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Wednesday October 20th, 2021
Banking

Sri Lanka’s SDB ‘BB+(lka)’ rating confirmed by Fitch amid strong credit growth

ECONOMYNEXT – Fitch Ratings has confirmed a ‘BB+ (lka)’ domestic rating of Sri Lanka’s Sanasa Development Bank’s (SDB) with a stable outlook, saying the bank has high loan growth but has boosted its capital.

“Our assessment of the high-risk appetite also captures SDB’s aggressive loan growth, which was at 19.5 per cent in 2020 relative to the sector’s 11.9 per cent and the peer median of 8.9 per cent,” the rating agency said.

The bank has raised 3.6 billion rupees of capital in August 2021 through a secondary public offering and 1.5 billion rupees in equity capital in December 2020.

“The capital infusions were prompted by the need to replenish the bank’s capital buffers,” Fitch Ratings said.

“We do not expect near-term pressure on SDB’s liquidity as the bank has not fully utilized the proceeds from the recent fund raising.”

The bank’s capital consumption is high compared with its peers due to loan growth that has outpaced internal capital generation, which, together with its exposure to more vulnerable customer segments, could exert pressure on capital buffers.

“That said, we believe SDB’s capital buffers are likely to remain adequate to absorb credit cost shocks in the near term, supported by its gradually improving profitability through increasing operating scale, which will likely benefit its income generation and cost efficiency,” Fitch said.

The bank had boosted credit despite weak operating conditions in the economy.

SDB’s stage 3 impaired loan-to-gross loan ratio fell to 6.4 per cent by end-2020 from 7.0 per cent at end-2019 due to strong loan growth.

SDB’s operating profit/risk weighted assets has increased to 2.1 per cent in 2020 from 1.6 per cent at end-2019 due to low impairment charges, supported by regulatory leniency on bad-loan classification.

“Continuing regulatory relief from the extended moratorium by the Central Bank of Sri Lanka could push the recognition of impairment into 2022,” Fitch said.

SDB has also moved in to digital channels to reach its customer segments, which Fitch says should help the bank to reduce its high cost-to-income ratio, which fell to around 63 per cent by end-June 2021 from 69 per cent. at end-2019.

Read the full statement:

Fitch Ratings – Colombo – 29 Sep 2021: Fitch Ratings (Lanka) Limited has affirmed
the National Long-Term Rating of SANASA Development Bank PLC (SDB) at
‘BB+(lka)’. The Outlook is Stable.

KEY RATING DRIVERS

SDB’s rating is highly influenced by Fitch’s assessment of the operating
environment and its high risk appetite as reflected in the bank’s larger-than-peer exposure to SMEs, which are highly susceptible to interest rate cycles, as a product of its business model.

Our assessment of the high risk appetite also captures SDB’s aggressive loan growth, which was at 19.5% in 2020 relative to the sector’s 11.9% and the peer median of 8.9%.

The operating environment for Sri Lankan banks remains challenging. Real GDP
contracted by 3.6% in 2020 as key economic sectors were severely disrupted by the
Covid-19 pandemic and the lockdowns that followed. We expect economic growth
to rebound to 3.8% in 2021 and 3.9% in 2022, but this forecast is highly uncertain and depends on the path of the pandemic.

We estimate SDB’s common equity Tier 1 ratio (CET1) was around 13.4% at endAugust 2021 (including the profit for the period) after a LKR3.6 billion capital infusion through a secondary public offering. The bank also raised LKR1.5 billion in equity capital in December 2020, which lifted its CET1 ratio to 9.9% from 8.2%. The capital infusions were prompted by the need to replenish the bank’s capital buffers.

SDB’s capital consumption is high compared with its peers due to loan growth that
has outpaced internal capital generation, which, together with its exposure to more vulnerable customer segments, could exert pressure on capital buffers.

That said, we believe SDB’s capital buffers are likely to remain adequate to absorb credit cost shocks in the near term, supported by its gradually improving profitability through increasing operating scale, which will likely benefit its income generation and cost efficiency.

We expect SDB’s profitability to improve in the medium term, underpinned by better income generation and cost efficiency.

SDB has increased its reliance on digital channels to increase its penetration into its customer segments, which should help the bank to reduce its high cost-to-income ratio, which fell to around 63% by end-June 2021 from 69% at end-2019.

SDB’s operating profit/risk-weighted assets increased to 2.1% in 2020 from 1.6% at end-2019 due to low impairment charges, underpinned by regulatory forbearance on bad-loan classification.

The ratio dropped to 1.9% by end-1H21 as the bank increased its provisioning amid a re-imposition of lockdown measures.

SDB’s asset-quality risk is likely to persist, similar to its peers, stemming from our assessment of the operating environment. Continuing regulatory relief from the extended moratorium by the Central Bank of Sri Lanka could push the recognition of impairment into 2022.

This will be exacerbated by SDB’s fast loan growth, particular to SMEs, which may lead to a significant increase in impaired loans as the portfolio seasons.

SDB’s stage 3 impaired loan-to-gross loan ratio fell to 6.4% by end-2020 from 7.0% at end-2019 due to loan growth that exceeded the absolute increase in impaired loans.

Loan-loss allowance covered around 48.8% of stage 3 loans at end-2020 (2019: 46.8%), which compared well with the peer median of 42%, reflecting SDB’s collateral-backed lending.

We do not expect near-term pressure on SDB’s liquidity as the bank has not fully
utilised the proceeds from the recent fund raising.

Its loan/deposit ratio remained flat at 113.4% at end-1H21 (2020: 113.6%), which is higher than its peer median of 89.4%, reflecting SDB’s lower-than-peer deposit
share in the funding mix (1H20: SDB 79% versus peer median 89%).

Nonetheless, the share of deposits from Sanasa societies and co-operatives of around 31% was significant as of end-2020. These deposits are likely to remain a stable source of funding for SDB.

The bank has accessed funding from foreign development-finance agencies to support its business model of serving the rural and underbanked
communities in Sri Lanka.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to a positive rating
action/upgrade:

An upgrade of SDB’s rating is contingent on a sustained improvement in its credit
profile relative to the universe of Sri Lankan rated entities.

Sustained improvement in SDB’s capital buffers commensurate with its high-risk appetite, particularly through improved internal capital generation, alongside an enhanced market share, would lead to positive rating action.

Moderation in SDB’s risk appetite, particularly through a slowdown in loan expansion into highly vulnerable market segments, would also be positive for the rating.

Factors that could, individually or collectively, lead to negative rating
action/downgrade:

SDB’s rating could be downgraded if capital buffers were to be substantially eroded due to weakening asset quality, higher under-provisioned impaired loans or
prolonged rapid loan growth in the more vulnerable customer segments, which
indicates a significantly higher risk appetite.

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