Fitch Ratings Lanka this week affirmed Union Bank of Colombo Ltd's (UB) National Long-term rating at 'BB+(lka)'. A press release from the agency stated that the rating reflects UB's moderate asset quality and lack of a broad deposit base. Also, the rating remains constrained by the bank's low profitability given the low-yielding deep-discount bond (DDB) and challenges to the scalability of its operations.

The positive outlook reflects the bank's plans to raise equity in 2010 and the expansion plan underway that is expected to improve its profitability. UB was restructured after posting negative equity in 2002, after the bank transferred Rs.600 million in cash and Rs.978 million of Non Performing Loans (NPL’s) to a special-purpose vehicle (SPV), in return for a 20-year DDB guaranteed by Sampath Bank which was involved in UB's restructuring process and also made equity infusions.

Thereafter the Central Bank of Sri Lanka in 2006 increased the minimum capital requirement (MCR) for licensed commercial banks to Rs.2.5 billion to be met by H110 (extended from the previous FYE09 deadline).

The release stated that several equity infusions occurred from FY03 to FY07, from both existing and new shareholders, which increased equity to Rs.1.5bn at Q309. Given UB's low profitability due to the low yielding DDB (17% of interest earning assets at Q309 and yield of 4%) and the resulting constraints in generating internal capital, Fitch notes that achieving the Rs.2.5 billion MCR by H110 would require a further equity infusion of approximately Rs.1 billion. UB's management has informed Fitch that investors are committed to infusing this balance equity by the stipulated deadline.