"With its copious asset base and over-capitalization, NDB Bank may be loading up on too much into a good thing," Nanayakkara said.
"It appears to be an obese lumbering giant in a sea of slim, swift, muscular competitors. To get its market performance up NDB Bank may need to go through a diet of capital restructuring."
NDB chief executive Eran Wickramaratne says the bank is erring on the side of prudence even if there appears to be too much capital.
"I think on the face of it if you look at ratios in isolation, it is way beyond requirement," says Wickramaratne.
"If you look beyond the ratios I think absolute numbers are not very big, generally there is a capital shortage in the industry.
"It is prudent for domestic and international reasons to be well-capitalized."
The bank also has the lowest cost to income ratio at 45 percent, compared to 49 percent for Commercial Bank and 59 percent for Hatton National Bank, says Nanayakkara. It also has low bad loans which are well provided for.
But low bad loans could also be an indicator of risk-averseness.
Nanayakkara says with the Central Bank requiring capital adequacy of 10 percent, 14 percent would be enough to buffer the bank against any future shocks.
In the meantime, however, the excess capital is dragging down profitability. Nanayakkara works out NDB's return on equity at 13.6 percent compared to 16.5 percent at Commercial Bank of Ceylon.
Total shareholder returns, inclusive of dividends and share price gains, were a negative 13 percent at NDB in 2007 compared to a positive 57 percent for Hatton National Bank and 17 percent for Commercial Bank, according to Nanayakkara's calculations.
Nanayakkara said if the bank does not have enough opportunities to lend in the current economic environment it should return the capital to shareholders who could make better use of it.
T-bills are returning 18 percent after a 10 percent tax while a credit card loan of a small shareholder costs about 45 percent a year, indicating a massive opportunity cost in holding onto NDB shares.
Nanayakkara says the bank should pay an extraordinary dividend and distribute capital using internal assets which could be liquidated especially in a subsidiary, or even borrowing new funds.
He says the bank should look at paying out 40 or even 50 rupees per share in dividends.
Under Sri Lanka's new company law a company could also buy back its own shares which would automatically push up earnings per share and profits, but Nanayakkara says the procedure is cumbersome.
He says the bank has been sitting on the capital for a while and has not made public any plans to use the money, especially for acquisitions which it is well positioned to do. If there are no acquisition plans it further strengthened the case to return capital.
But Wickramaratne says the bank has plans for "long term sustainable" growth and creating shareholder value with a "progressive forward looking management" and it is not "opportune" to distribute capital.
"Given that we have excess capital, clearly we have expansion plans to utilize it and give the shareholders a sustainable long-term return that is acceptable," Wickramaratne said.
"We are working on organic strategy, the expansion of the business and the retail franchise and non-organic opportunities," he said.
"So we are certainly open to looking at opportunities."
Nanayakkara says NDB's excess capital is making the bank a sitting duck for take-over where management time is used up in fighting off potential suitors instead of focusing on its core business of lending.
Nanayakkara has been associated with bringing Quest Investments to the country originally. The firm's Goldquest scheme spread like wildfire in the country and activists fell foul of authorities over foreign exchange and customs fraud.
Later the country also brought in a specific anti-pyramiding law to counter multi-level marketing schemes. Quest Investments has already sold out but some investors who could not prove their bona fides were refused shareholder registration by NDB.
Under Sri Lankan law there are limits on bank ownership and connected parties.
NDB has also briefly flirted with a merger with Commercial Bank which fizzled out later.
Wickramaratne says possibilities of future take-over attempts which will consume more management time are hypothetical.
"That question does not arise," he says. "Basically we welcome any reputable shareholder. There are certain laws everybody needs to work within."
Most foreign controlled listed firms including Ceylon Tobacco, Nestle and Chevron Texaco pay out high dividends to shareholders and run tight ships with lean balance sheets.
In Sri Lanka it is unusual for shareholders to press management to return capital.
Nanayakkara however has been associated with Sri Lanka's capital markets since its opening and has been involved in Asian Hotels Corporation and also ran the Bureau of Infrastructure Investment for the government at one time.. Download complete analysis by Mano Nanayakkara .