RAM Ratings Lanka has reaffirmed the respective long- and short-term financial institution ratings of Union Bank of Colombo PLC (Union Bank or the Bank) at BBB and P3. The long-term rating carries a stable outlook.
"The ratings are supported by the group's average capitalization but tempered by its small stature, below average asset quality and performance," the ratings agency said in a statement.
"The group's asset quality is deemed below average as reflected in its asset quality indicators that compare weaker than industry peers' coupled with the lack of seasoning in its credit assets.
The group's asset base expanded a slower 18.83% y-o-y in fiscal 2012 to LKR 31.63 billion (fiscal 2011: LKR 26.62 billion) amid the credit ceiling placed by the Central Bank of Sri Lanka (CBSL) during the year.
"That said, growth picked up in 9M fiscal 2013 to 20.50% (annualized) in line with the expansion of credit assets supported by branch expansion. Meanwhile, on the back of less conducive macroeconomic conditions coupled with the reduction in gold prices impacting pawning, resulted in the bank's absolute non-performing loans (NPLs) increasing to LKR 1.98 billion as at end-9M FY December 2013 (end-FY December 2012: 1.40 billion) . The bulk of the new NPLs stemmed largely from the pawning segment followed by the construction segment.
"Subsequently, Union Bank's gross NPL ratio worsened to 6.93% as at end-September 2013 from 5.54% as at end-December 2012 comparing weaker than its industry peers'. On the same note, the Group's absolute NPLs increased to LKR 3.34 billion as at end-September 2013 from LKR 2.64 billion as at end-December 2012, where the subsidiary UB Finance accounted for around 41% of group's total NPLs as at end-September 2013 and only around 9% of the group's credit assets.
"Elsewhere, the group's gross NPL coverage weakened to 36.74% as at end-September 2013 from 50.34% as at end-December 2011 amidst the influx of new NPLs. Looking ahead, although we expect the improving macro economic conditions and increased focus by management on recoveries will assist the group to uphold its asset quality, our concerns hinge on the lack of seasoning of its credit assets and the continued exposure to the relatively risky SME segment, as such we expect the asset quality indicators to remain weaker than its LCB peers'. Further, we note any further deterioration in the group's asset quality may lead to downward rating action.
"The group's performance is viewed to be below average reflective of weaker than peers' performance indicators. The group's net interest income grew by 37.83% y-o-y in fiscal 2012 to LKR 1.41 billion largely reflective of the growth in its credit assets. However, during 9M fiscal 2013, net interest income contracted 4.79% (annualized) owing to increase in interest expense outpacing growth in interest income amidst increased amount of funds being channelled to investments in non-interest bearing unit trust investments in line with the bank's treasury management strategy.
"The rapid increase in interest expense was largely due to higher funding costs, reflective of the increased reliance on customer deposits in the funding mix as well as the drop in low cost current account and savings account (CASA) deposits in the customer deposit mix. Consequently, the group's net interest margin (NIM) weakened to 4.50% in 9M fiscal 2013 from 5.58% in fiscal 2012. Looking ahead, in the short-term, we expect the company's NIM to improve as funding costs ease as deposits re-price faster than loans amidst a receding interest rate environment. Meanwhile, the group's operating expenses increased 35.76% y-o-y to LKR 1.39 billion in FY December 2012 (FY December 2011: LKR 1.03 billion), increasing a further 15.33% (annualised) in 9M FY December 2013.
"The increase in operating expenses was largely due to branch expansion and larger workforce. Consequently, the Group's cost to income ratio moderated to 76.95% in 9M FY December 2013 from 70.22% in FY December 2011 comparing weaker than its industry peers'. Despite an increase in net interest income, the group's pre-tax profit reduced 4.45% y-o-y in fiscal 2012 largely reflective of the increase in operating costs during the year.
"Moreover, pre-tax profit reduced a further 37.56% (annualized) in 9M fiscal 2013 owing to increase in operating cost and impairment charges. Consequently, the group's return on assets (ROA) moderated to 0.83% in 9M fiscal 2013 from 1.55% in fiscal 2012 (fiscal 2011: 2.09%) comparing weaker than its industry peers'.
"Group's funding composition remained relatively unchanged in fiscal 2013. Customer deposits made up the bulk of its funding base, accounting for 80.31% of the mix as at end-September 2013. Deposits grew 19.55% y-o-y in fiscal 2012 & 25.62% (annualized) in 9M FY December 2013 supported by the extended branch reach and improving franchise.
