RAM downgrades Lankaputhra Development Bank’s ratings to A- from A

RAM Ratings Lanka has downgraded the long-term financial institution rating of Lankaputhra Development Bank (LDB) from A to A-.

Concurrently, the outlook on the long-term rating has been revised from negative to stable while the short term rating has been reaffirmed at P1.

The downgrade reflects the Bank’s fragile credit quality vis-à-vis its peers, despite the marginal improvement in its gross non-performing-loans (NPL) ratio. In addition, the downgrade also reflects LDB’s lack of clear strategic direction which may reduce its systemic importance, and has led to the continued shrinking of its lending portfolio and a persistent decline in its performance. Nonetheless, the ratings continue to be supported by the Bank’s very strong capitalisation, funding and liquidity positions. As a wholly state-owned bank, LDB also derives financial flexibility from the Government.

Meanwhile, the Bank’s weak credit quality and moderate performance continue to weigh down on the ratings.

LDB is a licensed specialised bank (LSB), created by the GOSL as part of its vision of promoting the development of domestic enterprises. LDB focuses on providing funding to start-up small and medium-scale enterprises (SMEs), a segment underserved by other banks due to the inherently higher risks involved. LDB was incorporated in 2006, and was merged with 2 other state-backed development finance institutions in 2008. As at end-December 2011, the Bank remained a small player in the LSB industry, accounting for only 0.98% of the industry’s assets.

LDB’s credit quality is deemed weak owing to the very high delinquency rates in its lending portfolio. While the Bank’s gross NPL ratio improved slightly to 41.25% as at end-December 2011 from 44.34% as at end-December 2010, it remained significantly poorer than its banking peers; the poor credit quality is due to its weak underwriting quality and poor collections arising from its small branch network and lack of parate rights. The Bank’s loan books are also highly concentrated, with its top 20 loans accounting for around half of its entire loan base as at end-December 2011. Nevertheless, LDB’s overall asset quality is supported by its substantial investments in government securities and deposits in state-owned commercial banks, which accounted for 67.94% of its assets as at the same date. These low-risk investments somewhat balance out its highly risky lending portfolio, which constituted only 25.90% of its total assets.

We deem that the lack of clear strategic direction had resulted in a contraction of the Bank’s lending portfolio in the last few years. Meanwhile, the downward re-pricing of its loans and investments amid declining interest rates caused LDB’s performance to deteriorate in FYE 31 December 2011 (FY Dec 2011). Investments in government securities accounted for about two-thirds of the Bank’s interest income while the remainder stemmed from loans, reflecting LDB’s asset mix. Net interest income fell Rs. 86.49 million to Rs. 403.87 million in FY Dec 2011 while its net interest margin (NIM) narrowed to 6.09% as at end-December 2011 (end-December 2010: 7.27%) despite LDB’s funding base being dominated by concessional borrowings and shareholders’ funds. Meanwhile, LDB’s cost-to-income ratio of 67.24% as at end-FY Dec 2011 also remained higher than the overall banking peers.

RAM Ratings Lanka opines that LDB’s funding and liquidity positions remain very strong, as reflected by its state funding and liquid-asset ratio of 22.21 times as at end-December 2011 respectively. The Bank’s funding requirements remain fulfilled by its shareholders’ funds and a long-term concessionary loan from Kreditanstalt für Wiederaufbau (KfW), a development bank backed by the German government. Together, these accounted for 91.82% of LDB’s funding base as at end-December 2011, with customer deposits and other borrowings comprising the remainder.

LDB’s capitalisation is viewed to be very sturdy; the Bank’s tier 1 and overall risk weighted capital adequacy ratio (RWCAR) clocked in at 69.85% as at end-December 2011, similar to 69.75% as at end-December 2010. Furthermore, its Rs. 3.90 billion of shareholders’ funds could easily absorb its Rs. 418.65 million of net NPLs as at the same date, with its RWCAR still kept robust at around 65%. Nonetheless, LDB’s deteriorating performance clipped its rate of internal capital generation from 1.27% to only 0.65% over the same span.