GCR Ratings (“GCR”) has downgraded FSDH Merchant Bank Limited’s national scale long-term issuer rating to BBB+_(NG) and affirms the short-term issuer rating of A2_(NG). Concurrently, GCR has downgraded the national scale long-term issue ratings of FSDH Funding SPV Plc’s Series 1 Tranche A and Tranche B Bonds to BBB_(NG) and BBB+_(NG) respectively. The rating outlook is stable.

Rating Rationale

FSDH Merchant Bank Limited (“FSDH MB” or “the bank”) is considered a core operating entity to FSDH Holding Company Limited (“the Group”), as such, the national scale issuer credit ratings on the bank reflect the strengths and weaknesses of the Group.

The one-notch rating downgrade reflects the sizable moderation in FSDH MB’s capitalisation metrics, which has had a significant impact on our assessment of the bank’s credit profile. FSDH MB has grown strongly into its capital over the last 12 months, due to an acceleration in loan growth which surpassed the bank’s budget projections and prior years of conservative risk asset growth, as well as outstripping internal capital generation.

FSDH MB’s capital adequacy ratio (“CAR”) declined sharply, from 31.0% at December 2020 to 20.0% as of December 2021. Similarly, GCR’s computed core capital ratio for the Group deteriorated from the high range of 37.4% as at December 2020 to the intermediate range of our assessment, to register at 20.8% as of December 2021. The dip was largely driven the strong growth in risk weighted assets (“RWA”), having registered a 54.3% year-on-year growth in RWA relative to internal capital generation growth of 3.5% over the period. As of September 2022, RWA moderated by 14.9%, due to the write-off of the bank’s major non-performing loan (“NPL”) and relatively strong collateralization of the newly originated loans, which has supported capitalisation ratios. In the near term, we expect GCR core capital ratio for the Group to register within the 25%+ range, supported by the projected rebound in earnings and cautious RWA growth. However, the relatively high contribution of market-sensitive income to the earnings profile and foreign currency (“FCY”) exposures present downside risks to capitalisation, given the challenged operating environment.

FSDH MB’s competitive position reflects its growing franchise strength and potential for diversification as the Group continues to implement its strategic growth aspirations in both the banking and non-banking financial service segments. The bank has a long-standing position and compares well to merchant banking peers in the market. Over the past year, FSDH has demonstrated its increased competitiveness through the strong growth recorded, with a fast-growing client base comprising some of the top corporate and mid-sized industry players. Moving forward, continuous product innovation and targeted focus on key areas of comparative advantage in the market are expected to further support business growth and diversification for the Group.

The bank’s risk position has shown some improvement over the past year. Credit losses moderated from the high of 2.4% recorded in FY20 to 0.5% in FY21. Similarly, the non-performing loans (“NPL”) ratio also moderated to 4.7% from 5.6% over the period, albeit largely driven by strong loan growth. As of September 2022, the NPL ratio improved to 1.7% on account of the write-off of the bank’s major NPL, an industry-wide exposure in the telecommunication industry for which the bank made full provisions in FY21. Counterparty concentrations also improved, with the top twenty exposures contributing 83.9% to gross loans as of December 2021 compared to 98.8% recorded in December 2020. FCY loans contributed a significant 37.4% to gross loans as of December 2021 (December 2020: 40.5%), albeit balanced by the fact that FCY loans are granted to mainly to obligors with FCY receivables, thereby providing some level of natural hedge.

Notwithstanding, GCR is cognisant of the potential seasoning of the loan portfolio, as the newly originated loans mature. The bank grew its loan book by a high 37.1% as at 9M22 (FY21: 96.1%; FY20: -13.8%). This may subsequently result in a weakening of the risk metrics, especially given the uncertain and stressed macroeconomic outlook. Also, market risk is of key concern, given the highly volatile interest rate environment. A sizable portion of the bank’s securities portfolio comprises available-for-sale instruments, which are susceptible to potentially steep revaluation losses with an attendant impact on earnings and capitalisation.

