ECONOMYNEXT – Fitch Ratings said it was confirming a ‘CC’ long term rating of state-run Bank of Ceylon, and a national rating of A(lka) along with a rating watch.
The full statement is reproduced below –
Fitch Affirms Bank of Ceylon at ‘CC’; Maintains National Rating at ‘A(lka)’/RWN
Fitch Ratings – Singapore/Colombo – 13 Jun 2023: Fitch Ratings has affirmed Bank of Ceylon’s (BOC) Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘CC’. The rating does not carry an Outlook because of the potential for high volatility at this rating level, in line with Fitch’s rating definitions. At the same time, Fitch has maintained BOC’s Long-Term Local-Currency IDR of ‘CCC-‘ and National Rating of ‘A(lka)’ on Rating Watch Negative (RWN).
Fitch has also affirmed BOC’s Short-Term IDR at ‘C’, Viability Rating (VR) at ‘cc’ and Government Support Rating at ‘ns’.
A full list of rating actions is at the end of this commentary.
KEY RATING DRIVERS
Ratings Affirmed: BOC’s VR, Foreign-Currency and Short-Term IDRs continue to reflect a high risk of failure from a probable default on the sovereign’s domestic debt obligations, which could threaten the bank’s solvency as well as elevate risks to its funding and liquidity profile.
The bank’s Long-Term Local-Currency IDR is one notch above that of Sri Lanka, reflecting our view of a lower risk the authorities will impose restrictions on banks servicing their local-currency obligations than non-payment by the sovereign. This approach is consistent with Fitch’s criteria under certain circumstances when bank and sovereign ratings are both at very low levels.
Downside Risks to Ratings: The RWN on the bank’s Long-Term Local-Currency IDR reflects heightened near-term downside risks to its credit profile from potential capital and funding stress as default risk on domestic debt increases while access to foreign-currency funding remains constrained. This, together with the potential for the bank’s creditworthiness relative to other entities on the Sri Lankan national ratings scale to further deteriorate, underpins the RWN on BOC’s National Rating.
Debt Restructuring Weighs on OE: The impending restructuring of the sovereign’s domestic and foreign debt, and the ensuing risks to the broader economic environment could exacerbate the risks to banks’ already stressed credit profiles, further hindering their operational flexibility. The negative outlook on the operating environment (OE) reflects the downside risks that would stem from further deterioration in the economic environment.
OE Risks Pressure Business Profile: BOC’s business profile reflects the elevated vulnerability to heightened risks in the domestic market, which continue to affect its ability to generate and defend business volume. Limited lending opportunities, tight liquidity and the deterioration in the sovereign’s credit profile led to the share of net loans in the bank’s total assets dropping to 52.5% by end-1Q23 (2021: 63.6%).
High Sovereign Exposure: BOC’s risk profile is affected by its significant exposure – over half of its total assets – to the sovereign’s weak credit profile via its loan-book exposures, off-balance-sheet liabilities and investment securities, making the bank vulnerable to the sovereign’s repayment capacity and liquidity position.
Worsening Asset Quality: BOC’s asset-quality metrics will remain highly dependent on the creditworthiness of the sovereign due to the bank’s high sovereign exposure via its loans, off-balance-sheet liabilities and securities holdings. The bank’s core asset-quality metric – impaired (stage 3) loans ratio – inched up to 13.6% by end-1Q23 (end-2022: 12.9%, 2021: 10.2%) due to a contraction in gross loans. The bank’s large holdings of local- and foreign-currency government securities exacerbate risks to its asset quality.
Profit Pressure Continues: The sovereign default on foreign-currency debt and ensuing economic challenges increase the possibility of BOC becoming structurally unprofitable for a sustained period. The negative outlook on the score reflects the downside risk to its profitability from the potential domestic debt restructuring, which could erode earnings in the absence of forbearance. BOC’s operating profit/risk-weighted asset ratio continued to drop to 1.3% in 1Q23 (2022: 2.4%, 2021: 3.8%) on narrower net interest margins and a contraction in the loan book.