"Meanwhile, the loans to deposits ratio improved from 94.70% as at end-December 2011 to 89.93% as at end-September 2013 reflective of the faster growth in deposit-base compared to credit assets.
"On a related note, Union Bank's liquidity is viewed to be average. As at end-September 2013, its statutory liquid asset ratio moderated to 21.64% from 23.10% as at end-December 2012 amid loan growth during the 9M FY December 2013. Nevertheless, the ratio is in line with peers'.
"Although the bank's capitalization levels are healthy with tier-1 and overall risk-weighted capital adequacy ratios (RWCARs) clocking at 17.34% and 16.33% respectively as at end-3Q FY December 2013, the group's capitalization levels are viewed to be Average. In line with the credit asset expansion, group's tier-1 and overall RWCAR moderated to 17.73% and 17.96% respectively as at end- FY December 2012 (end-FY December 2011: 21.32% & 21.55%), the ratios moderated further to 13.79% & 13.74% as at end-3Q FY December 2013 reflective of the expansion of credit assets as well as the consolidation of losses from Serendib Capital Limited in line with the adoption of SLFRS's resulting in reduction of the group's capital base. Nevertheless, the group's tier-1 and overall RWCAR compares in line with LCB industry peers.
"On a similar note, our concerns continue to hinge on the weakening of the Group's net NPL's to shareholders' funds ratio, which deteriorated from 20.01% as at end-FY December 2011 to 45.36% as at end-3Q FY December 2013 owing to the influx of NPLs. Further, we note any further deterioration in the group's capitalization may lead to downward rating action," RAM Ratings Lanka said.
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"The ratings are supported by the group's average capitalization but tempered by its small stature, below average asset quality and performance," the ratings agency said in a statement.
"Incorporated in 1995, Union Bank is one of the smallest licensed commercial banks (LCB) in Sri Lanka, accounting for less than 1.00% LCB industry assets as at end-September 2013.
The Bank acquired The Finance and Guarantee Company Limited subsequently renamed UB Finance Company Limited (UB Finance) for LKR 600 million in November 2011. "UB Finance had faced financial strain under its previous ownership, resulting in its loan portfolio recording high delinquencies. The bank together with National Asset Management Limited (NAMAL) and UB Finance is referred to as 'the Group'. The Bank continues to account for the larger 93.54% of total assets of the group. Meanwhile, the group's main focus on lending is concentrated on small and medium enterprises (SMEs) that are relatively more susceptible to economic conditions.
The Bank acquired The Finance and Guarantee Company Limited subsequently renamed UB Finance Company Limited (UB Finance) for LKR 600 million in November 2011. "UB Finance had faced financial strain under its previous ownership, resulting in its loan portfolio recording high delinquencies. The bank together with National Asset Management Limited (NAMAL) and UB Finance is referred to as 'the Group'. The Bank continues to account for the larger 93.54% of total assets of the group. Meanwhile, the group's main focus on lending is concentrated on small and medium enterprises (SMEs) that are relatively more susceptible to economic conditions.
"The group's asset quality is deemed below average as reflected in its asset quality indicators that compare weaker than industry peers' coupled with the lack of seasoning in its credit assets.
The group's asset base expanded a slower 18.83% y-o-y in fiscal 2012 to LKR 31.63 billion (fiscal 2011: LKR 26.62 billion) amid the credit ceiling placed by the Central Bank of Sri Lanka (CBSL) during the year.
"That said, growth picked up in 9M fiscal 2013 to 20.50% (annualized) in line with the expansion of credit assets supported by branch expansion. Meanwhile, on the back of less conducive macroeconomic conditions coupled with the reduction in gold prices impacting pawning, resulted in the bank's absolute non-performing loans (NPLs) increasing to LKR 1.98 billion as at end-9M FY December 2013 (end-FY December 2012: 1.40 billion) . The bulk of the new NPLs stemmed largely from the pawning segment followed by the construction segment.
"Subsequently, Union Bank's gross NPL ratio worsened to 6.93% as at end-September 2013 from 5.54% as at end-December 2012 comparing weaker than its industry peers'. On the same note, the Group's absolute NPLs increased to LKR 3.34 billion as at end-September 2013 from LKR 2.64 billion as at end-December 2012, where the subsidiary UB Finance accounted for around 41% of group's total NPLs as at end-September 2013 and only around 9% of the group's credit assets.