Funding and liquidity assessment is slightly positive to the ratings. Core customer deposits as a proportion of the funding base dipped to 47.9% as at December 2021 from 63.7%as at December 2020, albeit improving marginally to 54.5% as at 9M22. Local currency liquidity is considered sufficient, with GCR liquid assets coverage of wholesale funding and customer deposits registering at 1.4x and 63.3% respectively, as at 9M22.

The Series 1 Tranche A and Tranche B Bonds (“the Bonds”) were issued in February 2021 under FSDH Funding SPV Plc’s (“the Issuer”) N30bn Debt Issuance Programme (“the Programme” or “DIP”). The Issuer was established by FSDH MB (“the Sponsor”) for the purpose of raising funds for the bank. The enabling resolution of the Issuer’s Board of Directors permits the directors to issue the Bonds in tranches, different forms, and under different terms and conditions as it may deem fit, subject to the approval of the relevant regulatory authorities.

The Series 1 Tranche A Bonds constitute direct, unsecured and subordinated obligations of the Issuer, ranking pari passu without any preference among themselves. On the other hand, the Series 1 Tranche B Bonds are senior unsecured obligations of the Issuer, and rank pari passu among themselves and equally with all other existing and future unsecured, unsubordinated obligations of the Issuer.

While the Issuer is FSDH Funding SPV Plc, repayment of the obligations under the Issues ultimately depends on the performance of the bank, as the direct obligor of the Issues. Thus, the accorded rating is linked to FSDH MB’s credit standing and financial position. Accordingly, the ratings on the Bonds have been downgraded in line with the rating action on the bank.

According to the periodic performance reports provided to GCR by the Trustees to the Bondholders, the Issuer has been meeting all its bond obligations on a timely basis .

Outlook Statement

The Stable Outlook reflects GCR’s expectation that FSDH will maintain a positive earnings trajectory such that the GCR core capital ratio for the Group registers at the projected level of over 25% in the next 12-18 months, while maintaining its relatively low credit losses and NPLs. FSDH’s demonstrated good market access is expected to support the bank’s FCY funding base, thereby averting FCY liquidity issues in the near term.

Rating Triggers

A downgrade will be triggered following a weakening of the bank’s earnings which adversely impact the capitalisation ratios. A deterioration of the credit losses and NPL ratio would also trigger a downgrade, as well as further strain in the FCY liquidity condition in the market. An upgrade is unlikely in the near term. Given that the ability of the Issuer to meet its obligations on the Bonds is dependent on the financial condition of FSDH MB, the accorded rating on the bonds would be sensitive to a positive rating action on the bank.  Non-compliance with the set covenants, as well as a downgrade of the bank’s rating could equally trigger negative rating actions on the Bonds.

Related Criteria and Research

Ratings History

FSDH Merchant Bank Limited

*Refers to First Securities Discount House Limited

FSDH Funding SPV Plc – Series 1 Tranche A Subordinated Unsecured Bonds

FSDH Funding SPV Plc – Series 1 Tranche B Senior Unsecured Bonds

Risk Score Summary

Salient Points of Accorded Rating

GCR affirms that a.) no part of the rating process was influenced by any other business activities of the credit rating agency; b.) the ratings were based solely on the merits of the rated entity, security or financial instrument being rated; and c.) such ratings were an independent evaluation of the risks and merits of the rated entity, security or financial instrument.

The credit ratings have been disclosed to FSDH Merchant Bank Limited. The ratings above were solicited by, or on behalf of, FSDH Merchant Bank Limited, and therefore, GCR has been compensated for the provision of the ratings.

Subsequent to an appeal by the rated entity, the national scale ratings were revised as reflected in the announcement.

FSDH Merchant Bank Limited participated in the rating process via face-to-face management meetings, as well as other written correspondence. Furthermore, the quality of information received was considered adequate and has been independently verified where possible. The information received from FSDH Merchant Bank Limited and other reliable third parties to accord the credit ratings included:

• The audited financial results as at 31 December 2021
• Unaudited interim account as at September 2022
• Four years of comparative audited numbers
• Other related documents