Fitch Affirms Regional Dev. Bank at ‘BBB+(lka)’/Stable

Fitch Ratings-Colombo/Mumbai/Singapore-23 July 2012: Fitch Ratings Lanka has affirmed Regional Development Bank’s (RDB) National Long-Term rating at ‘BBB+(lka)’. The Outlook is Stable.

RDB’s rating derives support from its 100% state ownership. The Stable Outlook reflects Fitch’s expectations of continued moderate state support in the event of stress. The rating is, however, constrained by the bank’s relatively small asset base by local standards and, therefore, relatively less systematic importance compared with other large state-owned banks.

The rating could be upgraded if the systemic importance of RDB were to increase, such as through a higher market share of rural lending or an enlarged franchise. Conversely, the rating would be downgraded if the state’s ability or willingness to support to the bank were to weaken, or if a significant deterioration in liquidity or solvency were to occur.

RDB’s exposure remains predominantly to farmers and SMEs in rural areas. Credit concentrations remain low, reflecting the granular nature of RDB’s micro finance loans (MFI loans). Sector concentration is mainly to agriculture/MFI loans (42% of loans at end-2010; 39% at end-2009) and pawning loans (43%; 37%). Many of the agricultural loans are backed by central bank poverty alleviation refinance schemes. The balance loan book comprises small loans for duration of three to four years, mainly towards house renovation mostly to government servants.

Historically, delinquency trends have followed the Maha and Yala agricultural seasons, and worsened when floods/droughts affected agricultural zones. Non-performing loans (NPLs)/gross loans improved to 1.8% at end-March 2012 (end-Q112) from 2.2% at end-2011 (2.9% at end-2010) due to recoveries resulting from close monitoring of the loan book via its field officers RDB’s loan loss coverage on NPLs was better than the sector average at 66% at FY11 (FY10: 68%)

Although net interest margins (NIMs) declined to 7.4% in FY11 from 9.4% in FY10 due to lower interest yields, improvements in RDB’s cost structure and lower effective tax rates in 2011 (FY11: 46%, FY10: 77%) enabled RDB to post improved return on assets (ROAs: 1.9% in FY11, FY10: 1.0%). Fitch expects NIMs to decline further in FY12 as interest yields continued to reduce and cost of funds increased in 1Q12.

Fitch expects that RDB’s ROA could fall below 1.9% in 2012 as the full effect of the collective agreement on staff pay and cost escalation for system integration and branch expansion is factored in the latter half of 2012. Reduced profits, combined with annual dividend obligations to the government, will likely weigh on internal capital generation. RDB’s wide network in the rural sector and its state franchise have ensured highly granular strong deposit growth.

Also, around 7% of RDB deposits were captive deposits connected to its MFI loan book in FY11.