Fitch maintains positive outlook on Sampath Bank's 'AA-'

Fitch Ratings Lanka has affirmed Sampath Bank PLC's (SB) National Long-Term rating at 'AA-(lka)'. The Outlook remains Positive. A full list of rating actions is provided at the end of this commentary.

The affirmation reflects SB's strong asset quality and profitability, its comfortable equity buffer maintained against future loan losses, as well as its rapid growth from 2010.

The retention of the Positive Outlook is driven by continuous improvements in the bank's credit metrics supported by ongoing structural changes since 2009 (in terms of tighter credit controls, improved recovery focus and better risk management), as well as its growing franchise and market share in terms of bank sector deposits, loans and assets.

An upgrade of SB's rating would depend on its ability to meet or surpass its core capitalisation levels relative to local and regional peers over the medium-term, particularly in view of its continued high loan growth, while maintaining strong asset quality and robust core returns on assets (ROA, excluding non-recurring items). Conversely, the Outlook may be revised to Stable if the bank's current growth momentum results in a further dilution of its core capitalisation to levels more in line with lower-rated peers'.

SB's tier 1 capital adequacy ratio (CAR) was strong at 10.5% at end-June 2011. However, its total CAR at 12.3% was marginally lower than rated-peers and has been decreasing due to rapid loan growth over 2009-mid-2011. While SB's high profitability supports incremental capital generation, its capital base may require further strengthening to enable it to maintain present capitalisation levels if the current growth momentum is sustained.

Gross non-performing loans (NPLs) fell by 33% yoy in 2010 and by a further 3% in H111, due to enhanced recovery initiatives, tighter underwriting standards than previous years (including credit centralisation), and structural improvements in the macroeconomy. Gross NPL ratio of 3.2% at end-H111 (FYE10: 4%) is considerably better than peers', also supported by its large pawning (gold-backed loans) portfolio (end-H111: 22% of advances) with near zero NPLs.

SB provides more prudently on NPLs compared to the sector, as well as does not give credence to collateral in its provisioning and aims to maintain a high coverage ratio. Specific loan loss coverage stood at 79% at H111 (around 49% for 'AA(lka)'-rated peers). Consequently, SB's un-provided NPLs at 5.4% of equity at H111, although higher than the 3.0% at end-2010, are significantly lower than historical levels (end-2009: 26%).

Profitability has been improving since 2007 supported by improving net interest margins (NIMs) up to 2009, falling provisioning costs and a largely stable cost structure despite branch expansion. Its core ROA has faced some pressure from narrowing NIMs which, although still healthy, decreased in 2010-H111. However, Fitch expects better core ROA in the medium term on the back of increased fee income from its growing corporate segment and improving economies of scale as its new branches generate business. Further, SB's revenue recognition policy is more prudent than the regulatory requirement, which, when adjusted, improves its core earnings ratios to be more in line with peers'.

NIMs fell to 4.7% in H111 (2010: 5.6%) due to funding costs not keeping pace with declining yields from decreasing market interest rates and increased corporate exposures. SB's funding costs are higher than large-rated peers as it has had to offer higher rates on its deposits relative to peers, so as to match deposit growth to loan growth and because funding from low-cost demand and savings deposits has been lower than peers' (SB: 46%, peers: 50% of deposits). However, Fitch expects SB's funding costs to trend closer to that of peers as newly opened branches increase its potential to mobilise deposits.

Established in 1986, SB is Sri Lanka's sixth-largest licensed commercial bank, accounting for 6.7% of sector assets as at end-March 11. As at-end June 2011, three employee share ownership plans and the bank's employee provident fund and pension fund, in aggregate held 17% of SB's equity. The bank's single-largest shareholder is Vallibel One Limited, which is controlled by Mr. K. D. D. Perera - a high net-worth businessman with holdings in several local corporates, banks and non bank financial institutions.