ICRA Lanka revises the issuer rating of State Mortgage and Investment Bank
|Instrument*||Rated Amount (LKR Mn)||Rating Action|
|Issuer rating||N/A||Revised to [SL]BBB+ (Stable) from [SL]A- (Negative)|
ICRA Lanka Limited, subsidiary of ICRA Limited, a group company of Moody’s Investors Service, has revised the issuer rating of State Mortgage & Investment Bank (SMIB or the Bank) to [SL]BBB+ (pronounced S L Triple B plus) from [SL]A- (pronounced S L A minus). The outlook is revised to Stable from Negative.
The rating revision factors in SMIB’s continued weakness in asset quality profile and moderate profitability indicators. The gross NPA ratio, excluding Employees’ Provident Fund (EPF) backed loans, has increased to 7.7% as of Jun-19 from 6.7% as of Jun-18 (7.3% as of Dec-18). The delinquencies excluding EPF backed loans in the 30+ day past due (dpd) was at about 30% as of Jun-19 (28% as of Dec-18 and 26% as of Dec-17). With the high exposure to the unsecured loans (about 48% of total loans as of Jun-19), the Bank is faced with higher credit risk, considering its modest internal controls, loan origination and monitoring systems. SMIB’s profitability remained moderate at 0.6% each in H1CY2019 and CY2018 below the banking industry average of 0.9% and 1.1% respectively on account of decline in lending spreads and high cost structure. ICRA Lanka notes that while the Bank’s Tier I and Total capital adequacy ratios (CAR) are adequate at 21.2% and 21.8% respectively as of Jun-19, its minimum core capital of about LKR 5.3 Bn as of Jun-19 needs to be enhanced to LKR 7.5 Bn by Dec-20 to meet the minimum core capital requirement applicable for Licensed Specialised Banks (LSBs). ICRA Lanka estimates that the Bank would need about LKR 1.9-2.0 Bn capital infusion to meet the regulatory requirement as the internal generation is likely to remain modest. ICRA Lanka envisages timely capital support from the Government of Sri Lanka (GoSL) to meet this requirement. Further, ICRA Lanka notes SMIB’s stretched liquidity profile with liquidity coverage ratio (LCR) breached in Mar-19 and Apr-19 (about 95% and 91% respectively against the threshold of 100%) and concentrated funding profile.
The rating, however, continues to factor in the 100% GoSL ownership in SMIB, which provides a strong likelihood of sovereign support to the Bank, when needed.
The Stable outlook reflects SMIB’s 100% state ownership with high likelihood of government support. The outlook may be revised to “Positive” in case of a steady improvement in its asset quality and profitability indicators while improving internal controls to make it commensurate with the portfolio’s risk profile. The outlook may be revised to “Negative” in case of a further weakening in asset quality, overall financial risk profile or in case of lower than expected support from the GoSL specially in meeting the minimum capital requirement on a timely basis.
Key rating drivers
100% government ownership; SMIB is a 100% GoSL owned LSB, and the Bank has received financial and managerial support from GoSL in the past. The GoSL has appointed three government administrative officers to SMIB’s Board representing the Ministry of Finance, Housing and Agriculture. GoSL also infused capital of LKR 250 Mn in 2016 by converting a loan granted by it in the past. ICRA Lanka therefore expects timely support from the GoSL, especially in meeting SMIB’s core capital requirement of LKR 7.5 Bn by December 2020.
Moderate scale of operations; share of unsecured loans to further increase; SMIB is a moderate sized LSB with a total asset base of LKR 45.6 Bn and branch network of 24 as of Jun-19. The Bank offers personal loans, mortgage loans and EPF backed loans which accounted for 45%, 30% and 22% respectively of its LKR 35.3 Bn portfolio as of Jun-19. ICRA Lanka takes note of the increase in the share of unsecured loans in the overall portfolio, as the share of personal loans has increased to 45% as of Jun-19 from 26% as of Dec-16. As the Bank expands its personal loan book further and diversifies to newer products namely SME loans and microcredit, the share of unsecured loans is expected to increase further going forward. However, the granular portfolio and low credit concentration, with top 10 loans accounting for about 1% of the total portfolio as of Jun-19, extends some comfort. SMIB’s ability to keep credit quality under control in view of the increased share of unsecured loans would be a key monitorable.
