ICRA assigns NSB’s upcoming Rs. 5 b hybrid bond issue AA

ICRA Lanka Ltd., has assigned a rating of [SL]AA(hyb) with Stable outlook for the proposed Rs. 5 billion Basel III Compliant, Unlisted, Rated, Unsecured, Subordinated, Perpetual, Additional Tier I Capital Bond Programme of National Savings Bank (NSB). 

The letters ‘hyb’ in parenthesis suffixed to a rating symbol stand for ‘hybrid’, indicating that the rated instrument is a hybrid subordinated instrument with equity-like loss-absorption features, which may translate into higher levels of rating transition and loss severity vis-à-vis conventional debt instruments.

ICRA Lanka has an issuer rating outstanding of [SL]AAA (pronounced SL triple A) with Stable outlook for the bank. ICRA Lanka also has an issue rating of [SL]AAA (pronounced SL triple A) with Stable outlook outstanding for the Rs. 20,000 million senior, unlisted, unsecured, redeemable debenture programme and an issue rating of [SL]AA+ (pronounced SL double A plus) with Stable outlook for the Rs. 6,000 million subordinated, unsecured, redeemable debenture programme of NSB.  

The rated Basel III compliant Tier I bond programme (Additional Tier I or AT-I bonds) has the following loss-absorption features that make them riskier:

Coupon payments are non-cumulative and discretionary, and the bank has the full discretion at all times to cancel coupon payments. Cancellation of discretionary payments shall not be an event of default.  

Coupon can be paid out of the current year profits. However, if the current year’s profit is not sufficient, or, if the payment of coupon is likely to result in a loss, the coupon payment can be done through reserves and surpluses created through appropriation of profits[1]. However, the coupon payment is subject to the bank meeting the minimum regulatory requirements for CET I, Tier I and total capital ratios (including capital conservation buffer, CCB) at all times as prescribed by the Central Bank of Sri Lanka under the Basel III regulations.

These Tier I bonds are expected to absorb losses through the write-down mechanism at the objective pre-specified trigger point. The trigger point event is the earlier of; a decision that a write-down, without which the bank would become non-viable, is necessary, as determined by the Monetary Board; and the decision to make a public sector injection of capital, or equivalent support, without which the bank would have become non-viable, as determined by the Monetary Board.

Given the above distinguishing features of the Tier I bonds, ICRA Lanka has assigned a one notch lower rating to these bonds compared to the rating of subordinated debentures. The distributable reserves[2], that can be used for servicing the coupon in case of inadequate profits or a loss during the year, stood at a comfortable 8.6% of the risk-weighted assets (RWAs) as on 30 June as compared to 9.19% as on 31 March. The rating of the Tier I bonds continues to be supported by NSB’s adequate capital profile (Capital Adequacy Ratio: 13.25%; Tier 1 ratio: 10.96% as on 30 June), which is likely to remain comfortable, given its low risk investment mandated by the NSB Act and healthy lending profile. The bank is mandated to invest a minimum 60% of the total deposits in government securities which attracts zero risk weight and supports its capital profile. The rating on the Basel III compliant Tier I bonds also factors in the bank’s muted profitability indicators, given the uncertainty regarding the asset quality amid the pandemic-induced stress on the same. However, the same is expected to be absorbed through NSB’s strong operating profits, the buffer in the existing capital levels and the sizeable distributable reserves for servicing the Tier I bonds.

The ratings of the bank take note of the 100% Government of Sri Lanka (GoSL) ownership, which provides a strong likelihood of sovereign support, and the 100% explicit guarantee provided by the Government of Sri Lanka (GoSL) for the money deposited with the bank and the interest thereof through the National Savings Bank Act (NSB Act). The ratings factor in the low-risk investment portfolio, healthy lending portfolio and the adequate capital profile. The bank’s investment portfolio is characterised by low risk, with NSB mandated to invest a minimum of 60% of the total deposits in government securities; as in June, 62.58% of the deposits were in government securities.

NSB’s asset quality remains better as compared to Licensed Specialised Bank (LSB) average with a GNPA ratio of 2.34% as in June, lower than the LSB segment’s GNPA ratio of 7.08% and system average of 5.43% for the same period. The quality of the lending portfolio is driven by zero Gross NPAs on its exposure to GoSL, State-owned Entities (“SOE”) and Corporate segments which accounted for 34% of the lending portfolio in Jun and 3.51% gross NPA in the retail portfolio (66% of the lending portfolio) as of June compared to 2.52% in March. NSB’s BASEL III complied capital adequacy ratio (CAR) stood at 13.25% (Common Equity Tier I and Tier-I capital ratios at 10.96%) as compared to regulatory requirement of 12.00% (Common Equity Tier I ratio at 4.00% and Tier-I capital ratio at 8.00%) as of June. Further, in December 2019, CBSL reclassified NSB as a Non-Domestic-Systemically Important Bank (“Non -DSIB”) based on its new criteria for this assessment. As a result, NSB’s regulatory capital requirement in terms of Tier I capital reduced to 8.50%[3] from 10% earlier. ICRA Lanka notes that a reduction in regulatory capital requirement would reduce the pressure of securing external capital in the medium term. Going forward, continuous maintenance of adequate buffers (at least 1%) over and above the minimum capitalisation requirements (Tier-I plus CCB and CAR) would be critical for the sustenance of the current rating.

ICRA Lanka believes that NSB will continue to benefit from Government support considering its position as the largest licensed specialised bank in Sri Lanka, which also provides vital funding support to GoSL as per the NSB Act. The outlook may be revised to ‘negative’ in case of a steady shortfall in NSB’s capital buffers over the regulatory requirements as compared to ICRA Lanka’s expectations, or significant weakening in the profitability and asset quality indicators.