Debt Restructuring Could Weaken Capitalisation: BOC’s regulatory common equity Tier 1 (CET1) ratio stood at 11.8% at end-1Q23, while its holdings of sovereign securities were nearly 7x its CET1 capital. We think the potential restructuring of the sovereign’s domestic debt, in addition to a possible haircut on foreign-currency securities, could have a significant effect on the bank’s solvency. The bank could require recapitalisation to restore viability in the absence of further regulatory forbearance.
Funding and Liquidity Risks Persist: We believe the bank’s funding and liquidity profile remains under pressure. Stress on foreign-currency liquidity has eased somewhat, reflected in the bank having met its obligations, but its access to foreign-currency wholesale funding remains constrained by the sovereign’s weak credit profile (Long-Term IDR: RD).
The bank’s local-currency funding and liquidity position is currently more manageable. That said, we believe any local-currency debt restructuring would elevate the bank’s funding and liquidity stress, given the predominance of local-currency funding and the significant amount of local-currency government securities held for statutory liquidity. It could also raise the likelihood of restrictions being placed on the bank’s ability to service its obligations.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
Fitch would downgrade BOC’s VR and IDRs if we perceive there is an increased likelihood that the bank would default on or seek a restructuring of its senior obligations to non-government creditors. The bank’s National Rating is sensitive to a change in the bank’s creditworthiness relative to other Sri Lankan issuers.
We expect to resolve the RWN on BOC’s Long-Term Local-Currency IDR and the National Rating when the impact of funding and capital stresses on the bank’s credit profile becomes more apparent, which may take longer than six months.
Potential triggers that could lead to a downgrade include:
– funding stress that impedes the bank’s repayment ability
– significant banking-sector intervention by authorities that constrain the bank’s ability to service its obligations
– a temporary negotiated waiver or standstill agreement following a payment default on a large financial obligation
– Fitch’s belief that the bank has entered into a grace or cure period following non- payment of a large financial obligation
– a reduction in the CET1 ratio below the regulatory minimum (4.5% without any buffers), even if there is regulatory forbearance regarding such a shortfall.
A downgrade of the sovereign’s Long-Term Local-Currency IDR could also lead to a downgrade of the bank’s ratings.
A deterioration in its key credit metrics beyond our base-case expectations relative to peers would also lead to increased downward pressure on the bank’s ratings, which are driven by its intrinsic financial strength.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
Fitch believes positive rating action on the Long-Term Foreign-Currency IDR, Short- Term IDR and VR is unlikely in the near term, given the sovereign’s weak credit profile, the bank’s strong linkage to the sovereign, and the broader challenging economic conditions.
There is limited scope for upward rating action on the Long-Term Local-Currency IDR in light of the RWN, and the negative outlook we have on several VR factors.
There is limited scope for upward rating action on the National Rating given the RWN.
The resolution of the Rating Watch with an affirmation could be driven by our view that risks from funding stresses have abated, both at the individual bank as well as the sector, to the extent that we believe the bank’s ability to service its obligations in local and foreign currency is not hindered.
OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS
BOC’s Basel II Sri Lankan rupee-denominated subordinated debt is rated two notches below its National Long-Term Rating, in line with Fitch’s baseline notching for loss severity for this type of debt and our expectations of poor recovery. The RWN on the subordinated debt stems from the RWN on the National Long-Term Rating.
The Government Support Rating of ‘ns’ reflects our assessment that there is no reasonable assumption of government support being forthcoming.
OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES
BOC’s subordinated debt rating will move in tandem with the National Long-Term Rating.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
The rating is already at its lowest level and thus has no downside risk.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
The Government Support Rating is constrained by the sovereign rating. An upward revision is possible, provided the sovereign’s ability to provide support significantly improves. However, this appears unlikely in the near-to-medium term.