ICRA Lanka revises the ratings of Merchant Bank of Sri Lanka & Finance PLC
ICRA Lanka Limited has revised the issuer rating of Merchant Bank of Sri Lanka & Finance PLC (MBSL or the Company) to [SL]BBB+ (Pronounced SL triple B plus) from [SL]A- (Pronounced SL A minus). ICRA Lanka has also revised the rating of the LKR 2,000 Mn Subordinated Unsecured Redeemable Debenture to [SL]BBB (Pronounced SL triple B) from [SL]BBB+ (Pronounced SL triple B plus). The outlook on the ratings are Negative.
ICRA Lanka has also revised the rating to [SL] A-(SO) (Pronounced SL A minus SO) with Negative outlook from [SL] A(SO) (Pronounced SL A SO) with Negative outlook on the Trust certificates of MBSL Trust-01 and has withdrawn the rating at the request of the Company, as the same has been fully redeemed.
The rating revisions factor in the continued weakening in the capital profile, poor profitability and weak asset quality profile of MBSL. Further, ICRA Lanka factors the non-availability of timely capital support since 2018 from the parent, Bank of Ceylon (rated [SL]AAA (Negative) by ICRA Lanka, “BOC”/”Parent”) with 81.59% stake. ICRA Lanka notes that MBSL’s capital profile continued to remain below minimum regulatory requirement with core capital and total capital adequacy ratios standing at 5.64% and 8.57% as in Mar-20, as compared to the regulatory requirement of 6.50% and 10.50%. This has resulted in lending and deposit caps of LKR 35 Bn and LKR 23 Bn, respectively, being imposed by Central Bank of Sri Lanka (“CBSL”/”Regulator”) from Apr-19 and May-19. However, the Company has complied with the regulatory minimum core capital requirement as the same stood at LKR 2,453 Mn in Mar-20 as compared to the regulatory requirement of LKR 1,500 Mn. Capital profile remained weak driven by poor profitability metrics as the Company reported operating losses (before deducting credit cost) of LKR 6 Mn in CY2019 and LKR 159 Mn in Q1CY2020, as the Cost to Income ratio continued to increase from 80.62% in CY2018 to 100.63% in CY2019 and 140.14% in Q1CY2020. ICRA Lanka notes that MBSL’s capital structure is already stretched with gearing at 13.2 times as in Mar-20. ICRA Lanka also notes MBSL’s weak asset quality profile (Gross NPA 18.50% in Jun-20 compared to 16.75% in Mar-20) has adversely impacted its solvency (Net NPA/Networth) further, which currently stands subdued at 105.55% in Mar-20.
As per ICRA Lanka’s estimates, MBSL will require a minimum capital infusion of LKR 500 Mn (~32% of its market capitalisation) immediately and LKR 1.5 Bn (~100% of its market capitalisation), during CY2021-22 to report a minimum Tier I capital ratio of 9.50%, including a cushion of 100 bps. The ratings also factor in the continued weakness in MBSL Insurance Company Limited’s (MBSLI) performance post the LKR 1.2 Bn capital infusion in Apr-19. ICRA Lanka notes that MBSLI would require additional capital to meet any contingent liabilities and to improve its overall risk profile going forward, as MSBL is expected to retain MBSLI as its subsidiary. ICRA Lanka takes into consideration the commitment from BOC via a comfort letter, to provide financial support to ensure that the company will continue as a going concern. ICRA Lanka will continue to monitor MBSL’s capital raising plan from BOC to raise a Tier I complied perpetual debenture of LKR 1,000 Mn (with the option to increase up to LKR 2,000 Mn) and timely capital support from BOC will remain a key rating sensitivity.
The Negative outlook reflects the continued moderation in MBSL’s financial risk profile characterized by weakening in its capital, asset quality and earnings profiles. The outlook may be revised to ‘Stable’ in case of steady improvement in MBSL’s capital profile, asset quality and earnings profile. The ratings may be further downgraded if timely capital support does not materialise and the Company fails to meet the minimum regulatory capital requirements by Dec-20.
