ECONOMYNEXT – Fitch Ratings said it was maintaining an ‘A(lk)’ national rating on Seylan Bank which was on rating watch negative.
“We believe risks to Sri Lankan banks’ operating environment (OE) remains high despite the exclusion of the banks’ holdings in Sri Lankan rupee-denominated government securities from the sovereign domestic debt restructuring,” the rating agency said.
“The resolution of the RWN with an affirmation of the ratings could result when there is further clarity around the sovereign debt restructuring process pointing to a reduction in stresses that have affected the banking sector in the past several quarters.”
Fitch has also maintained the ‘BBB(lka)’ rating on Seylan’s subordinated debt with a negative rating watch.
The full statement is reproduced below:
Fitch Maintains Seylan Bank ‘A-(lka)’ National Rating on Watch Negative
Fitch Ratings – Colombo – 25 Jul 2023: Fitch Ratings has maintained Seylan Bank PLC’s National Long-Term Rating of ‘A-(lka)’ on Rating Watch Negative (RWN). Fitch has also maintained the ‘BBB(lka)’ rating on Seylan’s outstanding subordinated debt on RWN.
KEY RATING DRIVERS
RWN Maintained: The RWN on Seylan’s National-Long Term Rating reflects the potential for the bank’s creditworthiness relative to other entities on our Sri Lankan National Ratings scale to deteriorate. This reflects heightened near-term downside risks to its credit profile from potential capital and funding stress from the restructuring of sovereign’s debt obligations while access to foreign-currency funding remains constrained.
The resolution of the RWN with an affirmation of the ratings could result when there is further clarity around the sovereign debt restructuring process pointing to a reduction in stresses that have affected the banking sector in the past several quarters.
Debt Restructuring Weighs on OE: We believe risks to Sri Lankan banks’ operating environment (OE) remains high despite the exclusion of the banks’ holdings in Sri Lankan rupee-denominated government securities from the sovereign domestic debt restructuring. This is due to the banks’ predominant exposure to the very weak domestic economy and debilitated sovereign’s credit profile (Long-Term Issuer Default Rating (IDR): RD; ShortTerm IDR: C), which continues to hinder banks’ operational flexibility.
The impact of the impending restructuring of the Sri Lankan sovereign’s foreign-currencydenominated debt also weighs on their credit profiles.
OE Risks Pressure Business Profile: Seylan’s business profile reflects the heightened risks in the domestic market, which continue to affect its ability to generate and defend business volumes. Limited lending opportunities and tight liquidity stress in the banking sector saw Seylan’s share of net loans in total assets decrease to 63.2% by end-1Q23 (end- 2021: 72.7%), similar to peers, as the bank increased its exposure to securities to 21.1% by end-1Q23, from 16.8% at end-2021.
Sovereign Exposure Risk: Seylan’s risk profile is constrained by its exposure to the sovereign’s debilitated credit profile via its investments in local- and foreign-currency government securities (21% of assets at end-2022). It makes the bank vulnerable to the sovereign’s repayment capacity and liquidity position, despite the exclusion of the bank’s rupee-denominated sovereign debt investments from any debt restructuring or optimisation exercise.
Asset Quality Weakening: Fitch expects Seylan’s asset-quality metrics to remain under pressure from rising loan defaults amid a challenging OE as well as the bank’s large exposure to the sovereign. We estimate that its impaired (stage 3) loans ratio rose to
around 16% in 1H23, from 12.6% at end-2022. This ratio was meaningfully above the 1Q23 average for Fitch-rated large Sri Lankan banks at 13.9%.
Profitability Challenged: Fitch expects Seylan’s earnings and profitability to continue to face pressures due to weakening asset quality, muted loan growth, sharp downward adjustment of interest rates and potential impact from the proposed domestic debt optimisation. Seylan’s operating profit/risk-weighted assets ratio rose to 2.3% by end- 1Q23 (end-2022: 2.1%), due mainly to a reduction in credit costs.
Capital Ratios Under Pressure: Seylan’s common equity Tier 1 (CET1) ratio of 11.5% at end-1Q23 was the second highest among the large private banks and we estimate this ratio would have been 23bp higher had the 1Q23 profit been included. Rising encumbrance from unprovided loans due to stressed loan quality, and the bank’s moderate foreign-currency sovereign exposures and the depreciated local currency continue to weigh on the bank’s capitalisation.
Funding and Liquidity Risks: Seylan’s funding and liquidity position is prone to sudden changes amid already weak creditor sentiment, similar to peers. The foreign-currency liquidity stress has eased somewhat, but the bank’s access to foreign-currency wholesale funding remains constrained due to the sovereign’s weak credit profile. Seylan’s localcurrency funding and liquidity position could be vulnerable in case of any setbacks to the domestic debt restructuring.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
Seylan’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 when the impact on the bank’s credit profile 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 intervention in he banking sector 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 nonpayment of a large financial obligation.
A deterioration in Seylan’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 and capital 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 and/or banks are able to continue as a going concern and avoid failure.
OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS
SUBORDINATED DEBT
Seylan’s Basel III-compliant 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 expectations of poor recoveries. There is no additional notching for non-performance risks, as the notes do not incorporate goingconcern loss-absorption features. The RWN on the subordinated debt rating stems from the RWN on the National Long-Term Rating.
OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES
The ratings on the subordinated debt will move in tandem with the National Long-Term Rating (Colombo/July20/2023)