Fitch Ratings-London/Colombo-24 September 2012: Fitch Ratings has assigned the Ceylon Income Fund a 'A-(lka)' National Fund Credit Rating. This is the first fund rating assigned by an international rating agency in Sri Lanka. The fund primarily invests in corporate debt instruments and is managed by Ceylon Asset Management (CAM).
KEY RATING DRIVERS:
The 'A-(lka)' National Fund Credit Rating is driven by the fund's weighted average rating factor (WARF) and rating distribution while reflecting Fitch's opinion that the fund is moderately concentrated.
Fitch has rated the fund on the basis of its understanding that the majority of investors in the fund are not exposed to mark-to-market risk. Instead, Fitch understands that the vast majority of investors are duration matched, i.e. investors enter the fund with a specified maturity which is matched to the maturity of securities in the fund. As a result, Fitch does not consider a National Fund Volatility Rating applicable and therefore the National Fund Volatility Rating is 'V-NR(lka)'.
ASSET CREDIT QUALITY:
The portfolio is exposed to Sri Lanka corporate debt instruments, bank deposits and securities issued or guaranteed by banks and government securities. The fund's WARF is consistent with a National Fund Credit Rating in the 'A(lka)' National Fund Rating category. The negative modifier in the fund's 'A-(lka)' National Fund Credit Rating reflects Fitch's view that the fund is moderately concentrated with a top-five issuer concentration of around 75% of the portfolio. Fitch's review of historic portfolio holdings indicates that the fund's credit quality has improved year to date and Fitch expects the fund's weighted average credit quality to remain stable, supported by the fund's investment guidelines which limit it to investments in investment-grade rated issuers only. The majority of issuers in the portfolio are rated in the 'A(lka)' and 'BBB(lka)' rating categories. Around 8% of securities in the portfolio had a Negative Outlook as of July 2012, but no securities were on Rating Watch Negative.
In Fitch's opinion, the fund is moderately concentrated. Consistent with its rating criteria, Fitch has therefore conducted deterministic stress tests on the portfolio. Based on its analysis, the agency believes the fund has a limited capacity to withstand negative rating migration before it would be downgraded to the 'BBB(lka)' National Fund Credit Rating Category. The negative modifier in the fund's 'A-(lka)' National Fund Credit Rating reflects the moderate concentration risk Fitch has identified in the fund.
Around 30% of the portfolio's holdings were over-collateralised as of July 2012. Fitch takes comfort from the presence of collateral, notably in cases where issuers are only rated by a local rating agency. Fitch has afforded no credit above public rating levels in its analysis of the fund (i.e. Fitch has not "notched-up" the ratings of issuers where the exposure is collateralised).
PORTFOLIO SENSITIVITY TO MARKET RISK:
Around 97% of the fund's investors are duration matched, i.e. investors enter the fund with a specified maturity which is matched to the maturity of securities in the fund. These investors are therefore not exposed to mark-to-market risk. Given this profile, Fitch does not consider a National Fund Volatility rating applicable and as a result the rating is 'V-NR'.
The fund is regulated by the Securities and Exchange Commission of Sri Lanka under the Unit Trust Code, 2011. The fund's trustee is Deutsche Bank Sri Lanka, a branch of Deutsche Bank AG ( 'A+/Stable/F1+'). The fund was launched in 2010 and has been growing. As of end July 2012, the fund's total assets under management were approximately LKR450m.
Fitch considers CAM suitably qualified, competent and capable of managing the fund. The investment committee has deep experience and the company has sufficient sources of information on which to base its decision making process. Fitch considers the systems supporting the fund's investment activities satisfactory.
CAM is 25% owned by Sri Lanka Insurance Corporation Ltd (SLIC, 'AA-(lka)'/ Stable) and 75% by Ceylon Capital Trust (Pvt) Ltd (NR). The business is currently in an investment phase and Fitch believes it to be supported by shareholders. CAM has been in existence and managing funds since 1999. The current management team has been in-place since 2005 and SLIC invested in the business in 2010.
As of end-July 2012, CAM's total assets under management (AUM) were approximately LKR760m and it employed 13 staff. Securities and Exchange Commission of Sri Lanka data as of December 2011 indicated that CAM had a market share of 2.6% in a small, but growing fund market. Given CAM's relatively small size and the importance of the fund to CAM, Fitch will closely monitor both the fund and asset manager. The agency expects to conduct an interim review of the fund and manager in March 2013, approximately six months after the initial rating assignment.
Funds in the 'A(lka)' rating category are considered to have high underlying credit quality relative to other entities in the Sri Lankan market. The fund's assets are expected to maintain a weighted-average portfolio rating of 'A(lka)'.
Comparisons between different national fund rating scales or between an individual national and international scale are inappropriate.
The ratings assigned to the fund may be sensitive to material changes in its credit quality. A material adverse deviation from Fitch criteria for any key rating driver could cause ratings to be downgraded by Fitch. Specifically, Fitch would expect to downgrade the National Fund Credit Rating in the event of sustained deterioration in credit quality of larger issuers in the portfolio. Fitch highlights the exposure of the fund to the leasing and financing sector.