ECONOMYNEXT – Fitch Ratings said it was confirming an ‘A(lka)’ national rating of Sri Lanka’s Commercial Bank of Ceylon, along with a negative rating watch.
The full statement is reproduced below
Fitch Maintains Commercial Bank of Ceylon’s ‘A(lka)’ National Rating on Watch Negative
Fitch Ratings – Colombo/Mumbai – 13 Jun 2023: Fitch Ratings has maintained Commercial Bank of Ceylon PLC’s (COMB) National Long-Term Rating of ‘A(lka)’ on Rating Watch Negative (RWN). Fitch has also maintained COMB’s subordinated debt rating of ‘BBB+(lka)’ on RWN.
A full list of rating actions is at the end of this commentary.
KEY RATING DRIVERS
RWN Maintained: The RWN on COMB’s National Long-Term Rating reflects the potential for the bank’s creditworthiness relative to other Sri Lankan national scale ratings to deteriorate. This is due to the 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.
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 risks to Sri Lankan banks’ already stressed credit profiles, further hindering their operational flexibility. The negative outlook on the operating environment (OE) reflects the risks that could stem from further deterioration in the economic environment.
OE Risks Pressure Business Profile: We believe COMB’s business profile is highly vulnerable to the elevated risks in the domestic market, which continue to affect its ability to generate and defend business volume. Limited business opportunities and tight liquidity in the sector, along with the deterioration in the sovereign credit profile, led to the bank’s share of net loans falling to 44% of assets by end-1Q23 (2021: 52%), in line with its peers.
Significant Exposure to Government Securities: Our assessment of COMB’s risk profile factors in its significant exposure to the sovereign through investments in foreign- and local-currency government securities, which made up 9% and 27% of total assets at end-2022, respectively. This makes the bank vulnerable to the sovereign’s repayment capacity and liquidity position.
Asset-Quality Headwinds: Fitch estimates that COMB’s impaired-loan ratio deteriorated further in 1Q23 from the reported 9.4% at end-2022 (2021: 7.4%) due to the effects of a protracted economic downturn and high inflation on household and corporate balance sheets. In addition, we estimate that the loan-loss allowance cover of stage 3 loans was lower in 1Q23 than the reported 77% at end-2022. The bank’s large holdings of local- and foreign-currency government securities also exacerbate risks to its asset quality.
Elevated Pressure on Profitability: Fitch believes there is significant downside risk to COMB’s profitability from the potential domestic debt restructuring, which could erode the bank’s earnings in the absence of forbearance. COMB’s operating profit/risk-weighted asset ratio recovered marginally to 2.3% by end-1Q23 after dipping to 2% in 2022 due to higher provisioning against loans and foreign-currency government securities.
Capital Impairment Risks: COMB’s regulatory common equity Tier 1 (CET1) ratio stood at 11.8% at end-1Q23. 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 may require recapitalisation to restore viability in the absence of further regulatory forbearance.
Funding and Liquidity Challenges Persist: We believe COMB’s funding and liquidity position is prone to sudden changes amid already weak creditor sentiment, similar to its peers. Stress on foreign-currency liquidity has eased somewhat, but the bank’s access to foreign-currency wholesale funding remains constrained by the sovereign’s weak credit profile (Long-Term Foreign-Currency Issuer Default Rating (IDR): RD).
The bank’s local-currency funding and liquidity position is currently more manageable. Still, we believe any local-currency debt restructuring would elevate funding and liquidity stress. It could also raise the likelihood of restrictions being placed on banks’ ability to service their obligations.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
The National Rating is sensitive to a change in the banks’ creditworthiness relative to other Sri Lankan issuers.
The RWN reflects rising risks to the banks’ ratings from funding stresses, which could lead to a multiple-notch downgrade. We expect to resolve the RWN once the impact on the issuers’ credit profiles becomes more apparent, which may take more than six months.
Developments that could lead to a multiple-notch downgrade include:
– funding stress that impedes the banks’ repayment ability;
– significant banking-sector intervention by authorities that constrains the banks’ ability to service their obligations;
– a temporary negotiated waiver or standstill agreement following a payment default on a large financial obligation;
– Fitch’s belief that a bank has entered into a grace or cure period following non-payment of a large financial obligation.
– A downgrade of the sovereign’s Long-Term Local-Currency IDR (CC) could also lead to a downgrade of the banks’ ratings.
– A deterioration in their key credit metrics beyond our base-case expectations relative to peers would also lead to increased downward pressure on the banks’ ratings, which are driven by their intrinsic financial strength.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
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 for COMB as well as the sector, to the extent that we believe the banks’ ability to service their obligations in local and foreign currency is not hindered.
OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS
COMB’s Sri Lankan rupee-denominated subordinated debt is rated two notches below its National Long-Term Rating anchor. This reflects Fitch’s baseline notching for loss severity for this type of debt and our expectations of poor recovery. There is no additional notching for non-performance risk, as the notes do not incorporate going-concern loss- absorption features. The RWN on the subordinated debt rating stems from the RWN on the National Long-Term Rating.