Union Bank of Colombo PLC: Rating reaffirmed
ICRA Lanka Limited has reaffirmed the issuer rating of Union Bank of Colombo (UBC or the Bank) at [SL]BBB (pronounced SL triple B). The outlook on the rating is Stable.
The rating reaffirmation takes into account the promoter holding of 70.8% stake by Culture Financial Holdings Ltd. (CFHL), an affiliate of the private equity investor Texas Pacific Group (TPG). TPG has three representatives on the nine-member Board of Union Bank of Colombo (UBC) and provides strategic support to the senior management team. The rating takes note of the experienced senior management team and adequate risk management systems. Further, the rating factors in the Bank’s comfortable capital profile with Capital Adequacy Ratio (CAR) of 15.81% as in Mar-20 and remains above the minimum regulatory level of 12.00%. Nevertheless, the rating takes note of the regulatory minimum core capital requirement of LKR 20 Bn to be complied by Dec-22 compared to LKR 17.6 Bn as in Mar-20. ICRA Lanka estimates that the Bank would require a capital infusion of LKR 0.7-1.0 Bn by Dec-22, to meet the LKR 20 Bn minimum regulatory core capital requirement. The LKR 3.4 Bn warrants issued to CFHL, maturing in Sep-20  could be exercised to meet the regulatory capital requirement. ICRA Lanka expects TPG to provide timely and adequate capital support to UBC, if required.
The rating factors in the Bank’s modest size with an asset base of LKR 131 Bn as in Mar-20. The Bank reported subdued profitability indicators with Return on Assets (“RoA”) of 0.57% and Return on Equity (“RoE”) of 4.16% for CY2019 as compared to the industry average of 0.93% and 10.26% for the same period. The rating considers its moderate resource profile with Current Account and Savings Accounts (“CASA”) ratio of 28.8% compared to system average of 32.5% as on Mar-20. ICRA Lanka notes that the Bank’s corporate exposures are quite concentrated with top 10 clients accounting for 26% of the loan book as on Mar-20. The Bank’s SME segment is highly vulnerable to slippages over the short term due to post effects of COVID-19 pandemic. The Bank has 21% of portfolio under moratorium due to the pandemic as on May-20. As a result, the Bank’s ability to control new slippages going forward, would be crucial from an asset quality perspective. Further, the improvement in operating efficiency, liquidity and deposit profile would be crucial from a rating perspective.
ICRA Lanka believes that UBC will continue to benefit from the support of TPG. The outlook may be revised to ‘Positive’ in case of a steady improvement in the resource, earnings and liquidity profile as portfolio expands, while keeping the asset quality under control. The outlook may be revised to ‘Negative’ in case of a significant weakening in the asset quality, profitability, liquidity or capital profile.
Key rating drivers
Strong financial and strategic support from TPG; UBC was incorporated in 1995 and presently offers its services through 67 branches. TPG acquired 70% stake of UBC for LKR 11.9 Bn in 2014 through its affiliate CFHL and presently holds 70.8% stake of the Bank. TPG has a long-term interest in the Bank since it has special regulatory permission to hold 75% stake till 2029 as compared to the regulatory cap of 10%. As per the regulation, TPG is required to reduce its stake in UBC to 15% by 2029. UBC’s board comprises of nine directors, of which TPG has three representatives on the board. These representatives provide strategic support to the Bank at board and sub-committee levels.
Comfortable capital position; UBC has a comfortable capital structure based on BASEL III regulatory requirements. The Bank reported a BASEL III complied CAR of 15.81% in Mar-20 as compared to regulatory requirement of 12.0%. The Bank has to meet CBSL’s minimum core capital requirement of LKR 20 Bn as on December 31, 2022 (extended by CBSL from December 31, 2020 deadline due to pandemic). The Bank reported LKR 17.6 Bn core capital in Mar-20. ICRA Lanka estimates that the Bank would require a capital infusion of LKR 0.7-1.0 Bn to meet the LKR 20 Bn regulatory core capital requirement in Dec-22. As a fallback option, the LKR 3.4 Bn warrants issued to CFHL which will mature in Sep-20 could be exercised by CFHL.
