Union Bank’s outlook revised to negative from stable

Fitch Ratings Lanka said yesterday it has revised Union Bank of Colombo PLC’s (UB) Outlook to Negative from Stable. Its National Long-Term rating has been affirmed at ‘BB+(lka)’.

The Negative Outlook reflects UB’s operational risks, given the nature of its disparate IT systems, weak operational branch procedures, while loan growth was high at 56.5% in nine months ended September 2011 (9M11).

The rating reflects UB’s moderate asset quality and lack of a broad deposit base.

The rating also reflects the challenges to the scalability of its operations given operational weaknesses and the impact on profitability of its holding of low-yielding deep-discount bond (DDB), which was part of the 2003 balance sheet restructuring.

The implementation of necessary risk management systems and processes (including the bank’s proposed implementation of a core banking system) would enable UB to manage its expansion plans and may result in the Outlook being revised to Stable.

Any further delays in the implementation of the core banking system or delays in the correction of highlighted operational risks would be negative for the rating.

UB’s loans grew by 56.5% in Q311, with overdrafts and term loans accounting for 35% and 34% of loans, respectively, at Q311 (2010: 39% and 24%). Furthermore, its loans had a sizable exposure to the trade sector.

Non-performing loan ratio improved to 3.5% at Q311 from 8.2% at FYE10, due to concerted recoveries and loan growth.

DDB accounted for 12% of UB’s interest earning assets at end-September 2011 from its peak of 35% at 2003. The DDB will yield 4% and mature in 2023.

The bank advises that the DDB will be held-to-maturity and consequently mark-to-market valuations would not be required post January 2012.

UB raised Rs. 375 million through an IPO in February 2011, thereafter it acquired a 51% stake in National Asset Management Ltd (NAMAL, a fund management company). In November 2011, UB and ShoreCap II (an international foreign investment fund) acquired 81.3% and 18.6%, respectively, of voting shares of The Finance Guarantee (TF&G, a distressed finance company that was part of the Ceylinco group). In December 2011, UB announced that 6.8% of its stake would be sold to UB’s shareholders.

The NAMAL investment will provide UB with additional fee-income sources through NAMAL unit trust activities and cross-selling opportunities to NAMAL clientele. Taken together and subsequent to the proposed 6.8% share sale, these two investments accounted for Rs. 881 million of UB’s capital.

UB’s total capital adequacy ratio was 28.0% at Q311 (2010: 34.5%). Driven by the recent equity raising programs, the bank was able to fund loan growth, and thereby increasing its profitability ratios (ROA: to 1.2% in Q311, 2010: 0.9% at 2010) and reducing the impact of the DDB.