Scope to improve overall risk management systems; ICRA Lanka notes that given SMIB’s limited internal controls and monitoring systems; there is scope to improve the same to make it commensurate with the increased business risk. The Bank’s business risk profile has changed over the period as the portfolio exposure has shifted from secured EPF loans (22% as of Jun-19 vis a vis 36% as of Dec-16) and mortgage loans (30% as of Jun-19 vis a vis 35% as of Dec-16) to personal loans (45% as of Jun-19 vis a vis 26% as of Dec-16), which warrants prudent loan origination and enhanced monitoring. Further, ICRA Lanka takes into cognisance that the Bank’s financial accounts were continuously qualified over the period because of the unreconciled balances carried forward since 2015. The Bank’s ability to clear these audit concerns in CY2019 as envisaged would be closely monitored.
Weak asset quality indicators; The Bank’s gross NPA ratio stood at 20.7% as of Jun-19 (20.7% as of Jun-18 and 21.8% as of Dec-18). EPF loans contribute significantly for the overall high NPA’s, as most borrowers expect the Bank to recover loan liabilities out of EPF balances. Historically, SMIB recorded lower NPAs during the second quarter of the year as the claims for previous year’s over dues on EPF backed loans are paid during this period by the EPF division of CBSL. As of Jun-19, gross NPA ratio of EPF loans remained elevated at 68.3% from 64.7% as of Jun-18 (68.6% as of Dec-18). Despite a YoY growth of 10% in gross advances (excluding EPF loans) as of Jun-19, the gross NPA ratio of the same increased to 7.7% as of Jun-19 from 6.7% as of Jun-18 (7.3% as of Dec-18). The delinquencies (excluding EPF loans) also remained high with 30+ days past due (dpd) at about 30% as of Jun-19 (28% as of Dec-18 and 31% as of Jun-18). The increase in gross NPAs in personal loan segment (GNPA% at 6.5% as of Jun-19 vis a vis 6.1% as of Dec-18 and 5.0% as of Jun-18) during the period largely contributed to weaker asset quality in non-EPF loan book. In the mortgage loan category, the GNPA ratio stood high at 8.3% as of Jun-19, however marginally improved from 8.7% as of Jun-18 (8.3% as of Dec-18) because of some recoveries and incremental slippages decreased.
SMIB’s overall net NPA ratio remained elevated at about 19% as of Jun-19 (20% as of Dec-18 and 19% as of Jun-18). The net NPA ratio, excluding EPF loans, also stood high at 5.6% as of Jun-19 (5.4% as of Dec-18 and 5.0% as of Jun-18). The elevated net NPA position mainly resulted in SMIB’s weak solvency position (net NPA/Net worth) at about 135% as of Jun-19 (132% as of Dec-18 and 124% as of Jun-18). Further, the solvency ratio, excluding EPF book, deteriorated to about 34% as of Jun-19 vis a vis 24% as of Jun-18 (27% as of Dec-18). Going forward, as the non-EPF loan portfolio seasons and as the share of unsecured loans increases, SMIB’s ability to keep its asset quality under control would be crucial.
Sizeable capital required for meeting minimum regulatory core capital; SMIB has adequate capital adequacy ratios since its exposures to EPF loans and mortgage loans (22% and 30% as of Jun-19) have lower risk weights of 0% and 50% respectively. The Bank’s Tier I and Total CAR stood at 21.2% and 21.8% respectively as of Jun-19, comfortably above the regulatory threshold of 8.5% and 12.5%. SMIB’s core capital was at about LKR 5.3 Bn which was above the minimum requirement of LKR 5 Bn (effective from Jan-16 and SMIB obtained an extension till Jan-18 to comply with). In October 2017, CBSL has issued another direction, further increasing the minimum capital of LSBs to LKR 7.5 Bn by Dec-20. Based on ICRA Lanka’s estimates, the Bank would require capital support of about LKR 1.9-2.0 Bn, assuming 10-15% growth in the risk weighted assets (RWAs), to meet the LKR 7.5 Bn core capital by Dec-20, as its internal generation is expected to remain moderate. However, timely capital support from the GoSL is envisaged to meet the above minimum regulatory requirement.