"Elsewhere, the group's gross NPL coverage weakened to 36.74% as at end-September 2013 from 50.34% as at end-December 2011 amidst the influx of new NPLs. Looking ahead, although we expect the improving macro economic conditions and increased focus by management on recoveries will assist the group to uphold its asset quality, our concerns hinge on the lack of seasoning of its credit assets and the continued exposure to the relatively risky SME segment, as such we expect the asset quality indicators to remain weaker than its LCB peers'. Further, we note any further deterioration in the group's asset quality may lead to downward rating action.
"The group's performance is viewed to be below average reflective of weaker than peers' performance indicators. The group's net interest income grew by 37.83% y-o-y in fiscal 2012 to LKR 1.41 billion largely reflective of the growth in its credit assets. However, during 9M fiscal 2013, net interest income contracted 4.79% (annualized) owing to increase in interest expense outpacing growth in interest income amidst increased amount of funds being channelled to investments in non-interest bearing unit trust investments in line with the bank's treasury management strategy.
"The rapid increase in interest expense was largely due to higher funding costs, reflective of the increased reliance on customer deposits in the funding mix as well as the drop in low cost current account and savings account (CASA) deposits in the customer deposit mix. Consequently, the group's net interest margin (NIM) weakened to 4.50% in 9M fiscal 2013 from 5.58% in fiscal 2012. Looking ahead, in the short-term, we expect the company's NIM to improve as funding costs ease as deposits re-price faster than loans amidst a receding interest rate environment. Meanwhile, the group's operating expenses increased 35.76% y-o-y to LKR 1.39 billion in FY December 2012 (FY December 2011: LKR 1.03 billion), increasing a further 15.33% (annualised) in 9M FY December 2013.
"The increase in operating expenses was largely due to branch expansion and larger workforce. Consequently, the Group's cost to income ratio moderated to 76.95% in 9M FY December 2013 from 70.22% in FY December 2011 comparing weaker than its industry peers'. Despite an increase in net interest income, the group's pre-tax profit reduced 4.45% y-o-y in fiscal 2012 largely reflective of the increase in operating costs during the year.
"Moreover, pre-tax profit reduced a further 37.56% (annualized) in 9M fiscal 2013 owing to increase in operating cost and impairment charges. Consequently, the group's return on assets (ROA) moderated to 0.83% in 9M fiscal 2013 from 1.55% in fiscal 2012 (fiscal 2011: 2.09%) comparing weaker than its industry peers'.
"Group's funding composition remained relatively unchanged in fiscal 2013. Customer deposits made up the bulk of its funding base, accounting for 80.31% of the mix as at end-September 2013. Deposits grew 19.55% y-o-y in fiscal 2012 & 25.62% (annualized) in 9M FY December 2013 supported by the extended branch reach and improving franchise.
"Meanwhile, the loans to deposits ratio improved from 94.70% as at end-December 2011 to 89.93% as at end-September 2013 reflective of the faster growth in deposit-base compared to credit assets.
"On a related note, Union Bank's liquidity is viewed to be average. As at end-September 2013, its statutory liquid asset ratio moderated to 21.64% from 23.10% as at end-December 2012 amid loan growth during the 9M FY December 2013. Nevertheless, the ratio is in line with peers'.
"Although the bank's capitalization levels are healthy with tier-1 and overall risk-weighted capital adequacy ratios (RWCARs) clocking at 17.34% and 16.33% respectively as at end-3Q FY December 2013, the group's capitalization levels are viewed to be Average. In line with the credit asset expansion, group's tier-1 and overall RWCAR moderated to 17.73% and 17.96% respectively as at end- FY December 2012 (end-FY December 2011: 21.32% & 21.55%), the ratios moderated further to 13.79% & 13.74% as at end-3Q FY December 2013 reflective of the expansion of credit assets as well as the consolidation of losses from Serendib Capital Limited in line with the adoption of SLFRS's resulting in reduction of the group's capital base. Nevertheless, the group's tier-1 and overall RWCAR compares in line with LCB industry peers.
"On a similar note, our concerns continue to hinge on the weakening of the Group's net NPL's to shareholders' funds ratio, which deteriorated from 20.01% as at end-FY December 2011 to 45.36% as at end-3Q FY December 2013 owing to the influx of NPLs. Further, we note any further deterioration in the group's capitalization may lead to downward rating action," RAM Ratings Lanka said.
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