RAM reaffirms State Mortgage and Investment Bank’s ratings

RAM Ratings Lanka has reaffirmed the respective long- and short-term financial institutions ratings of A and P1 for State Mortgage and Investment Bank (“SMIB” or “the Bank”); the long-term rating has a stable outlook.

The ratings are based on the Bank’s strong capitalisation and the financial flexibility it derives from its sole shareholder, the Government of Sri Lanka (“GOSL”). However, the ratings are moderated by SMIB’s higher than industry level of non-performing loans (“NPLs”) and the substantial negative gap in its short-term asset-liability maturity mismatch (“ALMM”).

SMIB is a licensed specialised bank (“LSB”), created by the GOSL under the State Mortgage and Investment Bank Act No. 13 of 1975. SMIB comes under the purview of the Ministry of Finance and Planning (“MOF”). While the Bank is permitted, as per the Act, to provide loans for housing and agricultural purposes, its main role is as an institution that fulfils the GOSL’s social obligations vis-a-vis facilitating home ownership for the masses.

Despite its conservative lending in the recent past, the Bank’s NPLs have increased and remain significantly higher than its peers’. SMIB recorded a gross NPL ratio of 37.02% as at end-December 2009 (end-December 2008: 27.58%); this remained unchanged as at end-September 2010. The high NPL levels mainly stem from its EPF-backed lending portfolio, which accounted for about 48.75% of its total loans as at end-September 2010. However, we note that SMIB bears no default risk for these loans as they are backed by the borrowers’ EPF funds. Nevertheless, the Bank’s NPL ratio on conventional mortgages remained weak at 14.81% as at end-September 2010 (industry: 10.14%). Its social obligation of lending to the low-and middle-income segments exerts downward pressure on the Bank’s credit quality, due to its customers’ weaker repayment ability.

Notably, SMIB’s focus on long tenured mortgage loans funded by its short term deposit base has rendered its ALMM position weak. While the negative gap in the Bank’s ALMM had narrowed as at FY-December 2009, we expect the gap to widen again as it expands its loan book. Nonetheless, SMIB’s liquidity issues are moderated by its strong deposit franchise (anchored by state support). Public deposits took up 79.89% of SMIB’s total funding as at end-FY Dec 2009 (end-FY December 2008: 75.92%).

Owing to its state ownership and its social agenda, SMIB derives financial flexibility from the GOSL. That said, RAM Ratings Lanka has accorded limited benefit to this financial flexibility given the Bank’s restricted scope, i.e. its focus on housing loans and the fact that its role can be easily replicated by bigger and more systemically important state-backed financial institutions.

SMIB’s performance had strengthened during the period under review. The Bank recorded a net interest margin (“NIM”) of 4.44% for FY December 2009 (FY December 2008: 3.47%). This ameliorated further to 8.21% as at end-September 2010, as delinquent loans had not been re-priced downwards while deposit rates were reduced in line with market rates. Costs, however, had not increased in line with its NIM as the Bank had continued its operations with its existing 12 branches. Therefore, its Return on Assets (“ROA”) and return on equity (“ROE”) climbed up to 0.76% and 4.97%, respectively, as at end-FY December 2009 (end-FY December 2008: 0.40% and 2.18%). The ratios strengthened further to 3.89% and 24.94% as at end-September 2010.

In tandem with its healthier profit showing, the Bank’s internal rate of capital generation (“IRCG”) improved to 3.05% in FY December 2009 (FY December 2008: 1.74%), before advancing further to 13.50% as of end-September 2010. Meanwhile, SMIB’s capital adequacy is deemed healthy as its riskweighted capital-adequacy ratios (“RWCARs”) are well above the regulatory minimums. The Bank’s tier-1 and overall RWCARs clocked in at 25.82% and 26.51%, respectively, as at end-September 2010.