Sri Lanka’s Ceylon Income Fund 'A-(lka)' confirmed: Fitch ratings

June 04, 2013 (LBO) – Fitch Ratings has confirmed an 'A-(lka)' National Fund credit rating of Ceylon Income Fund that is managed by Ceylon Asset Management, a fund that primarily invests in corporate debt instruments.

“The affirmation of the 'A-(lka)' National Fund Credit Rating is driven by the fund's stable weighted average rating factor (WARF) and rating distribution,” Fitch Ratings said in a statement.

“The majority of investors in the fund are not exposed to mark-to-market risk. Instead the vast majority of investors are duration matched with investors entering the fund with a specified maturity which is matched to the maturity of securities in the fund.”

Fitch says 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.”

The full rating report is below

Fitch Ratings-London/Colombo-31 May 2013: Fitch Ratings has affirmed the National Fund Credit Rating assigned to the Ceylon Income Fund at 'A-(lka)'. The fund primarily invests in corporate debt instruments and is managed by Ceylon Asset Management (CAM).

The affirmation of the 'A-(lka)' National Fund Credit Rating is driven by the fund's stable 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. Furthermore, Fitch believes that there is no secondary market for the corporate instruments held by the fund. Given the absence of a viable secondary market and the fact that the majority of the fund's investors are not exposed to market risk, Fitch does not consider a National Fund Volatility rating applicable and as a result the rating is 'V-NR'.

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 WARF has been broadly stable since Fitch rated the fund in September 2012. 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 78% of the portfolio as of April 2013. The fund's investment guidelines limit it to investment-grade rated issuers only. The majority of issuers in the portfolio are rated in the 'A(lka)' and 'BBB(lka)' rating categories. Around 4% of securities in the portfolio were subject to Rating Outlook Negative as of April 2013, but no securities were subject to Rating Watch Negative.

CONCENTRATION:

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 Fitch 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.

COLLATERAL:

Around 30% of the portfolio's holdings are over-collateralised as of April 2013, comparable to the level in September 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. The remaining 3% of investors in the fund may face minor daily mark-to-market volatility owing to the fund's use of mark-to-market pricing (based on the yield curve published by the Unit Trust Association of Sri Lanka) for securities with a residual term to maturity of over one year (implemented since January 2013). Given this, and the absence of a viable secondary market for the corporate instruments held by the fund, Fitch does not consider a National Fund Volatility rating applicable and as a result the rating is 'V-NR'.

FUND PROFILE:

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 (rated 'A+/Stable/F1+'). The fund was launched in 2010 and has been growing. As of April 2013 the fund's total assets under management were approximately LKR470m.

THE ADVISOR:

Fitch considers CAM suitably qualified, competent and capable of managing the fund. The investment committee has relevant 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.

RATING SENSITIVITY:

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.

For additional information about Fitch rating criteria applicable to bond funds, please review the criteria referenced below, which can be found on Fitch's web site at www.fitchratings.com.

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