RAM Ratings Lanka reaffirms SCB’s Sri Lanka branch ratings at AAA/P1

RAM Ratings Lanka has reaffirmed the respective long- and short-term financial institution ratings of Standard Chartered Bank – Sri Lanka Branch, at AAA and P1; the long-term rating has a stable outlook.

The ratings are firmly anchored by the credit profile of SCBSL’s ultimate parent, Standard Chartered Bank, for which the bank is a branch. The ratings also reflect SCBSL’s healthy asset quality and capital adequacy, as well as excellent funding and liquidity positions.

SCBSL started operations in 1892 as part of The Chartered Bank of India, Australia and China. In 1969, the latter merged with The Standard Bank of British South Africa, thus creating SCB and bringing SCBSL under its enlarged stable. SCB currently operates in over 70 markets, with a workforce of almost 85,000 personnel.

Nonetheless, the Group’s main focus is still on the Asian and African markets, which accounted for 90.54% of its operating income and 96.19% of its US$ 6.12 billion pre-tax profit in FYE 31 December 2010. SCB’s asset base expanded 18.30% year-on-year to US$ 516.54 billion as at end-FY Dec 2010, as credit demand had picked up in its key markets.

Amid high and escalating oil prices in 2007 and 2008, SCBSL entered into a derivatives deal with state-owned Ceylon Petroleum Corporation. As world commodity prices subsequently crashed, however, the deal had gone against CPC, resulting in amounts payable to the bank.

The Government of Sri Lanka had directed CPC to halt payments to the bank, following which SCBSL classified Rs. 18.5 billion (US$ 161.7 m) due from CPC as a non-performing-loan in FY Dec 2009. The bank made a provision of Rs. 9.2 billion (US$ 81 m) that same year.

In FY Dec 2010, the bank transferred the NPL to SCB. The Group consequently filed legal action against the CPC in the English High Court to recover the dues. In July 2011, the courts ruled in favour of the Group, requiring CPC to pay a minimum of US$ 162 million plus interest; the Government intends to file an appeal in higher courts. On a separate note, in March 2011, SCBSL was served with a Notice issued by the Exchange Control Department (intimating a fine of approximately US$ 245 m) for alleged exchange control violations, connected to the hedging derivatives with CPC. The bank has appealed against the said notice served.

Nonetheless, SCBSL’s asset quality has remained strong, backed by its stringent underwriting standards and conservative investment strategy. The bank’s gross NPL ratio clocked in at 1.94% as at end-FY Dec 2010 – better than those of its similarly rated peers.

The top 20 borrowers made up 47% of its total gross loans as at end-FY Dec 2010, which is largely made up of top-tier local corporates and multinational companies that are considered to be of low credit risk. At the same time, the bank’s investment portfolio consisted almost exclusively of low-risk and highly liquid government securities.

In terms of financial performance, the bank’s gross income eased to Rs. 6.44 billion in FY Dec 2010 (FY Dec 2009: Rs. 7.63 billion), weighed down by lower interest rates and lacklustre credit growth.

Nonetheless, SCBSL’s bottom line was boosted by a reversal of provisions that had been made on the CPC derivatives deal in FY Dec 2009. With the reversal, Rs. 9.2 billion had been brought back into the bank’s profits. As a result, SCBSL turned around with a Rs. 10.50 billion pre-tax profit in fiscal 2010, in contrast to a Rs. 4.40 billion loss the previous year.

RAM Ratings Lanka considers SCBSL’s funding and liquidity positions to be excellent, supported by lower costs and a diversified pool of deposits as well as a relatively liquid asset base. The Bank depends on current and savings accounts, which accounted for roughly half of its deposit base.

As at end-FY Dec 2010, the bank reported liquid-asset ratios of 50.36% and 35.76% for the Domestic Banking and Foreign Currency Banking Units, respectively, together with a prudent loan-to-deposit ratio of around 77%.

The reversal in provisions and subsequent improvement in profit performance had lifted the bank’s tier-1 and overall risk-weighted capital-adequacy ratios to 17.22% and 17.66%, respectively, as at end-FY Dec 2010 (end-FY Dec 2009: 5.79% and 6.38%). Although the fine intimated by the CBSL is significant, the reaffirmation of the ratings takes into consideration the financial strength of the Group.