RAM reaffirms the ratings of BBB/P3 to Union Bank

RAM Ratings Lanka has reaffirmed the respective long- and short-term financial institution ratings of Union Bank of Colombo PLC at BBB and P3; the long-term rating has a stable outlook.

The ratings are premised on the Group’s healthy capitalisation but tempered by its small stature, moderate asset quality, performance, funding and liquidity.

Incorporated in 1995, Union Bank is one of the smallest licensed commercial banks in Sri Lanka. As at end-December 2010, the Group accounted for only 0.63% of the local banking industry’s assets.

In February 2011, it was listed on the Colombo Stock Exchange, raising Rs. 375 million of capital. That same month, Union Bank acquired 51% of National Asset Management Limited for Rs. 331.50 million, thereby venturing into unit-trust management. Established in 1991, NAMAL is the pioneer unit-trust management company in Sri Lanka.

Meanwhile, Union Bank had also acquired 81.27% of The Finance and Guarantee Company Limited for Rs. 600 million, as a medium-to-long-term investment.

Union Bank’s asset quality is deemed moderate, albeit with an improving trend since fiscal 2010. The Group concentrates on second-tier corporates that are more susceptible to economic fluctuations.

Supported by the more conducive macroeconomic climate, the Group’s non-performing loans have been easing since fiscal 2010. The value of its NPLs improved to Rs. 342.96 million as of end-September 2011 (FYE 31 December 2010: Rs. 796.51 million), translating into a gross NPL ratio of 3.53% (end-FY Dec 2010: 8.11%).

That said, RAM Ratings’ concerns hinge upon the possible NPLs that could arise as new loans season. As at end-September 2011, the Group’s top 20 loans accounted for a smaller 26.65% of its lending (end-September 2010: 38.85%), although still at a high level.

Union Bank’s performance is deemed moderate, albeit with an improving trend since fiscal 2009. Supported by its robust loan growth that had diluted the effects of the low-yielding deep discounted bond, the Group’s interest income surged in 9M FY Dec 2011, thus pushing its net interest margin up to 4.79% year-on-year.

Nevertheless, its NIM remains weaker than those of its banking peers due to the DDB. Meanwhile, Union Bank’s cost-to-income ratio also eased in fiscal 2010 and 9M FY Dec 2011, backed by its rising top line, but still weaker than its peers’ owing to its small stature. That said, the Group achieved a record pre-tax profit of Rs. 307.99 million in FY Dec 2010, followed by Rs. 324.04 million in 9M FY Dec 2011 (+40.28% y-o-y).

Union Bank’s funding profile is perceived to be moderate due to the Group’s weak franchise and lack of geographical reach in comparison to larger LCBs. Due to the Group’s aggressive loan growth and enlarged shareholders’ funds, its loans-to-deposits ratio weakened to 92.82% as at end-September 2011 (end-FY Dec 2010: 72.48%).

At the same time, the Group’s historically better-than-peer statutory liquid-asset ratio dipped from 36.33% as at end-FY Dec 2010 to 22.42% as at end-September 2011 amid its aggressive loan expansion. This level of liquidity may constrain its loan growth.

Following a rights issue in 2010, the Group’s capitalisation levels are deemed healthy. Its respective tier-1 and overall risk-weighted capital-adequacy ratios improved to 34.82% and 35.11% as at end-FY Dec 2010. By end-September 2011, however, the ratios had declined to 27.46% and 27.76% amid its aggressive loan expansion, despite further capital infusions following its initial public offer this year. That said, the ratios are still healthy relative to its peers’, leaving ample room for growth.

Furthermore, the Group’s ratio on net NPLs to shareholders’ funds is one of the lowest among the industry, providing an adequate cushion against unfavourable movements in its asset quality.