ECONOMYNEXT – Fitch Ratings said it was maintaining an ‘A-(lka)’ rating on Sri Lanka’s National Development Bank with a negative rating watch, though domestic debt restructuring has excluded banks.
“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,” Fitch said.
“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.”
Banks in Sri Lanka faced elevated non-performing loans and foreign currency funding risks, Fitch said.
The full statement is reproduced below:
Fitch Maintains National Development Bank’s ‘A-(lka)’ National Rating on Watch Negative
Fitch Ratings – Colombo – 25 Jul 2023: Fitch Ratings has maintained National Development Bank PLC’s (NDB) National Long-Term Rating of ‘A-(lka)’ on Rating Watch Negative (RWN). Fitch has also maintained the bank’s ‘BBB(lka)’ subordinated debt rating on RWN.
KEY RATING DRIVERS
RWN Maintained:The RWN on NDB’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 NDB’s 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 the banks’ credit profiles.
OE Risks Pressures Business Profile: NDB’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 volumes. Limited lending opportunities and tight liquidity in the banking sector, together with the bank’s low capital buffers, saw the bank’s share of net loans in total assets decrease to 63.0% by end-1Q23 (end-2021: 71.0%) while securities investments rose to 27.0% of total assets (end-2021: 20.5%), similar to peers.
Sovereign Exposure Risk: NDB’s risk profile remains constrained by its exposure to the sovereign’s debilitated credit profile via its investment securities, making the bank vulnerable to the sovereign’s repayment capacity and liquidity position. This is despite the exclusion of NDB’s holdings of rupee-denominated debt from any debt restructuring or optimisation exercise. The bank held 25% of its assets in foreign- and local-currencydenominated government securities at end-2022.
Stressed Asset Quality: Fitch expects NDB’s asset-quality metrics to remain under pressure from rising stage 3 loans amid a challenging OE as well as the bank’s aboveaverage exposure to the sovereign’s weak credit profile through investments in foreigncurrency-denominated government securities. We estimate the bank’s impaired (stage 3) loans to have increased to 13.6% in 1Q23, slightly below the 13.9% average for Fitchrated large Sri Lankan banks, from 11.2% at end-2022.
Profitability Challenges Remain: Fitch expects NDB’s earnings and profitability to remain challenged by weakening asset quality, muted loan growth prospects, sharp downward adjustment of interest rates and any potential impact to earnings from the proposed domestic debt optimisation strategy. NDB’s operating profit/risk-weighted assets ratio improved to 1.2% by end-1Q23 (end-2022: 0.5%) but remains the weakest among the Fitch-rated large Sri Lankan banks.
Thin Capital Buffers: We believe that weakening loan quality, high capital encumbrance from unprovided impaired loans and susceptibility to even moderate shocks weigh on NDB’s capitalisation, despite the exclusion of its holdings of rupee-denominated treasury securities alleviating some stress on its capital. NDB’s regulatory common equity Tier 1 (CET1) ratio of 10.6% at end-1Q23 (group level; bank level – 10.1%) was one of the lowest among the Fitch-rated Sri Lanka banks, and we estimate this ratio would have been only 17bp higher had the 1Q23 profit been included.
Funding and Liquidity Risks Persist: We believe NDB’s overall funding and liquidity position is prone to sudden changes amid already weak creditor sentiment, similar to peers. Stress on foreign-currency liquidity has somewhat eased. Even so, 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 also susceptible to any setbacks to the domestic debt restructuring.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
NDB’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 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 intervention in the 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 NDB’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
NDB’s Basel II and 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 subordinated debt ratings will move in tandem with the bank’s National Long-Term Rating.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.