Capital Alliance Limited

ICRA Lanka reaffirms the issuer rating at [SL]A- for Capital Alliance Limited; outlook revised to Stable

Instrument* Previous Rated Amount
(LKR Mn)
Current Rated Amount
(LKR Mn)
Rating Action
Issuer rating N/A N/A [SL]A-reaffirmed; outlook revised to Stable from Negative

Rating action

ICRA Lanka Limited, subsidiary of ICRA Limited, a group company of Moody’s Investors Service, has reaffirmed the issuer rating of [SL]A- (pronounced SL A minus) for Capital Alliance Limited (CAL or “the Company”). The outlook on the rating has been revised to Stable from Negative.

Rationale

The revision in outlook factors in the healthy performance of CAL, with company earning a net profit of LKR 795 Mn in 9M FY2020, in comparison to LKR 37 Mn in FY2019 (LKR 573 Mn in FY2018). The improvement in profitability supported its capital profile with company’s net worth increasing to LKR 2.2 Bn in December 2019, above the regulatory threshold of LKR 1.0 Bn. The higher net worth is expected to provide a buffer/cushion against adverse interest rate movements. The Tier 1 capital adequacy ratio (CAR) was healthy at 15.57% in December 2019, reduced from 17.81% in March 2019 (22.45% in June 2018), due to an increase in portfolio duration (to 4.17 years from 3.59 years) and portfolio growth during the period. The rating takes into account the company’s expectation of maintaining a capital buffer in the range of LKR 0.5-1.0 Bn above the regulatory threshold, going forward, which is expected to keep the company’s capitalization profile comfortable. The rating continues to factor in CAL’s position as one of the leading standalone primary dealers in Sri Lanka with an established track record. The rating also considers CAL’s modest portfolio risk, its good internal control and robust IT systems, and synergies emerging from group entities which offer other financial services such as equity brokering, asset management and financial advisory. The rating takes cognizance of the significant short-term asset liability mismatches, as the long-term investment positions are funded by short-term repo borrowings; liquid nature of the portfolio, access to Central Bank of Sri Lanka (CBSL) funding and availability of credit lines however provide comfort.

Outlook: Stable

The revision in the outlook factors in the improvement in CAL’s earnings and capital profile in the nine months ended December 2019, and its track record as one of the leading primary dealers in Sri Lanka. The outlook may be revised to “Positive” based on further improvement in CAL’s capital profile and its ability to operate profitably across cycles, whilst maintaining comfortable liquidity. The outlook may be revised to “Negative” in case of significant weakening in the earnings, liquidity and capitalization profile or in case its portfolio shifts away from government securities.

Key rating drivers

Credit strengths

Position as one of the leading stand-alone primary dealers (PD) in Sri Lanka: CAL is one of the leading standalone primary dealers in Sri Lanka with a total asset base of LKR 14.1 Bn as in December 2019 (LKR 10.5 Bn in December 2018). ICRA Lanka notes that CAL has an experienced management team headed by the group MD (founder) and department head, who each have 30 plus years of experience in the PD industry. Further, trading operations are supported by an in- house research team as well as robust IT and risk management systems. The presence of group entities offering various related financial services such as equity trading, asset management and investment banking bring in synergistic benefits.

Modest credit risk profile: CAL’s portfolio comprises solely of government securities (treasury bills, bonds and reverse repos on treasury securities) and therefore carries no significant credit risk. However, the portfolio is susceptible to market risk stemming from adverse interest rate movements.

Improvement in capital profile mainly supported by strong internal accruals: Due to strong internal generation with a return on equity of 48.65% (9M FY2020), compared to 2.64% in FY2019, the net worth of the company grew to LKR 2,178 Mn in December 2019, compared with LKR 1,419 Mn in March 2019 (LKR 1,384 Mn in March 2018). The trading losses of the company in FY2019 as well as the sizable share buy- back of LKR 373 Mn in FY2018 had moderated the net worth to about LKR 1,159 Mn in December 2018. However, the robust net profits of the company amounting to LKR 795 Mn in the 9M FY2020 (LKR 37 Mn in FY2019 and LKR 574 Mn in FY2018), due to the favourable interest rate environment which prevailed, had enabled it to improve its capital profile. The risk weighted capital adequacy ratio stood at 15.57% in December 2019 (above the regulatory limit of 10.0%) compared with 17.81% in March 2019; gearing stood at about 5.3 times in December 2019, compared with 6.8 times in March 2019 (6.7 times in March 2018).

