Fitch rates NDB Bank’s sub debt ‘AA-’; Affirms ‘AA’ National LT Rating

Fitch Ratings Lanka has assigned National Development Bank PLC’s (NDB) proposed subordinated debentures of up to LKRs.1bn. a National rating of ‘AA-(lka)’. The agency has also affirmed NDB’s National Long-term (LT) rating at ‘AA (lka)’ with a Stable Outlook.

The ratings reflect NDB’s strong financial profile in terms of its capitalisation, asset quality and profitability compared with local peers. The ratings are constrained by its developing franchise and shorter history as a licensed commercial bank (LCB), which is reflected in a less diversified loan portfolio and a more modest deposit base. NDB’s ratings may be upgraded if the bank consolidates its franchise as an LCB while maintaining a strong financial profile. A significant weakening of NDB’s financial profile on a sustained basis eroding its capital position could result in a downgrade.

Since its transformation to a LCB in 2005, NDB has operated as a niche player, focusing on selected customer segments. However, management is gradually repositioning the bank over the medium term, and has set about extending its product offering and expanding its customer reach. To facilitate the shift in NDB’s focus, accompanying structural changes are being implemented, including the merging of certain business lines, the migration of the core banking systems onto a single platform, and centralisation of processing for most business lines.

NDB’s equity/assets ratio of 14.8% and core and total capital adequacy ratios of 17.8% and 20.3% at end-2010 remained well above larger LCB peers’. However, Fitch notes that NDB’s capitalisation could get diluted if equity accretion fails to keep pace with the expected increased asset growth and with the gradual shift in its business model. NDB’s net non performing loan (NPL)/equity ratio (excluding discretionary provisions on performing loans) remained low at 2% at end-2010.

Core profitability as measured by return on assets (adjusted for gains on equities and government securities) increased to 1.6% in 2010 (1.3% in 2009), driven by provision reversals and higher non-interest income. While NDB’s lean cost structure has supported profitability, anticipated cost increases as the bank builds scale could impact profitability.

NDB’s gross NPL ratio remained among the lowest in the sector and decreased to 1.9% at end-2010 (2.6% at end-2009), reflecting its cautious approach to lending. While loan growth had on average been below the sector in the past, it accelerated to 28.9% in 2010 and 9.2% in Q1FY11 (the three months ended 31 March 2011). Project loans remained considerable, accounting for 19.4% of loans at end-2010 while loans to corporate (other than project loans including loans to SMEs) and retail customers accounted for 54.3% and 26.3% respectively. While NPLs could increase as the loan book expands and seasons, NDB’s asset quality is expected to compare favourably with peers. Further, NDB continues to maintain additional discretionary provisions (19% of total provisions at end-2010).

NDB’s deposit funding increased further to 55% at end-2010 from 33% at end-2006 but remained under that for larger LCB peers with more mature franchises. Fitch notes that current and savings accounts accounted for only 29% of total deposits at end-2010. Credit lines backing project loans declined further to 14% at end-2010 with 35% maturing by 2015. Consequently, NDB would need to secure alternative sources of term funding, such as the proposed subordinated debt issue, to manage potential maturity mismatches.

NDB was established in 1979 as National Development Bank of Sri Lanka, a licensed specialised bank engaged in the provision of project finance. It accounted for 3% of banking sector assets at end-2010 and operates through 48 branches.