RAM reaffirms MBSL’s ratings at AA-/P1

RAM Ratings Lanka has reaffirmed Merchant Bank of Sri Lanka PLC’s respective long- and short-term financial institution ratings, at AA- and P1. Concurrently, the long-term rating of the company’s Rs. 1 billion Senior Unsecured Redeemable Debentures (2011/2015) and the short-term rating of its Rs. 500 million Unsecured Commercial Paper (2011/2012) have been reaffirmed at AA- and P1, respectively.

Meanwhile, RAM Ratings Lanka has assigned a short-term P1 rating to MBSL’s proposed Rs. 1 billion Commercial Paper (2012/2013). All the long-term ratings have a stable outlook.

The ratings are supported by MBSL’s strong capitalisation and the financial flexibility derived from its parent, the State-owned Bank of Ceylon (BOC). On the other hand, the ratings are weighed down by the company’s weak asset quality.

MBSL is a 72.14%-owned subsidiary of BOC, Sri Lanka’s largest licensed commercial bank in terms of assets. On the other hand, MBSL is a medium sized specialised leasing company that accounted for 7.41% of the industry’s asset base as at end-December 2011.

MBSL’s ratings are firmly supported by its parent’s financial backing. BOC has consistently demonstrated its support via equity injections and funding lines. Going forward, BOC intends to transfer its investment-banking portfolio to MBSL over the medium term.

MBSL has three subsidiaries: Merchant Credit of Sri Lanka (MCSL), a licensed finance company; MBSL Savings Bank and MSBL Insurance Company Ltd. (MBSL Insurance); it also has an associate stake in Lanka Securities Pvt. Ltd. (LSL) (these are collectively known as the MBSL Group or the Group). The MBSL Group’s asset base stood at Rs. 19.24 billion as at end-December 2011.

Although MBSL had intended to merge with MCSL and Ceylease Financial Services Ltd (another SLC owned by BOC) and convert into a licensed specialised bank, these plans have now been shelved. Meanwhile, MBSL has entered into an agreement with a consortium of investors to dispose of its interest in MBSL Savings Bank; the sale is anticipated to be completed by end-June 2012.

As at end-December 2011, the Group’s asset quality remained weaker than that of its LFC and SLC peers, as reflected by its gross non-performing-loan ratio of 9.97% as at end-December 2011, which remained relatively unchanged despite a strong 18.66% year-on-year loan expansion.

The delinquencies had primarily stemmed from MBSL, which recorded a 75.12% y-o-y spike in NPLs, mainly driven by two sizeable loans that accounted for around 85% of the NPL influx during the period; these loans are currently being recovered.

The company’s gross NPL ratio thus weakened to 10.37% as at end-December 2011 (end-December 2010: 8.32%), with MCSL’s ratio clocking in at 9.40% (end-December 2010: 13.43%). Looking ahead, the Group’s gross NPL ratio is anticipated to improve against a backdrop of recoveries and loan expansion, albeit still weaker than its peers’.

In line with the downward repricing of credit assets, the MBSL Group’s net interest margin thinned from 8.23% in FYE 31 December 2010 to 7.65% the next year. The Group’s NIM is reflective of MBSL’s, which also contracted from 10.78% to 9.23% over the same period. Despite the decline, the Group’s core profitability improved, propelled by strong credit growth.

On the other hand, its overall profit performance eased y-o-y as a result of more modest equity investment gains; the Group recorded a pre-tax profit of Rs. 591.04 million for FY Dec 2011, compared to Rs. 795.60 million the previous year. MBSL had accounted for 75.01% of the Group’s pre-tax profits, with the remainder generated by MCSL and MBSL Insurance. On the contrary, MBSL Savings Bank continued to incur losses.

On a separate note, RAM Ratings Lanka opines that the Group’s funding position is moderate. As an SLC, the company (the Group’s largest subsidiary) is not permitted to accept public deposits, thus limiting its funding sources. Its funding profile is further moderated by the Group’s reliance on short-term borrowings. Meanwhile, the Group’s liquidity position is deemed adequate, supported by the financial flexibility derived from its parent. Furthermore, the company’s statutory liquid-asset ratio came up to 9.0% as at end-January 2012, better than those of its SLC peers.

MBSL’s strong capitalisation continues to uphold its ratings. The company’s risk-weighted capital-adequacy ratio clocked in at 28.64% as at end-fiscal 2011, well above the regulatory minimum as well as those of SLC and LFC peers.

Looking ahead, the company’s capital is anticipated to be strengthened further via a Rs. 1.3 billion rights issue this year. RAM Ratings Lanka’s concerns had previously hinged on MBSL’s funding commitments to its subsidiaries, mainly MBSL Savings Bank, which had required over Rs. 2 billion of capital infusions. As such, the disposal of this subsidiary is viewed positively.