Fitch assigns Lankaputhra first-time BBB-(lka) rating; outlook positive

Fitch Ratings has assigned Lankaputhra Development Bank Limited (LDB) a National Long-Term Rating of 'BBB-(lka)'. The Outlook is Positive. KEY RATING DRIVERS LDB's National Long-Term Rating reflects Fitch's expectation that the bank would receive extraordinary support from the Sri Lankan sovereign, if required. Fitch believes the sovereign's propensity to extend support to the bank stems from the state's 100% direct holding and LDB's development banking role in supporting the state's initiatives for micro-, small- and medium-scale industries. However, Fitch sees the potential for state support for LDB as being much lower than for the country's larger state-owned banks. The sovereign's ability to provide support is reflected in Sri Lanka's 'B+'/Stable rating. The Positive Outlook on LDB's rating reflects our expectation that sovereign support is likely to increase if the bank's operations were combined with those of a larger entity, thereby becoming of greater systemic importance. Fitch believes smaller state banks such as LDB could be part of the government's broader consolidation agenda amid enhanced minimum capital requirements. LDB is one of the smallest banks in Sri Lanka with a market share of less than 0.1% of the banking sector's total assets, loans and deposits as of end-September 2017. It has eight branches across seven provinces and mainly relies on non-deposit funding. LDB's business model is predominantly focused on development-related lending via project loans to SMEs and micro-finance lending (65.3% of total lending at end-1H17), which is in line with the bank's role as stated in its articles of association. The share of development-related lending has declined alongside the increased exposure to leasing (24.2% at end-1H17) and institutional lending (6.1% at end-1H17). The bank's loan book accounted for just 45.9% of its assets by end-3Q17 (2016:42.3%), which is lower than that of its peers, although the ratio had been increasing with loan growth until end-September 2017. LDB was established in 2006 as a Licensed Specialised Bank and had assets of LKR9.2 billion at end-September 2017. The government has proposed, through the National Budget 2016, to merge LDB with Regional Development Bank, which is 100% state owned. If this merger were to materialise, the combined entity would have assets of LKR160 billion. RATING SENSITIVITIES The rating is sensitive to Fitch's expectations of sovereign support. Fitch may upgrade LDB's rating if the bank's importance and linkages to the sovereign were to strengthen through an amalgamation with another bank. Fitch will reassess our expectations of sovereign support if the authorities were no longer considering LDB for a merger with a larger entity, if state ownership were to decline or LDB's development role were to change. Fitch could downgrade the rating by several notches if we were to conclude that the bank can no longer rely on sovereign support as the bank's intrinsic strength is materially weaker.