RAM assigns BBB/P3 to Union Bank of Colombo

RAM Ratings Lanka has assigned respective long- and short-term financial institution ratings of BBB and P3 to Union Bank of Colombo Limited; the long-term rating has a stable outlook.

The ratings are premised on the bank’s healthy capitalisation as well as adequate funding and liquidity positions. On the other hand, they are constrained by the bank’s small size, limited geographical reach and its relatively concentrated loan book.

Union Bank was incorporated in 1995, to focus on the needs of second-tier corporates as well as the SME sectors; it is presently the smallest domestic licensed commercial bank. As at end-September 2010, the bank’s asset base stood at Rs. 17.91 billion, accounting for 0.75% of the total banking industry’s assets. Union Bank has limited geographical reach, with 21 branches as at end-December 2010. Going forward, the bank intends to operate over 55 branches by 2013, using the new capital infusion.

Weighed down by the harsh economic climate and the deterioration of its lending portfolio in 2002, Union Bank faced financial difficulties. Subsequently in 2003, a consortium of investors, led by Sampath Bank PLC, stepped in to recapitalise and restructure the Bank.

As part of this exercise, Union Bank transferred Rs. 600 million of cash and Rs. 978 million of bad debts to a special purpose vehicle. In return, the bank had received a deep discounted bond yielding a relatively low return of 4%. Maturing in 2023, the DDB is guaranteed by Sampath Bank PLC (rated AA/P1 by RAM Ratings Lanka). The debt instrument accounted for 11.34% of Union Bank’s asset base as at end-December 2010.

Union Bank’s gross non-performing-loan ratio is higher than its peers’ owing to slower loan growth due to lower demand for credit and delinquencies of a few large loans amid the weak macro economic climate in 2008 and 2009.

Union Bank’s gross NPLs had increased from Rs. 366.42 million as at the end-FYE 31 December 2008 to Rs. 866.70 million as at end-September 2010 causing the gross NPL ratio to rise from 4.91% to 9.30%. The jump in the gross NPL ratio was precipitated by the bank’s concentrated loan book as top 20 loans took up 38.85% of the loan base as at end-September 2010. This was reflected in the NPLs with the top 20 NPLs accounting for 76.53% of gross NPLs as at the same date.

That said, the bank’s efforts to rein in NPLs are bearing fruit; NPLs receded to Rs. 794.28 million as at end-FY Dec 2010. As such, Union Bank’s gross NPL ratio improved to 8.24% as at the same date. The improvement in the bank’s gross NPL ratio had been driven by more recoveries, lower incidences of new NPLs as the economy improved and the expansion of its loan books.

RAM Ratings Lanka expects the same factors to underscore further improvement in its asset quality. On this note, Rs. 385 million of NPLs had been restructured by end-FY Dec 2010, and should be returning to the ‘performing’ category over the next three to six months. If the rescheduling exercise is successful, the bank’s gross NPL ratio is expected to decrease to 5%.

Union Bank has benefited from the dilution of the low-yielding DDB through loan expansion and the lower overall cost of funding.

As a result, the bank’s net interest margin widened from 3.48% in FY Dec 2009 to 4.73% in FY Dec 2010. Excluding the impact of the DDB, the bank’s margins would have been in line with its peers’. As at end-FY Dec 2010, Union Bank’s return on assets clocked in at 1.90% (end-FY Dec 2009: 1.01%) – lower than those of its peers.

The bank’s margins are envisaged to improve as its loan books expand and further dilute the DDB’s effects, coupled with prospectively lower funding costs due to new capital infusion.

However, its overall profitability will be constrained by increased overheads arising from its branch expansion, as well as the gestation period needed for the new branches to break even.

Union Bank’s funding and liquidity positions are deemed to be adequate. The bank’s funding base is dominated by deposits (73.00% as at end-FY Dec 2010).

Moreover, the bank’s statutory liquid asset ratio clocked in at 36.31% as at end-FY Dec 2010, well above the regulatory minimum of 20%.

On the other hand, its deposit base tilted towards more expensive time deposits and certificates of deposit. This is reflected by the bank’s ratio of interest expenses over interest bearing liabilities, which is higher than its peers’. However, RAM Ratings Lanka notes that the bank’s dependence on these higher cost funding has been receding as time and certificate of deposits took up 67.51% of the deposit base as at end-September 2010, lower than 76.07% recorded as at end-FY Dec 2009.

At the same time, Union Bank’s deposit base was relatively concentrated as top 20 depositors made up 28.67% of its total deposits (end-FY Dec 2009: 24.65%).

Meanwhile, the Bank’s capital adequacy is deemed healthy; its tier-1 risk-weighted capital adequacy ratio and overall RWCAR clocked in at a respective 28.59% and 28.97% as at end-September 2010 after a Rs. 1.94 billion private placement exercise in June 2010.

This has also strengthened the bank’s buffer against adverse movements in its asset quality, as measured by its ratio on net NPLs to shareholders’ funds, which stood at 13.37% as at end-FY Dec 2010 (end-FY Dec 2009: 39.38%).  

Going forward, in addition to the Rs. 840 million raised through a combination of rights issue and private placement, the bank is in the process of raising Rs. 375 million by end-February 2011, via its planned IPO.