ECONOMYNEXT – Fitch Ratings said it was confirming an ‘A(lka)’ national rating of Sri Lanka’s Hatton National Bank, along with a negative rating watch.
The full statement is reproduced below
Fitch Maintains Hatton National Bank’s ‘A(lka)’ National Rating on Watch Negative
Fitch Ratings – Colombo – 13 Jun 2023: Fitch Ratings has maintained Hatton National Bank PLC’s (HNB) National Long-Term Rating of ‘A(lka)’ on Rating Watch Negative (RWN). Fitch has also maintained HNB’s senior and subordinated debt ratings of ‘A(lka)’ and ‘BBB+(lka)’, respectively, on RWN.
A full list of rating actions is detailed below.
KEY RATING DRIVERS
RWN Maintained: The RWN on HNB’s National-Long Term Rating reflects the potential for the bank’s creditworthiness relative to other entities on the Sri Lankan national ratings scale to deteriorate. This reflects heightened near-term downside risks to its credit profile from potential capital and funding stress, as the default risk on sovereign’s domestic debt increases while access to foreign-currency funding remains constrained.
Impending Restructuring Weighs on OE: The impending restructuring of the Sri Lankan sovereign’s (RD) domestic debt, in addition to foreign debt, and the ensuing risks to the broader economic environment could exacerbate risks to banks’ already stressed credit profiles, further hindering their operational flexibility. The negative outlook on the operating environment (OE) reflects downside risks that would stem from further deterioration in the macroeconomic environment.
OE Risks Pressure Business Profile: HNB’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 and tight liquidity stress in the sector saw the bank’s share of net loans to total assets decreasing to 52.0% at end-1Q23 (end-2021: 62.7%), while securities investments rose to 33.2% of total assets (end-2021: 26.4%), similar to peers.
Sovereign Exposure Risk: HNB’s risk profile is constrained by its exposure to the sovereign’s weak credit profile via its investment securities, making it vulnerable to changes in the sovereign’s repayment capacity and liquidity position. The bank’s holdings of foreign and local currency-denominated government securities accounted for 30% of total assets at end-2022. We estimate this share to have increased further in 1Q23 as HNB continued to increase its investments in treasury bills.
Asset Quality Weakening: Fitch expects HNB’s asset-quality metrics to remain under pressure from rising loan defaults amid a challenging OE as well as its large exposure to the sovereign’s weak credit profile through investments in foreign and local currency denominated government securities. We estimate its impaired (Stage 3) loans ratio to have edged up in 1Q23, albeit below the 13.9% average for Fitch-rated large Sri Lankan banks, from 9.9% at end-2022, while its exposure to the sovereign was substantial at over one- third of total assets at end-1Q23.
Profit Pressures Remain: Fitch believes the potential domestic debt restructuring would lead to significant downside risks to HNB’s profitability that could erode the bank’s earnings in the absence of forbearance, particularly if banks’ treasury bill holdings are also subject to restructuring. HNB’s operating profit/risk-weighted assets ratio rose to 5.6% at end-1Q23 (end-2022: 1.8%), the highest among large private banks, stemming from an increase in short-term, high-yield treasury bill investments.
Debt Restructuring Could Weaken Capitalisation: HNB’s regulatory common equity Tier 1 ratio of 11.8% at end-1Q23 was in line with that of peers. However, we estimate this ratio would have been 70bp higher had it included the bank’s 1Q23 profits. We believe the sovereign’s potential debt restructuring, in addition to a possible haircut on foreign-currency securities, could have a significant effect on the bank’s capital. It could then require recapitalisation to restore viability in the absence of further regulatory forbearance.
Funding and Liquidity Risks Persist:> We believe HNB’s overall funding and liquidity position is prone to sudden changes amid already weak creditor sentiment, similar to its peers. Stress on foreign-currency liquidity has somewhat eased. Nonetheless, the bank’s access to foreign-currency wholesale funding remains constrained by the sovereign’s weak credit profile.
The bank’s local-currency funding and liquidity position is currently manageable, but we believe any local-currency debt restructuring could elevate funding and liquidity stresses. 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
HNB’s National Rating is sensitive to a change in the bank’s creditworthiness relative to other Sri Lankan issuers.
The RWN reflects rising risks to the bank’s rating 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 bank’s repayment ability;
– significant banking-sector intervention by authorities that constrains 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 downgrade of the sovereign’s ‘CC’ Long-Term Local-Currency Issuer Default Rating could also lead to a downgrade of the bank’s rating.
A deterioration in HNB’s key credit metrics beyond our base-case expectations relative to peers would also lead to increased downward pressure on the bank’s rating, which is driven by its intrinsic financial strength.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
There is limited scope for upward rating action given the RWN. Resolution of the Rating Watch with an affirmation could be driven by our view that risks from funding stresses have abated, at both the individual bank and the sector level, 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
SENIOR DEBT
HNB’s outstanding senior unsecured debentures are rated at the same level as its National Long-Term Rating, in accordance with Fitch’s criteria. This is because the issue ranks equally with the claims of the bank’s other senior unsecured creditors. The RWN on the senior debt rating stems from the RWN on the National Long-Term Rating.
SUBORDINATED DEBT
HNB’s Basel II- and Basel III-compliant Sri Lankan rupee subordinated debt is rated two notches below the National Long-Term Rating anchor. This reflects Fitch’s baseline notching for loss severity for this type of debt and our expectation of poor recoveries.
There is no additional notching for non-performance risks, 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.