Sri Lanka Fitch upgrades Ceylon Income Fund to ‘A(lka)’
EconomyNext – Fitch Ratings has upgraded the National Fund Credit Quality Rating assigned to the Ceylon Income Fund to ‘A(lka)’ from ‘A-(lka)’.
The fund primarily invests in corporate debt instruments and is managed by Ceylon Asset Management (CAM).
Fitch said the one notch upgrade to ‘A(lka)’ is driven by the fund’s stable weighted average rating factor, improving rating distribution, and guidelines to limit its exposure to debt rated ‘BBB(lka)’ to a maximum of 25 percent of the overall fund.
The full rating report follows:
Fitch Ratings-Colombo-28 January 2015: Fitch Ratings has upgraded the National Fund Credit Quality Rating assigned to the Ceylon Income Fund to ‘A(lka)’ from ‘A-(lka)’. The fund primarily invests in corporate debt instruments and is managed by Ceylon Asset Management (CAM). The National Fund Volatility Rating is ‘V-NR’.
KEY RATING DRIVERS:
The one notch upgrade to ‘A(lka)’ is driven by the fund’s stable weighted average rating factor (WARF), improving rating distribution, and guidelines introduced by the manager to limit the fund’s exposure to debt rated ‘BBB(lka)’ to a maximum of 25% of the overall fund. However, in Fitch’s opinion the fund is still moderately concentrated.
Fitch has rated the fund on the basis of its understanding that the majority of investors in the fund are not exposed to mark-to-market risk. Instead Fitch understands that the vast majority of investors are duration matched, that is, investors enter the fund with a specified maturity that is matched to the maturity of securities in the fund. Furthermore, Fitch believes that the secondary market for the corporate instruments held by the fund has weak liquidity. Given the absence of a viable secondary market and the fact that the majority of the fund’s investors are not exposed to market risk, Fitch does not consider a National Fund Volatility Rating applicable and as a result the rating is ‘V-NR’.
ASSET CREDIT QUALITY:
The portfolio is exposed to Sri Lanka corporate debt instruments, bank deposits, securities issued or guaranteed by banks and government securities. The fund’s WARF is consistent with a National Fund Credit Quality Rating in the ‘A(lka)’ National Fund Credit Quality Rating category. The WARF has remained in the ‘A(lka)’ category since Fitch rated the fund in September 2012. The fund’s investment guidelines limit it to investment-grade rated issuers only and, since mid-2014, cap its exposure to ‘BBB(lka)’ securities at 25%, a level to which the fund has broadly adhered to date. The majority of issuers in the portfolio are rated in the ‘A(lka)’ and ‘AA(lka)’ rating categories. Around 8.4% of securities in the portfolio were on Negative Outlook as of December 2014.
In Fitch’s opinion, the fund is moderately concentrated with the five largest issuers accounting for around 63.5% of the portfolio as of December 2014. Consistent with its rating criteria, Fitch has therefore conducted deterministic stress tests on the portfolio. Based on its analysis Fitch believes the fund has a sufficient capacity to withstand negative rating migration before it would be downgraded to the ‘BBB(lka)’ National Fund Credit Quality Rating category.
PORTFOLIO SENSITIVITY TO MARKET RISK:
Around 97% of the fund’s investors are duration matched. These investors are therefore not exposed to mark-to-market risk. The remaining 3% of investors in the fund may face minor daily mark-to-market volatility owing to the fund’s use of mark-to-market pricing (based on the yield curve published by the Unit Trust Association of Sri Lanka) for securities with a residual term to maturity of over one year (implemented since January 2013).
The fund is regulated by the Securities and Exchange Commission of Sri Lanka under the Unit Trust Code, 2011. The fund’s trustee is Deutsche Bank Sri Lanka, a branch of Deutsche Bank AG (A+/Negative/F1+). The fund, launched in 2010, has been growing. Its total assets under management of approximately LKR2.7bn at end-2014 was about five times the amount a year earlier.
Fitch considers CAM suitably qualified, competent and capable of managing the fund. The investment committee has relevant experience and the company has sufficient sources of information on which to base its decision-making process. Fitch considers the systems supporting the fund’s investment activities adequate.
CAM is 21%-owned by Sri Lanka Insurance Corporation Ltd (SLIC; AA(lka)/Stable), 69% by Ceylon Capital Trust (Pvt) Ltd and 10% by Commercial Credit and Finance PLC (CCF). The 350% growth in CAM’s assets under management in 2014 was mainly due to the growth in Ceylon Income Fund. CAM broke even in 4Q14 aided by the growth in assets under management and several cost-cutting initiatives. CAM has been managing funds since 1999. The current management team has been in-place since 2005 and SLIC and CCF invested in the business in 2010 and 2013 respectively.
The ratings assigned to the fund may be sensitive to material changes in its credit quality. A material adverse deviation from Fitch criteria for any key rating driver could cause ratings to be downgraded by Fitch. Specifically, Fitch would expect to downgrade the National Fund Credit Quality Rating in the event of sustained deterioration in portfolio credit quality. The rating is sensitive to the fund’s exposure to lower-rated securities. Any increase in exposure to ‘BBB(lka)’ rated securities, particularly if the exposure exceeds 25% of the portfolio, could cause Fitch to downgrade the rating.
Additionally, the rating is sensitive to any increase in the level of concentration risk posed by the fund. If the three largest issuers account for more than 50% of the portfolio, Fitch would consider the portfolio concentrated, in line with the concentration risk guidelines in its applicable rating criteria. Funds in the ‘A(lka)’ rating category are considered to have high underlying credit quality relative to other entities in the Sri Lankan market. Fitch expects the fund’s assets to maintain a weighted-average portfolio rating of ‘A(lka)’.