Sep 19, 2017 (LBO) – Fitch Ratings has assigned Sri Lanka Sampath Bank's proposed Basel III compliant subordinated debentures an expected National Long-Term Rating of 'A(lka)(EXP)'. The notes, the first Basel III compliant subordinated debt in Sri Lanka, will total 6 billion rupees, mature in five years and carry fixed coupons and include a non-viability clause and will qualify as regulatory Tier II capital for the bank. The bank plans to use the proceeds to support its loan book expansion and to strengthen its Tier II capital base and the debentures are to be listed on the Colombo Stock Exchange. Fitch Ratings said in a statement that the final rating is subject to the receipt of final documentation conforming to information already received. KEY RATING DRIVERS Fitch rates the proposed Tier II instrument one notch below the bank's National Long-Term Rating of 'A+(lka)' to reflect the notes' subordinated status and higher loss-severity risks relative to senior unsecured instruments. The notes would convert to equity upon the occurrence of a trigger event, as determined by the Monetary Board of Sri Lanka. Sampath's National Long-Term Rating is used as the anchor rating because the rating reflects the bank's standalone financial strength. Fitch believes that the bank's standalone credit profile best indicates the risk of becoming non-viable. Fitch has not differentiated the notching on the proposed notes from the notching on Sampath's legacy Tier II notes. This is because we assume that the authorities would step in late, moving the point of non-viability close to liquidation. The legacy Tier II notes will taper off by end-2021. Fitch has not applied additional notching to the notes for non-performance risk, as they have no going-concern loss-absorption features, in line with Fitch's criteria. Sampath's ratings reflect its weaker capitalisation and higher risk appetite relative to peers, which counterbalance its growing franchise and satisfactory asset quality. The Negative Outlook on Sampath's rating reflects Fitch's expectation of further deterioration in the bank's capitalisation as a result of high loan growth. The bank expects to raise LKR7.6 billion in 4Q17 from a rights issue announced in July 2017. We expect the rights issue along with retained profits to boost the Tier I ratio to over 9% by end-2017 (8.5% at bank level at end-June 2017). In addition, the proposed Basel III Tier II debt would increase the total capital ratio to over 13% by end-2017 (12.2% at end-June 2017). The bank has to meet regulatory Tier 1 and total capital ratio ratios of 8.875% and 12.875% by end-2017. These requirements will be raised to 10% and 14% by end-2018, respectively. RATING SENSITIVITIES The rating of the notes would move in tandem with Sampath's National Long-Term Rating. Our Outlook on Sampath could be revised to Stable if it can demonstrate a fundamental/sustainable improvement in its capital buffers commensurate with its risk profile. Failure to sustain a reasonable buffer above rising regulatory capital requirements, increased risk taking or a sharp decline in asset quality could lead to a downgrade.