Fitch affirms Union Bank at ‘BB+’; outlook negative

Fitch Ratings Lanka has affirmed Union Bank of Colombo PLC’s (UB) National Long-Term Rating at ‘BB+(lka)’. The Outlook is Negative.

The Negative Outlook reflects persistent operational weaknesses and risks to asset quality following rapid growth. The rating also reflects UB’s small size and developing franchise as well as its strong capital ratios.

Significant improvements to its risk management system and processes, including effective implementation of a core banking system capable of supporting UB’s expanding operations, and maintaining satisfactory asset quality, profitability, and capitalisation could result in the Outlook being revised to Stable.

The bank is in the process of finalising the purchase of a core banking system and has also signed up for the purchase of a risk management system. UB’s management expects to complete the system implementation by end-2013.

Excessive loan growth leading to weaker asset quality relative to peers or impairment in capitalisation could result in a rating downgrade. Additionally a failure of UB to resolve operational weaknesses due to ineffective system implementation or delays could also put pressure on the rating.

UB’s rapid growth alongside limited operational system support could further weigh on asset quality. Its loan growth of 19% in the nine months to 30 September 2012 (2011: 72%) outpaced that of the commercial bank sector (9M12: 17%, 2011: 32%), albeit in line with similarly sized peers.

The bank’s gross non-performing loan (NPL) ratio rose to 6.4% at end-9M12 (end-2011: 4.1%), driven by NPLs in the construction sector and in its retail customer base. Fitch expects credit costs in 2012 to remain manageable due to some NPL recoveries.

UB’s return on assets declined to 1% in 9M12 from 1.4% in 2011 owing to its investment in UB Finance Limited (2% of assets) in November 2011 and rising funding costs. Net interest margin continues to be muted by a low yielding bond (accounting for 8% of the bank’s assets at end-9M12) on which it earns a negative interest spread.

Equity injections supported a high equity assets ratio of 17.9% and a core capital adequacy ratio of 21.3% at end-9M12. However, capitalisation could come under pressure if the bank is unable to curtail the rise in its NPLs.

UB is a small licensed commercial bank (LCB) accounting for less than 1% of the sector’s assets as at end-September 2012. Vista Knowledge Limited and Select Gain Limited, which are companies associated with Genting Berhad, together hold 25.2% of UB’s equity while Sampath Bank PLC holds a further 7.5%.