Fitch Affirms National Development Bank at ‘A+(lka)’; Outlook Stable
Fitch Ratings has affirmed National Development Bank PLC’s (NDB) National Long-Term Rating at ‘A+(lka)’. The Outlook is Stable. At the same time Fitch has affirmed the bank’s outstanding subordinated debt at ‘A-(lka)’. Key Rating Drivers NDB’s National Long-Term Rating is driven by its intrinsic credit profile and reflects its modest franchise and weaker financial profile relative to higher-rated peers.
This is despite the recent capital infusion that bolstered NDB’s deteriorating capitalisation. Our assessment of the operating environment for Sri Lankan banks reflects the risk of doing banking business due to the sovereign’s credit profile (CCC) and the impact of the coronavirus pandemic. Sri Lanka’s economy contracted by 3.6% in 2020, and we expect GDP growth of 3.8% in 2021. Our forecasts are subject to a high degree of uncertainty as they depend on the path of the pandemic. The outlook on the operating environment assessment remains negative due to the potential for deterioration in the sovereign credit profile and pressure on domestic operating conditions beyond our expectation independent of changes in the sovereign rating.
The operating environment for Sri Lankan banks has a high influence on banks’ ratings, as it is likely to constrain their intrinsic credit profiles through its effect on financial and non-financial key rating factors. We expect pressure on NDB’s asset quality to persist in the near to medium term, stemming from our assessment of the operating environment. Its impaired-loan ratio based on stage 3 loans rose to 8.3% by end-2020 from 6.9% at end-2019. Pressure on impaired loans is likely to manifest across an extended period due to relief measures that halted the recognition of credit impairments and ongoing discretionary restructuring.
NDB’s loan-loss allowances increased to 4.3% of gross loans by end-1Q21 and 4.0% by end-2020 from 3.1% at end-2019 in recognition of asset quality risks. We expect NDB’s earnings and profitability to remain under pressure from high credit costs despite the potential for improved pre-provision profit buffers. Operating profit/riskweighted assets decreased to 2.2% in 2020 from 2.6% in 2019 alongside a sharp increase in impairment charges that consumed 43% of pre-impairment profits in 2020, before rebounding to 3.3% in 1Q21. NDB’s net interest margins could remain thin due to its sustained focus on corporates and a smaller base of lower-cost current and savings deposits.
Profitability could be supported through improved cost efficiencies and increased focus on non-interest income. The capital infusion of LKR9.5 billion from a rights issue and private placement in 2Q21 lifted NDB’s common equity Tier 1 (CET1) ratio to 10.8% by end-1H21 from 9.7% at end2020. The ratio has been declining as a result of the strong increase in loans (CAGR) of 17% over 2017-2020) alongside the bank’s pursuit of enhancing its asset base and market position. Medium-term capitalisation hinges on the pace of expansion as NDB seeks to cross LKR1 trillion in assets in 2025, after reaching LKR500 billion in assets in 2019 ahead of its 2020 target.
NDB’s loan/deposit ratio decreased to an average of 99% over 2017-2020 from 105% over 2016-2019. Its exposure to project lending (24% of gross loans) that is financed through non-deposit funding sources and its appetite for loan expansion could result in the loan/deposit ratio remaining high in the medium term relative to higher-rated peers. The share of foreign currency funding is significant, exposing the bank to challenges in access to - and pricing of - foreign-currency funding due to the sovereign’s credit profile.