Sri Lanka Savings Bank

ICRA Lanka places the Issuer Rating of Sri Lanka Savings Bank on Rating Watch with Developing Implications

Instrument* Rated Amount (LKR Mn) Rating Action
Issuer rating N/A [SL]BBB- Placed on Rating Watch with Developing Implications

Rating action

ICRA Lanka Limited, subsidiary of ICRA Limited, a group company of Moody’s Investors Service, has placed the issuer rating of [SL]BBB- (Pronounced S L Triple B minus) assigned to Sri Lanka Savings Bank (SLSB or the Bank) on watch with developing implications.

Rationale

The rating action factors in the expected near-term acquisition of SLSB by National Savings Bank (NSB; rated [SL]AAA; Stable). ICRA Lanka would closely monitor the acquisition process and take further rating action, as required. The rating continues to take note of the 100% Government of Sri Lanka (GoSL) ownership in SLSB, which provides a strong likelihood of sovereign support to the Bank, if the acquisition programme delays or does not materialise as expected. The Bank has a comfortable capital adequacy ratios (CAR) characterised by a Tier I and total CAR of about 94% each as of Jun-19. However, SLSB would have to enhance its core capital to LKR 7.5 Bn by Dec-20 from about LKR 5.7 Bn as of Jun-19 to meet the minimum core capital requirement for Licensed Specialised Banks (LSBs). ICRA Lanka expects timely capital support from GoSL or NSB if acquired, to meet the regulatory capital requirement.

The rating takes cognizance of SLSB’s modest scale of operations (total assets at about LKR 9.5 Bn) and limited franchise. Further the rating takes note of currently inadequate internal controls, processes and systems to effectively manage the risky market segments serviced by the Bank; namely microfinance, micro and small-scale enterprises, and retail credit. This is evident from the Bank’s weak asset quality indicators with gross NPA ratio of about 21.5% in the active portfolio (i.e. excluding the legacy PSDB[1] portfolio) as of Jun-19. SLSB’s profitability is expected to be supported by its investment income (about 68% of total interest income in H1CY2019) and its low leverage levels.

Outlook: Rating watch with developing implications

The outlook may be revised to “Positive” depending on the successful acquisition by NSB and improvement in the Bank’s overall risk management and internal controls. The outlook may be revised to “Negative” in case of lack of timely capital support from GoSL or a significant deterioration in the earnings, capital or asset quality profile of the Bank.

Credit strengths

100% government ownership; SLSB is a 100% GoSL owned LSB, with focus on microfinance, micro SME and retail credit. The Bank has received financial and managerial support from GoSL in the past and, ICRA Lanka envisages timely support in the future also. GoSL has demonstrated support and assistance through LKR 500 Mn initial capital infusion in 2006, merger of National Development Trust Fund (NDTF) to address capital shortage in 2010, and LKR 362 Mn capital infusion in 2017 to meet the minimum core capital requirement of LKR 5 Bn. Further, GoSL proposed acquisition of SLSB by NSB, is expected to be completed in the near term. In case, the acquisition programme delays or does not materialise as expected, we expect the GoSL to provide capital support to meet the regulatory capital requirement.  

Credit challenges

Modest scale of operations and limited franchise; SLSB is a modest sized LSB with a total asset base and a gross lending portfolio of LKR 9.5 Bn and LKR 2.5 Bn, respectively, as of Jun-19. The Bank has only 4 branches, including head office. The asset base is characterised by investments accounting for 67% as of Jun-19 (65% as of Dec-18 and 63% as of Dec-17). Historically, SLSB has maintained a high proportion of investments in order to facilitate repayment of the deposit holders of failed Pramuka Savings and Development Bank (PSDB). Since vesting of PSDB’s liabilities, SLSB has paid out about LKR 2.8 Bn (including interest on PSDB debentures) and there is a remaining unclaimed balance of about LKR 650 Mn (including interest) as of Jun-19. Since December 2017, the Bank has refrained from taking any significant business decisions pending acquisition by NSB and continued to maintain its high exposure to investments. The lending portfolio consists of exposures to microfinance bulk lending, micro SME loans, consumer loans, and leasing and hire purchase which accounted for 31%, 16%, 14% and 12%, respectively, as of Jun-19. The legacy portfolio inherited from PSDB accounted for 27% of the total lending portfolio.

Weak internal controls, processes and systems; ICRA Lanka notes there is substantial scope to improve SLSB’s internal controls, processes and systems to adequately manage the underlying risks of dealing with the key target lending segments; microfinance, consumer loans and leasing. Further, SLSB has significant limitations with the adequacy of competent human resources to carry out its operations. ICRA Lanka, however, expects this to be addressed post acquisition by NSB, and this would remain a key monitorable from a rating perspective.

