Fitch upgrades Seylan Bank to ‘A-(lka)’

Fitch Ratings has upgraded Seylan Bank PLC’s National Long-Term rating to ‘A-(lka)’ from ‘BBB+(lka)’. The Outlook is Stable. A full list of rating actions is provided at the end of this commentary.

The upgrade is driven by the Government of Sri Lanka’s improved ability to provide support to Seylan if required, as evidenced by Fitch’s upgrade of the Sri Lanka Sovereign rating to ‘BB-’ on 18 July 2011. The potential support is based on Seylan’s status as one of six systemically important domestic commercial banks as identified by the country’s regulator.

State support has been forthcoming to Seylan since its failure in December 2008, including two equity infusions totalling Rs. 7.7 b. As at 30 June 2011, the Government effectively controlled 30% of Seylan’s voting equity.

Seylan’s standalone credit profile has improved since the Government’s intervention and subsequent recapitalisations, which resulted in a new Board and significant restructuring of the bank’s systems and controls.

However, Fitch views Seylan’s standalone rating to be considerably lower than the current support-driven rating of ‘A-(lka)’, stemming mostly from its still-high unprovided NPL/equity ratio (end-H111: 72%), and weak management information systems that limit effective control. The bank’s unprovided NPLs are mostly a function of available collateral, the disposal of which is subject to market risk. The management expects the first phase of an IT system upgrade to occur by March 2012.

Seylan’s asset quality continues to improve, helped by management’s strong focus on recoveries and a more conducive economic environment.

At end-H111, NPLs reduced by 32% in absolute terms from their peak at end-H109.

Seylan’s NPL ratio (H111: 18.29%) is still high compared with the other domestic private sector commercial banks rated by Fitch (H111: 3.53%), mostly a result of weak credit controls and the bank’s higher risk appetite in the past.

 While credit controls are being tightened, Fitch notes that the bank’s risk appetite has moderated post-new management.

Aggressive recoveries, capital infusions, and streamlining operating costs have improved Seylan’s recurring return on assets (ROA) to an annualised 2.64% at end-H111 (end-2009: 0.31%). A further impairment of Rs. 420 m is expected in H211, while a further one-off NPL provision of Rs. 680 m could arise in 2013, all on investments originated prior to 2009.

Given Seylan’s improved recurring ROA, Fitch expects these impairments to be absorbed within the bank’s operating profitability, without further erosion of its capital base.

The bank targets to maintain its Tier 1 regulatory capital adequacy ratio above 11% over a three-year horizon.

Upside potential for Seylan’s rating is limited over the medium-term, and is likely to be driven solely by an upgrade of the Sovereign rating, as Fitch views the bank’s standalone credit profile as being weak, despite considerable improvements and restructuring efforts since its failure in 2008.

Conversely, a perceived weakening of the Government’s ability or propensity to extend support, including a downgrade of the sovereign rating, could lead to a downgrade of Seylan’s rating.

Seylan’s ratings:

n    National Long-Term rating: upgraded to ‘A-(lka)’ from ‘BBB+(lka)’; Outlook Stable.

n    Outstanding Rs. 465 m of senior unsecured debentures: upgraded to ‘A-(lka)’ from ‘BBB+(lka)’.

n    Outstanding Rs. 3.4 b of subordinated debentures: upgraded to ‘BBB+(lka)’ from ‘BBB(lka)’.