Key rating drivers
Being a subsidiary of BoC; MBSL is 81.59% owned subsidiary of Bank of Ceylon (“BoC”, rated [SL]AAA (Negative) by ICRA Lanka). MBSL’s board consists of six directors, out of which three directors are from BOC. The Company derives strategic and financial support from its parent company. As the parent company, BoC has continued to provide financial support by providing term loan facilities and contingent funding lines. However, timely capital support has not been provided since 2018 to meet the regulatory requirements of the Company. The Company was incorporated in 1982 as a specialised bank, operated as the leasing and merchant banking arm of BoC. Subsequently, it became a Non-Banking Financial Institution offering leasing, term loans, personal loans, microfinance, and gold loan facilities to its customers. The Company has its own corporate advisory division which provides transaction advisory services to its clients. The Company has a network of 49 branches around the country and over 900 employees as in Mar-20.
Capital ratios below regulatory levels, timely capital support and infusion remains a concern; MBSL reported weak Tier-1 core capital ratio and total capital adequacy ratio (CAR) of 5.64% and 8.57%, respectively as in Mar-20 and remained below the regulatory requirement of 6.50% and 10.50%. Due to weak internal capital generation and IFRS 9 adjustment, the Company is unable to meet the regulatory capital requirements since Dec-18 and as a result CBSL had imposed LKR 35 Bn cap on lending and LKR 23 Bn cap on deposits in Apr-19 and May-19, respectively. However, the Company has complied with the regulatory minimum core capital requirement as the same stood at LKR 2,453 Mn in Mar-20 as compared to the regulatory requirement of LKR 1,500 Mn. The gearing continues to increase and was high at 13.2 times as in Mar-20 as compared to 12.6 times in Dec-19 (12.7 times in Dec-18). ICRA Lanka expects the gearing to remain elevated, due to poor earnings performance reported in the latest quarter. As per ICRA Lanka’s estimates, the Company would immediately require a minimum of LKR 500 Mn external capital and it will require a minimum of LKR 1.5 Bn fresh equity for the next three years to meet the regulatory capital adequacy requirements with a comfortable buffer of 1%. The Company is planning to issue a Tier 1 complied, LKR 1,000 Mn (option to increase up to LKR 2,000 Mn) perpetual debentures on or before December 31, 2020, to meet the immediate capital requirement. If the Company fails to meet the regulatory capital requirement by Dec-20, it could lead to further rating downgrade.
Asset quality pain to continue in CY2020, given high share of loan book under moratorium; MBSL reported a loan portfolio of LKR 30.9 Bn as in Mar-20 as compared to LKR 32.1 Bn reported in Dec-19 (LKR 33.3 Bn in Dec-18). The portfolio comprises of 46% leasing, 41% loans, 11% gold loans and the balance micro finance and hire purchase during the same period. ICRA Lanka notes that around 30-35% of the portfolio is under moratorium as in Jun-20 and is likely to face asset quality stress in the coming quarters. MBSL’s asset quality continued to deteriorate as the Gross NPA ratio increased to 14.53% in Dec-19 from 11.24% in Dec-18, it further increased to 16.75% as in Mar-20. The GNPA ratio was higher than the Licensed Finance Company (LFC) sector average of 11.56% in Mar-20. The portfolio quality deteriorated due to poor performance reported in term loans, personal loans, leasing and bill & cheque financing. The Company has taken action to strengthen the collateralised portfolio while discontinuing micro finance and unsecured short-term business loan facilities and curtailing the personal loan segment. Provision coverage ratio of the Company marginally declined to 50.77% in Mar-20 as compared to 51.13% in Dec-19 and remained below the system average of 54.82% in Mar-20%. As a result, the solvency profile deteriorated with Net NPA/ Networth at 105.6% in Mar-20 as compared to 84.92% in Dec-19 (78.17% in Dec-18). ICRA Lanka notes the actions taken by the Company to control the NPAs and further deterioration in asset quality will have a negative impact on the earnings and capital adequacy of the Company. MBSL’s ability to control the new slippages which may arise after the end of the moratorium period and to make recoveries from the legacy NPA portfolio would be a key rating sensitivity.