Stretched liquidity profile; SMIB’s asset liability management (ALM) profile is characterized by significant negative cumulative mismatches in the less than 1-year bucket (39% of total assets as of Jun-19), as majority of its borrowings are short-term compared to long-term nature of its lending portfolio. ICRA Lanka notes the healthy deposit renewal rate of about 85-90% and availability of contingent funding lines. SMIB’s liquid asset ratio stood at about 28.6% as of Jun-19 comfortably above the threshold of 20%. While the liquidity coverage ratio (LCR) was at 108% as of Jun-19, above the regulatory threshold of 100% effective since Jan-19, the same was below the requirement in Mar-19 and Apr-19 (at 95% and 91% respectively). Further, the Bank violated the LCR in Dec-18 (84% vs. threshold of 90%) and Jan-19 (93% vs. threshold of 100%). It would be crucial for the Bank to adhere to regulatory thresholds and improve its liquidity profile to offset refinance and interest rate risks.
Moderate profitability indicators; SMIB’s RoA remained moderate during H1CY2019 and CY2018 at about 0.6% each below the LSBs industry average level of 0.9% and 1.1% respectively. The Bank’s net interest margins (NIMs) marginally improved to about 4.7% in H1CY2019 vis a vis 4.4% in H1CY2018 (4.6% in CY2018) because of the increase in interest spread (3.6% in H1CY2019 vis a vis 3.2% in H1CY2018 and 3.5% in CY2018). The credit cost increased to about 0.4% in H1CY2019 from 0.3% in H1CY2018 (0.4% in CY2018), largely on account of increased slippages of non-EPF book and transition into IFRS9 accounting standard. Operating expenses (as a proportion of total assets) increased to 3.5% in H1CY2019 against 3.0% in H1CY2018 (3.4% in CY2018) and cost to income ratio increased to about 70% against 65% (68% in CY2018). This is mainly on account of the increase in staff related costs. Going forward, it is crucial for SMIB to further improve its operating efficiencies and keep borrowings and credit costs under control.
Concentrated funding profile; SMIB’s total borrowings stood at LKR 39.0 Bn and 95% of it was deposits (88% FDs, 4% savings and 3% special scheme deposits) as of Jun-19, while borrowings from banks (4%) and refinance loans (1%) accounted for the rest. However, the top 10 deposits concentration has come down to about 9% of total deposits as of Jun-19 vis a vis about 36% as of Jun-18 because of the decrease in bulk deposits. SMIB’s savings deposits as a proportion of total deposits stood low at about 4% as of Jun-19 against LSBs average of about 32%, largely because of the unavailability of debit cards.
Analytical approach: For arriving at the rating, ICRA Lanka has applied its rating methodologies as indicated below.
Links to applicable criteria: ICRA Lanka’s Credit Rating Methodology for Banks
About the company:
The State Mortgage & Investment Bank is a 100% GoSL owned, Licensed Specialized Bank operating with 24 branches. SMIB is one of the five entities in Sri Lanka to offer EPF backed loans. Apart from the above, the Bank also offers mortgage backed housing loans, personal loans and leasing facilities to its customers. It commenced operations as the Ceylon State Mortgage Bank (CSMB) in December 1931. SMIB was formed by the State Mortgage & Investment Bank Act No. 13 of 1975, amalgamating CSMB and the Agricultural and Industrial Credit Corporation and commenced its operations from January 1979. In April 1998, the Bank was granted the license to operate as a licensed specialized bank by the CBSL.
In CY2018, SMIB reported a profit after tax (PAT) of LKR 245 Mn (LKR 179 Mn in CY2017) on a total asset base of LKR 42.6 Bn (LKR 42.0 Bn as of Dec-17) as of Dec-18. For the six months ended Jun-19, the Bank reported a PAT of LKR 138 Mn (un-audited) on a total asset base of LKR 45.6 Bn.
Key financial indicators (audited)
Rating history for last three years:
Mr. Vidura Welathanthri
+94 11 4339907
Mr. Niraj Jalan
+91 33 71501146
Mr. W. Don Barnabas
+94 11 4339907
 All the asset quality numbers are based on principal outstanding
 Provisioning and write off as a proportion of total assets
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