The company currently has a comfortable capital buffer of about LKR 1,178 Mn above the regulatory minimum capital requirement (LKR 1,000 Mn).  The company expects to retain a healthy capital buffer in the range of LKR 500 Mn – 1.0 Bn going forward, which is expected to provide a cushion/buffer against adverse market movements.

Credit challenges

Vulnerability to adverse interest rate movements: CAL’s portfolio in December 2019 stood at LKR 14.0 Bn, in comparison to LKR 11.0 Bn in March 2019. Company has been intermittently growing and de- growing its portfolio in recent months in order to book capital gains generated by a falling interest rate environment. CAL reported a trading gain of LKR 728 Mn in 9M FY2020 compared to the trading loss of LKR 82 Mn in FY2019. The portfolio duration has been relatively high in 9M FY2020 in order to benefit from the higher volatility in the rates; weighted average portfolio duration stood around 4.17 years in December 2019 vis-à-vis 3.59 years in March 2019 and 1.26 years in March 2018. As the key strategy of CAL is to generate trading gains through churning its portfolio positions, it remains vulnerable to any future adverse interest rate movements which could impact its earnings and capital profile.

Exposure to liquidity risk due to short-term asset liability maturity (ALM) mismatch: CAL’s longer duration portfolio funded by shorter duration repo borrowings creates a sizeable short –term mismatch in the ALM profile. As in December 2019, the cumulative ALM mismatch stood at negative 28.3% in the less than 7-day bucket and negative 74.0% in the less than one year bucket, exposing the portfolio to short term liquidity risk. However, the highly liquid nature of the portfolio, availability of bank funding lines (as in December 2019, CAL had unutilized credit lines totaling LKR 1.3 Bn) and access to CBSL funding, provide comfort from a liquidity perspective.

Analytical approach: For arriving at the ratings, ICRA Lanka has applied its rating methodologies as indicated below. Links to applicable criteria:  ICRA Lanka Rating Methodology for Primary Dealers  

About the Company:

CAL is a licensed primary dealer in government securities in Sri Lanka. The Company is 90.8% held by Capital Alliance Holdings Limited, which is the holding company of the group, offering various financial and investment solutions including fixed income trading, stock broking, asset management and financial advisory. For the year ended March 31, 2019, CAL reported a net profit of LKR 37 Mn on a total asset base of LKR 11.1 Bn vis-à-vis a net profit of LKR 573 Mn on a total asset base of LKR 10.8 Bn in March 31, 2018. During the 9 months ended December 31, 2019, the Company reported a net profit of LKR 795 Mn on a total asset base of LKR 14.1 Bn vis-à-vis a net loss of LKR 210 Mn on a total asset base of LKR 10.5 Bn in the same period of the previous fiscal.

Key financial indicators (Audited)

FY2018 FY2019 9M FY2019* 9M FY2020*
Net Interest Income 261 222 164 254
Net Trading Profit 575 (31) (253) 815
Net Operating Income 843 202 (88) 1,080
Profit after Tax 573 37 (210) 795
Net worth 1,384 1,419 1,159 2,178
Trading Portfolio 10,225 10,575 10,505 13,966
Total Assets 10,780 11,133 10,455 14,083
Return on Equity 41.45% 2.64% -24.17% 48.65%
Return on Average Assets 6.27% 0.34% -2.64% 8.42%
Capital Adequacy Ratio 43.71% 17.81% 13.82% 15.57%
Gearing (times) 6.75 6.80 7.99 5.27
Stock in Trade/ Net worth (times) 7.39 7.45 9.06 6.41

*Unaudited

ANALYST CONTACTS

Ms. Apsara Thurairetnam +94 11 4339907 apsara@icralanka.com   Mr. Niraj Jalan +91 33 71501146 niraj.jalan@icraindia.com

RELATIONSHIP CONTACT

Mr. W. Don Barnabas

+94 11 4339907 wdbarnabas

@icralanka.com


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