Weak earnings profile; The Company’s operational viability is hindered by the higher operating expenses as it reported a cost to income ratio of 140% in Q1CY2020 as compared to 101% in CY2019 and 81% in CY2018. As a result, the Company reported a loss of LKR 149 Mn at operating level in Q1CY2020 as compared to a loss of LKR 6 Mn in CY2019 and a profit of LKR 523 Mn in CY2018. The credit cost to average total assets ratio marginally increased to 0.24% in CY2019 as compared to 0.21% in CY2018 (0.88% in CY2017) and it stood at 0.11% in Q1CY2020. Presently, the Company’s credit cost remained low due to reversal of over provisioning made under collective provisioning in CY2018 and CY2019. The Company reported a net loss of LKR 159 Mn in Q1CY2020 as compared to Profit After Tax (PAT) of LKR 173 Mn in CY2019 vis-à-vis LKR 181 Mn in the previous year. Profitability for CY2019 was mainly due to the reversal of LKR 314 Mn provisions made for its insurance subsidiary MBSLI. The loss in the latest quarter was mainly due to drop in Net Interest Margin (NIM) from 5.96% in CY2019 to 4.90% in Q1CY2020, rise in operating expenses and the loss of LKR 81 Mn reported on financial instruments due to fair value adjustment. Going forward, ability to rationalise the operating expenses and control credit costs would be critical for the improvement in the profitability indicators.
Moderate liquidity; The Company reported a short term (less than 1 year) negative cumulative mismatch of 6.40% in Mar-20 as compared to 9.74% in Mar-19. However, the Company has close to LKR 2.9 Bn contingent funding lines available from the commercial banks as in Jul-20 (close to LKR 1,000 Mn from BOC). Further, the Company’s liquidity profile is supported by its 80% deposit renewal rate.
Analytical approach: For arriving at the ratings, ICRA Lanka has applied its rating methodologies as indicated below. The ratings also factor in the capital support from BOC, which uplifted the credit risk profile of MBSL. Links to applicable criteria: ICRA Lanka’s Credit Rating Methodology for Non-Banking Financial Institutions
About the Company:
MBSL was established in 1982 as a merchant bank. The Company had two subsidiaries, MBSL Savings Bank Ltd (MSB, Licensed Specialised Bank) and MBSL Insurance Company (Composite Insurer) and two associate companies, Lanka Securities (Pvt) Ltd (registered stockbroker) and MCSL Financial Services Ltd (a licensed finance company). Pursuant to the Master Plan on Consolidation of the Financial Sector proposed by the Central Bank of Sri Lanka (CBSL), in January 2015, MBSL Savings Bank Limited (MSB) and MCSL Financial Services Limited (MCSL) were merged with MBSL. MBSL offers leasing & HP, long and short-term loans, microfinance and gold loans to its clients. The Company has 49 branches and employs more than 900 staff members as in Mar-20. MBSL Insurance Company Limited (MBSI) is 54% owned subsidiary of MBSL. The Company offers life and general insurance products to its customers. MBSI has close to 50 branches and window offices covering Sri Lanka.
For the CY2019, MBSL reported a PAT of LKR 173 Mn (CY2018: LKR 181 Mn) with a total asset base of LKR 36,975 Mn as at December 31, 2019 (LKR 35,864 Mn as at December 31, 2018). For the Q1CY2020, MBSL reported a loss of LKR 159 Mn with a total asset base of LKR 35,921 Mn.
MBSL group reported a loss of LKR 192 Mn for the CY2019 (CY2018: PAT of LKR 472 Mn) with a total asset base of LKR 39,235 Mn as at December 31, 2019 (LKR 37,314 Mn as at December 31, 2018). For the Q1CY2020, MBSL group reported a loss of LKR 164 Mn with a total asset base of LKR 37,850 Mn.
Key financial indicators
Rating history for last three years:
 BOC’s direct stake is 74.49% and it holds 7.10% through its fully owned subsidiary Ceybank Unit Trust
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