RAM reaffirms MBSL rating at AA-/P1

RAM Ratings Lanka said yesterday it has reaffirmed Merchant Bank of Sri Lanka’s (MBSL) long- and short-term financial institution ratings at AA- and P1, respectively.

At the same time, the long-term rating of AA- for the company’s Rs. 186.80 million Unsecured Unlisted Public Debentures (2007/2011) has also been reaffirmed. All the long-term ratings have a stable outlook. Meanwhile, RAM Ratings Lanka has assigned a short-term rating of P1 to the company’s proposed Rs. 500 million Unsecured Commercial Paper Programme (2010/2011).

All the ratings are supported by MBSL’s strong capitalisation and the financial flexibility it derives from its parent, Bank of Ceylon (BOC). On the other hand, the ratings are weighed down by the company’s weak asset quality albeit we note that it had improved during the year.

MBSL is a 72.14%-owned subsidiary of BOC, i.e. Sri Lanka’s largest licensed commercial bank in terms of assets. However, MBSL remains a small specialised leasing company, accounting for only 4.85% of the industry’s asset base as at end-December 2010.

Despite its small size, MBSL’s ratings are supported by its parent’s financial backing. BOC has consistently demonstrated its support via equity injections and funding lines; it infused Rs. 347.91 million into MBSL by way of a rights issue in December 2009, and has to date provided the company with Rs. 600 million of unutilised funding lines.

MBSL has three subsidiaries, i.e. Merchant Credit of Sri Lanka (MCSL), MBSL Savings Bank and MBSL Insurance Ltd. (MBSL Insurance), as well as an associate company, Lanka Securities Pvt. Ltd. (LSL) (collectively, the MBSL Group). The MBSL Group has an asset base of Rs. 14.44 billion.

MBSL intends to convert itself into a licensed specialised bank by merging with MCSL, a registered finance company and Ceylease Financial Services Ltd., another SLC owned by BOC.

As an LSB, the company will be permitted to accept public deposits, which SLCs are not permitted to do. While the Central Bank of Sri Lanka’s (CBSL) approval has been obtained for the merger, the company has yet to secure LSB status.

MBSL is allowed one year from the CBSL approval date to complete the merger process, i.e. until May 2012. To this end, the operational integration of the three entities has yet to be carried out. RAM Ratings Lanka views that the merger will not have any immediate rating impact on MBSL’s ratings. Further to its core operations of leasing and hire purchases, MBSL is also involved in corporate advisory services, capital market activities including initial public offerings and also offered portfolio management services.

While the MBSL Group’s asset quality has remained weaker than its peers’, its gross non-performing-loan ratio had eased to 10.06% as at the end of FYE 31 December 2010, from 12.83% a year earlier. The improvement had been largely driven by a 30.83% expansion in MBSL’s loan portfolio over the same period, which had alleviated its NPL ratio from 10.47% to 8.32%. The substantial loan growth had stemmed from the leases and hire-purchase segments.

Nonetheless, its overall gross NPLs increased from Rs. 457.19 million to Rs. 475.48 million over the year, mainly due to a delay in payments on term loans and bills from a large client. That said, its strengthened recoveries team has successfully reined in the company’s NPLs in the leases and HP segments; its quantum of gross NPLs shrank from Rs. 282.26 million as at end-December 2009 to Rs. 217.18 million as at end-December 2010.

Going forward, the company’s gross NPL ratio is expected to ease further in the short term, backed by its aggressive loan expansion against the favourable macroeconomic backdrop. RAM Ratings Lanka believes that loan growth can be achieved without sacrificing underwriting standards as MBSL will remain focused on HPs and leases, i.e. products that generally have lower-than-average delinquency rates.

RAM Ratings Lanka derives comfort from the conservative manner in which MBSL is venturing into new areas such as micro-financing. Meanwhile, we note that the asset quality of its subsidiaries has remained weak, with MBSL Savings Bank and MCSL recording respective gross NPL ratios of 8.98% and 13.43% as at end-December 2010.

In tandem with its robust loan growth, the MBSL Group’s performance improved in fiscal 2010. The group’s net interest margin broadened from 7.42% to 8.94% from FY Dec 2009 to FY Dec 2010. The group’s NIMs were upheld by MBSL’s NIMs, which improved from 7.70% to 10.78%.

In addition to its enlarged loan base, the high proportion of equity (40.23%) in MBSL’s funding structure and the shift towards short-term borrowings as at end-December 2010 had also allowed it to maintain its better profitability compared to the SLC industry.

Meanwhile, the increase in MBSL’s gross income was also supported by rising non-interest income from equity gains amid the booming stock market and fee income from its investment-banking arm, which had handled a larger number of listings on the Colombo Stock Exchange.

While overheads have augmented in line with new branch openings, this had been offset by the increase in the MBSL Group’s gross income, thus reducing its cost-to-income ratio from 67.04% to 56.53%. Going forward, the MBSL Group’s financial performance is expected to improve with the further expansion of its loan book and the government’s reduction of the value-added tax.

While the MBSL Group’s gearing ratio had increased to 1.86 times as at end-December 2010 (end-December 2009: 1.31 times), its capitalisation remained strong. Nonetheless, we are still concerned that MBSL’s funding commitments to its subsidiaries could strain its balance sheet.

To date, capital infusions required by its subsidiaries are estimated to amount to Rs. 2.63 billion, out of which Rs. 2.27 billion is meant to meet MBSL Savings Bank’s minimum capital requirement of Rs. 2.5 billion by end-December 2012. That said, even if the entire amount were to be debt-funded, Ram Ratings Lanka expects the MBSL Group’s gearing ratio to peak at just over two times, i.e. still strong compared to its peers.

The MBSL Group’s liquidity position is deemed moderate. It has been tilting towards short-term financing over the past year, with MBSL accounting for 89.31% of the amount as at end-December 2010. While this has exacerbated the gaps in the short-term asset-liability maturity mismatch buckets, Ram Rating Lanka’s concerns are somewhat mitigated by its Rs. 1 billion of standby lines and the financial flexibility derived from its parent. Going forward, MBSL will be able to tap public deposits once it has secured its LSB status; this will reduce its dependence on borrowings.