion at end-October 07 (LKR746.9 million at FYE06). Given UBC’s low profitability and resulting constraints in generating internal capital, Fitch notes that achieving the LKR2.5bn minimum capital requirement (MCR) by end-2009 is likely to require a further equity infusion of around LKR1.0bn.

Advances growth was low at 4.5% during 9M07, compared to 21.3% between FYE05 and FYE06.

Aided by cautious lending practices and a relatively unseasoned loan book, gross NPL/gross loans ratio improved to 3.5% at Q307, from 5.0% at FYE06, and was well below the sector average.

Subsequent to posting negative equity in 2002, UBC underwent a restructuring exercise which resulted in the bank holding onto a 20-year deep discounted bond (DDB) with a face value of LKR3.458bn and an implicit rate of return of 4%. The DDB accounted for 18.7% of assets at Q307.

While the interest yield computed on average interest earning assets without the DDB is broadly in line with peers, the overall interest yield is constrained by about 2.0% due to the low yielding DDB. NIMs declined to 2.0% during 9M07 from 2.3% in FY06 due to competitive market conditions.

Consequently, ROA was low at 0.3% in 9M07; down from 0.6% in FY06, although better than the 0.1% in FY05.

Deposits (85.9% of assets at Q307) dominated funding, although nominal deposit growth slowed to 9.1% in Q307 in line with asset growth. Fitch notes that there are significant deposit concentrations, with the single largest depositor and the top 20 depositors accounting for 4.5% and 21.9%, respectively, of total deposits at FYE06.

Opened in 1995, UBC is a small commercial bank with 12 branches and accounts for 0.4% of banking system assets. Sampath Bank (SB) (‘AA-(lka)’ (AA minus (lka)) which was involved in the restructuring process at the behest of the Central Bank of Sri Lanka held 18.75% of UBC’s issued capital at Q307.

Fitch’s National ratings provide a relative measure of creditworthiness for rated entities in countries with relatively low international sovereign ratings and where there is demand for such ratings. The best risk within a country is rated ‘AAA’ and other credits are rated only relative to this risk. National ratings are designed for use mainly by local investors in local markets and are signified by the addition of an identifier for the country concerned, such as ‘AAA(lka)’ for National ratings in Sri Lanka.

Specific letter grades are not therefore internationally comparable.
A credit update report will be made available shortly on Fitch’s websites, www.fitchratings.com and www.fitchratings.lk.