Improving funding profile; The Bank’s funding is largely in the form of deposits, which accounted for 76% of the total funding as in Mar-20. UBC improved the share of CASA ratio to 28.8% in Mar-20 from 25.3% in Dec-19 due to aggressive deposit drive carried out since 2019. The improvement in CASA ratio was due to 20.5% Y-o-Y growth in CASA deposits while total deposits grew by 7.7% in Mar-20. This resulted in the UBC’s CASA ratio to improve and be in-line with the System’s average of 32% reported in Mar-20. The credit to deposit ratio increased to 104% in Dec-19 as compared to 96% in Dec-18 as the advance growth moderated to 4.7% Y-o-Y during CY2019 as compared to the deposit de-growth of about 3.4% Y-o-Y. Although the same improved to 96% as in Mar-20 as the Y-o-Y growth of advances slowed down to 2.5% as compared to an increase in deposit growth by 7.7%.
Comfortable liquidity profile; The Bank reported a comfortable positive cumulative mismatch in the less than 12 months bucket of 14.48% in Mar-20 as compared to positive cumulative mismatch of 15.26% in the same bucket in Dec-19. As a prudent measure, UBC maintains LKR 3 Bn contingent funding lines from Banks and money market lines which provide comfort over the current weak macro-economic condition. Further, the Bank reported a liquid asset ratio of 24% and 22% at domestic and foreign levels in Mar-20 as compared to the regulatory requirement of 20%. Bank’s liquidity coverage ratio at 123% and 186%, respectively for all currency and Rupee deposits was higher as compared to the regulatory requirement of 100% as in Mar-20.
Moderate asset quality indicators mainly due to the SME segment; UBC’s Gross NPA (GNPA) increased to 5.11% in Mar-20 as compared to 5.03% reported in Dec-19 (3.68% in Dec-18). The Bank’s GNPA ratio remained marginally above the system average of 5.08% in Mar-20. The high GNPA ratio was mainly due to the poor performance of the SME portfolio (80% of total GNPA; 32% of total loans) as in Mar-20. The weak asset quality performance of SME portfolio was driven by adverse effects of the political and security events at the macroeconomic level and the poor-quality of the legacy SME portfolio (before 2015). At a standalone level SME portfolio reported high GNPA ratio of 6.13% followed by Retail (0.99%) and Corporate (0.55%) as of Mar-20. The Bank is closely monitoring the recovery of existing NPAs and has strengthened the credit underwriting norms and risk management systems to improve the quality of the new credit generation. Further, the Bank granted moratorium to 21% of its lending portfolio due to the pandemic as in May-20. The impact of the pandemic is yet to be substantiated. The asset quality of the Bank would depend on the recovery of the SME and Corporate segments post the pandemic. The rating continues to take note of the high NPAs in its subsidiary, UB Finance (GNPA at about 17.0% as on December 31, 2019). The sharp increase in NPAs during 2018 and 2019 pressured the solvency profile (net NPA / net worth) to remain at 15% in Mar-20 (14% in Mar-19) as compared to the system average of 22%. Going forward, the Bank’s ability to keep the group level NPAs under control by restricting incremental slippages and improving the Bank’s provision coverage, which is presently moderate at about 32% as in Mar-20, would be crucial.
Modest scale and franchise; UBC has segmented its market to corporate, SME and retail and offers term loans, personal loans, import/export loans, mortgage loans, asset-backed loans and credit cards to its customers. The Bank has a modest scale of operations with a total asset base of LKR 131 Bn and a franchise of 67 branches in Mar-20. The corporate banking segment accounts for 48% of the portfolio followed by SME (32%) and Retail (20%) in Mar-20. The loan portfolio’s Y-o-Y growth moderated to 4.7% in Dec-19 as compared to 6.0% reported in Dec-18 and it has further moderated to 2.5% in Mar-20. The portfolio growth slowed as a result of tightening credit underwriting norms and adverse macro level events witnessed in CY2019 and Q1CY2020. The Bank intends to consolidate the loan portfolio in the short term and envisages growth in the medium term.
