March, 28, 2025
Fitch Ratings has assigned Sri Lanka-based State Mortgage & Investment Bank (SMIB) a first-time National Long-Term Rating of 'BB(lka)'. The Outlook is Stable.
Intrinsic Profile Drives Rating: SMIB's rating reflects its standalone financial strength and factors in its weaker-than- peers funding profile that has led to balance sheet mismatches. Risk controls are showing improvement, but still have room for enhancement, and the bank's capital position is not as strong as peers. SMIB has a long operating history, but its franchise remains modest as reflected in its negligible market share (0.3% of sector assets at end-3Q24). SMIB's credit profile, similar to peers, is influenced by Sri Lanka's improving, yet vulnerable, operating environment, and exposure to the sovereign.
SMIB is a licensed specialised bank that is fully owned by the government of Sri Lanka (CCC+). Its core business is retail focused, with the majority of its exposure to personal loans, housing finance loans backed by Employee Provident Fund (EPF) balances and mortgage loans.
Improving Operating Environment: The operating environment for Sri Lankan banks continues to stabilise, as macroeconomic and systemic risks recede, supporting the recovery in banks' operational flexibility. Further progress depends on the sovereign's creditworthiness, given the strong link between the sovereign's financial health and banks' operating conditions. We believe an improvement in underlying borrower creditworthiness would ease loan-quality stress, while an uptick in private credit demand would boost new business prospects.
Constrained Business Profile: SMIB's lending activities remain limited given its mandate as defined in its governing act, the State Mortgage and Investment Bank Law No. 13 of 1975. This has resulted in SMIB's concentration in housing finance, including EPF and unsecured personal loans (95% of gross loans at end-2024) which we expect to persist. SMIB's funding franchise is evolving, given its narrower offering compared with peers. That said, SMIB's ability to generate business volume should be aided by Sri Lanka's improving economic conditions.
High-Risk Retail Exposure: SMIB's concentrated retail lending and structural balance-sheet risk influence our risk profile assessment. The bank's main product is unsecured personal loans, at 40% of loans, which we regard as higher risk, but we expect the share to moderate in the medium term. SMIB's structural balance-sheet risk exposes it to net interest margin volatility, as seen during Sri Lanka's recent economic crisis, owing to the duration differences of its assets and liabilities.
Below-Peer Loan Quality: SMIB's asset-quality metrics are weaker than peers' with the impaired loan ratio at 33.0% at end-2024 (end-2023: 26%) compared with the Fitch-rated small bank average of 20.8%. This stems from SMIB's exposure to housing finance and unsecured retail lending. We expect the rising exposure to EPF-backed loans to weigh on the bank's reported impaired loan ratio, despite their materially lower loss rates due to periodic settlement from the central bank. Excluding EPF-backed loans, the impaired loan ratio is 15pp lower. A decline in the share of unsecured lending, which carry higher loss rates, if sustained, would be positive for its loan quality.
Volatile Profitability: SMIB experiences greater cyclical earnings volatility than peers, a trend we expect to persist. This was evident during the country's recent economic crisis, when SMIB's operating profit/risk-weighted assets ratio dropped to -4.6% in 2023, from 2.3% prior to the crisis in 2021, following the spike in interest rates. Having returned to profitability (end-2024: 1.8%), we expect the ratio to modestly improve over the medium term, helped by the favourable interest rate environment and risk density benefits from the higher EPF loan share.
Modest Capital Base: SMIB's small capital base falls short of the regulatory minimum threshold. We believe the limited access to capital makes the bank's capitalisation susceptible to profitability and asset-quality shocks. SMIB's common equity Tier 1 capital ratio of 19.3% at end-2024 was slightly below the Fitch-rated small bank peer average of 20.1%. Residual risk to capital from impaired loans remained high at 246% at end-2024 (peer average: 83%), given SMIB's large EPF loan exposure.
Funding and Liquidity Challenges: SMIB's asset-liability mismatches from its longer-tenor loan book and short-tenor concentrated deposit base, relative to peers, weighs on its funding and liquidity profile. Its loan/deposit ratio of 93% at end-2024 was higher than the 86% of small bank peers, while its liquidity position was weaker than peers' (liquidity coverage ratio of 105%, peer average: 310.5%, regulatory minimum: 100%). We expect the state-related deposits and the bank's focus on expanding reach to keep its funding challenges at bay.
The National Long-Term Rating is sensitive to a change in the bank's creditworthiness relative to other Sri Lankan issuers rated on the National Rating scale.
A deterioration in SMIB's key credit metrics beyond our base-case expectations relative to peers would also pressure the rating, which is driven by the bank's intrinsic financial strength. This may include a large decline in its liquidity position, which would signal elevated default risk relative to peers. A sustained deterioration in SMIB's capital position owing to losses from interest rate risk in the balance sheet or a higher-than-expected increase in the share of unprovisioned impaired loans in comparison to peers may also pressure the bank's rating.
A sustained improvement in key credit metrics beyond our base-case expectations relative to peers could lead to a rating upgrade. This would include a sustained improvement to SMIB's liquidity profile, including a reduction in structural mismatches on its balance sheet and earnings volatility in comparison with peers. This is in addition to maintaining adequate capital buffers commensurate with its high-risk appetite, which may include a demonstration of capital access, if necessary.
SMIB has a 1.78% equity stake in Fitch Ratings Lanka Ltd. No shareholder other than Fitch, Inc. is involved in the day- to-day rating operations of, or credit reviews undertaken by, Fitch Ratings Lanka.
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