The rating is also constrained by the Bank's low profitability given the low-yielding deep-discount bond, 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."
Union Bank was restructured after posting negative equity in 2002.
It transferred 600 million rupees in cash and 978 million rupees worth of non-performing loans to a Special Purpose Vehicle in return for a 20-year Deep Discount Bond guaranteed by Sampath Bank PLC.
Sampath Bank was involved in Union Bank's restructuring process and also made equity infusions.Several equity infusions occurred between 2003 and 2007 from both existing and new shareholders, which increased equity to 1.5 billion rupees as at the third quarter 2009.
"Given Union Bank's low profitability due to the low yielding Deep Discount Bond and the resulting constraints in generating internal capital, Fitch notes that achieving the 2.5 billion rupee minimum capital requirement by the first half 2010 would require a further equity infusion of approximately 1 billion rupees."
"Union Bank's management has informed Fitch that investors are committed to infusing this balance equity by the stipulated deadline."
Non-performing loans deteriorated in the third quarter 2009, while its loan book remained flat amidst challenging macroeconomic conditions.
As a result, Union Bank's gross loans increased to 11.6 percent in the third quarter of 2009.
"Focused recoveries in the period ensured that 'advances in arrears more than 12 months' remained static in nominal terms throughout the period."
Union Bank received Central Bank approval to open five new branches – mostly in the Northern Province – in the third quarter of 2009.
Increased branch expansion is expected to provide Union Bank with opportunities to increase its scale of operations in terms of lending and deposits.
Union Bank is currently ramping up credit controls and personnel to create capacity to handle increased lending volumes in its new and existing network, Fitch said.
Established in 1995, Union Bank is a small commercial bank with 14 branches and an asset base of 13.3 billion rupees as at the third quarter 2009.
Sampath Bank was the single largest shareholder in Union Bank, holding 17.7 percent of issued capital over the same period.