Exposure to riskier asset classes resulted in weak asset quality; ICRA Lanka notes that SLSB’s portfolio is exposed to vulnerable customer segments through microfinance bulk loans to microfinance institutions, consumer loans and micro-scale enterprise lending, which accounted for about 84% of the active portfolio (excluding PSDB portfolio), and stood at LKR 2.3 Bn as of Jun-19. Further, SLSB has considerable loan concentration in bulk microfinance segment with top 10 microfinance borrowers representing about 22% of the total active loan portfolio. The Bank reported a high gross NPA ratio of 42.5% as of Jun-19 (36.7% as of Dec-18 and 33.0% as of Dec-17). The asset quality is also affected by the legacy portfolio taken over from PSDB (about LKR 1.0 Bn as of Jun-19), which is almost entirely non-performing and is fully provided. The gross NPA ratio of the active portfolio increased to 21.5% as of Jun-19 vis-a-vis 14.7% as of Dec-18 (11.2% as of Dec-17), largely because of increased slippages in the microfinance bulk lending product. The GNPA ratio of microfinance bulk lending increased sharply to 24.4% from 16.5% (9.5% as of Dec-17) during the period because of challenges faced by the country’s microfinance industry. In addition, the trade union action in Q1CY2019 also negatively affected the collections and recovery function of the Bank. The micro enterprise segment recorded the highest GNPA ratio of 30.6% as of Jun-19 (26.5% as of Dec-18 and 28.6% as of Dec-17) largely because of weak loan assessment process followed at the branch level. The gross NPA of leasing and HP, and consumer loans categories were relatively low at 13.6% and 11.3% respectively as of Jun-19 (4.8% and 7.6% respectively as of Dec-18), which also is higher than peers.

Profitability is expected to be supported largely by investment income until the acquisition program concludes; SLSB’s healthy level of NIM and RoA (about 10.1% and 4.7% respectively in H1CY2019) was supported by the modest cost of borrowings and low leverage (gearing at 0.49 times as of Jun-19). The Bank’s cost of borrowing has been below 4% (3.42% in H1CY2019) since CY2016. The Bank’s gearing has moderated to 0.49 times as of Jun-19 vis a vis 0.97 times as of Dec-16, largely because of repayment of PSDB debentures (about LKR 1.5 Bn) during the period. Further, SLSB received an equity infusion by the GoSL of LKR 362 Mn in Dec-17.  SLSB’s investments accounted for about 67% of total assets base and 68%of the interest income in H1CY2019. Pending the acquisition by NSB, ICRA Lanka expects the Bank’s borrowings to remain modest and investment income to mainly support the profitability of the Bank.

Sizable capital required for meeting minimum regulatory core capital; SLSB’s minimum core capital stood adequate at about LKR 5.7 Bn as of Jun-19, above the regulatory requirement of LKR 5.0 Bn for LSBs effective since January 2016. The Bank is required to increase the same to LKR 7.5 Bn by December 2020 and ICRA Lanka estimates that the Bank would require about LKR 1.7-1.9 Bn in fresh capital to achieve this. The acquisition by NSB is expected to provide timely capital support to SLSB in meeting this upcoming requirement. SLSB’s Tier I CAR and total CAR were at 93.8% each as of Jun-19 (89.9% each as of Dec-18) vis a vis regulatory threshold of 8.50% and 12.50%. The CAR ratios were mainly supported by the moderate risk weighted assets as about 67% of the asset base comprised of investments.

Analytical approach: For arriving at the ratings, ICRA has applied its rating methodologies as indicated below.

Links to applicable criteria:  ICRA Lanka’s Credit Rating Methodology for Banks

About the Bank:

The Sri Lanka Savings Bank was established in July 2006 as a state owned licensed specialized bank, with the primary objective of taking over the assets and liabilities of Pramukha Savings and Development Bank (PSDB). In 2010, with state intervention, National Development Trust Fund (NDTF) was merged with SLSB to meet the capital deficiency of the Bank. Until 2011, SLSB was only authorised to recover the PSDB portfolio and pay-off its deposit holders. Subsequently, in 2011, the articles of the Bank were amended to enable SLSB to commence its own lending operations.

In CY2018, SLSB reported a profit after tax (PAT) of LKR 351 Mn on a total asset base of LKR 9.2 Bn as of Dec-18 compared to PAT of LKR 604 Mn on a total asset base of LKR 9.5 Bn as of Dec-17. For the 6-months ended Jun-19, the Bank reported a PAT of LKR 143 Mn (un-audited) on a total asset base of LKR 9.5 Bn.

Key financial indicators (audited)

Rating history for last three years:

ANALYST CONTACTS

Mr. Vidura Welathanthri

+94 11 4339907

vidura@icralanka.com

Mr. Dasith Fernando

+94 11 4339907

dasith@icralanka.com

Mr. Niraj Jalan

+91 33 71501146

niraj.jalan@icraindia.com

RELATIONSHIP CONTACT

Mr. W. Don Barnabas  

+94 11 4339907

wdbarnabas@icralanka.com


[1] Pramukha Savings and Development Bank


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