Subdued earnings profile as compared to the system; The Bank’s Net Interest Margin (NIM) improved to 3.62% in CY2019 as compared to 2.98% in CY2018 due to improvement in yields. The NIM moderated in Q1CY2020 to 3.26% as a result of the reduction in Average Weighted Prime Lending Rate (“AWPLR”) and CBSL imposed rate cuts. The overall funding cost improved to 8.12% in CY2019 as compared to 8.22% in CY2018, and it further improved to 7.64% in Q1CY2020 due to improvement witnessed in the CASA ratio. The Bank’s cost to income ratio improved to 75% in CY2019 compared to 79% in CY2018, it marginally improved to 74% in Q1CY2020. However, UBC’s cost to income ratio remains high as compared to the systemic average of 53% in CY2019. The Bank’s improvement in the NIM and cost to income ratio resulted in a rise in net profit to LKR 710 Mn in CY2019 compared to LKR 473 Mn in CY2018. At PAT level, RoA improved to 0.57% in CY2019 as compared to 0.39% in CY2018 and it remained at 0.57% in Q1CY2020. The RoE ratio improved to 4.16% in CY2019 as compared to 2.74% in CY2018, it marginally moderated to 4.10% in Q1CY2020. The Bank’s return ratios were relatively subdued as compared to the systemic average RoA (at PAT) of 0.93% and RoE of 10.26%, respectively in CY2019.
Analytical approach: For arriving at the ratings, 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:
UBC, incorporated in 1995, is a small Licensed Commercial Bank (LCB) accounting for about 1% market share of the Sri Lankan banking sector advances as on March 31, 2020. After a Restructuring process in 2003, which included Union Bank transferring LKR 978 Mn of NPAs and LKR 600 Mn of Cash to an SPV in return for low yielding long term Deep Discount Bonds (DDB), the Bank has raised capital from various investors. The Bank was listed on the main board of the Colombo Stock Exchange with an IPO offering in March 2011. UBC acquired controlling interest in National Asset Management Limited (NAMAL) and The Finance and Guarantee Company Limited (TF&G), subsequently renamed UB Finance (a licensed finance company). As on March 31, 2020, it holds about 51% of the share capital in NAMAL and 73% share capital in UB Finance (81% of the total voting rights). In 2014, UBC received equity infusion of about LKR 11.4 Bn from Culture Financial Holdings Ltd (CFHL), an affiliate of the private equity investor TPG; CHFL presently holds about 70.8% of the equity share capital. CHFL also subscribed to about 218 Mn share warrants, which could result in further equity infusion of LKR 3.4 Bn, if exercised and, increase CHFL’s shareholding to 75%. Given the restrictions on Bank shareholdings in Sri Lanka, special approval was granted by Central Bank of Sri Lanka (CBSL) to CHFL to reduce the holding to 15% by 2029.
During the year ended December 31, 2019, UBC reported a PAT of LKR 710 Mn on a total asset base of LKR 122 Bn as compared to a PAT of LKR 473 Mn on a total asset base of LKR 126 Bn in the previous financial year. For Q1CY2019, UBC reported a PAT of LKR 180 Mn on a total asset base LKR 131 Bn.
 The value is based on the current exercise price of LKR 16.00 per warrant. The Bank has already obtained regulatory concurrence to revise the exercise price to a price that is equivalent to the average closing price per share for the five days period that immediately precedes the exercise of Warrants and would seek shareholder approval for same prior to the expiry of the current term of the warrants.
Key financial indicators
Rating history for last three years:
 The Bank has already obtained regulatory concurrence to extend the exercise period of the warrants by further two years (i.e. until 30 September 2022) and would seek shareholder approval for same prior to the expiry of the current term of the warrants.
 Relief measure announced by the Central Bank of Sri Lanka in Mar-20
 The Bank has already obtained regulatory concurrence to extend the exercise period of the warrant by further two years (i.e. until 30 September 2022) and would seek shareholder approval for same prior to the expiry of the current term of the warrant.
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