Fitch cuts outlooks for three banks following sovereign action

ECONOMYNEXT- Ratings agency Fitch has revised the international (IRD) and national outlooks of Bank of Ceylon, National Savings Bank and DFCC Bank Plc to negative from stable following a sovereign outlook cut.

Bank of Ceylon’s (BOC) outlook (national) was cut to AA+ (lka) negative while IRD was cut to B negative.

National Savings Bank’s (NSB) national rating outlook was cut to AA+ (lka) negative and IRD lowered to B negative, while DFCC’s was lowered to AA- (lka) negative and B negative respectively.

The actions follow Fitch cutting the outlook for the sovereign to B negative from stable over tax cuts and a higher risk of doing business.

Fitch said it expects strong sovereign support for BOC, moderate support for NSB and while state help may be possible but may not be timely for DFCC.

Fitch said although DFCC’s capital buffers are above average, they may not sufficiently counterbalance the pressure from a deteriorating operating environment and weak profitability compared to peers.

The ratings agency said if NSB’s core activity changes from a policy role which indicates a reduced importance to the state, and lower expectation of state support could trigger a downgrade.

DFCC’s outlook may be revised to stable if it can sustain capital buffers to manage weaker asset quality and higher risks in the operational environment, Fitch said.

The full Fitch Ratings review follows:

Fitch Ratings-Singapore/Colombo-22 January 2020: Fitch Ratings has revised the Outlook to Negative from Stable on the Long-Term Issuer Default Ratings (IDR) and National Long-Term Ratings of the following Sri Lanka-based banks and has affirmed their ratings:

– Bank of Ceylon (BOC),

– National Savings Bank (NSB) and

– DFCC Bank PLC (DFCC)

The revision of the Outlooks follows Fitch’s Outlook revision on the Sri Lankan sovereign (B/Negative); see Fitch Revises Outlook on Sri Lanka to Negative; Affirms at ‘B’, dated 18 December 2019.

Fitch has revised its assessment of Sri Lanka’s operating environment to ‘b’/negative, from ‘b’/stable, primarily to reflect the risk of doing business in the jurisdiction, which we believe could heighten in the medium term.

Increased macroeconomic volatility could pressure the banks’ and non-bank financial institutions’ credit profiles should the sovereign’s credit profile deteriorate further.

The operating environment has a high influence on the banks’ ratings, as it is likely to constrain their intrinsic credit profiles through its effect on financial and non-financial key rating factors.

KEY RATING DRIVERS

IDRS, VIABILITY RATINGS, NATIONAL RATINGS AND SENIOR DEBT

BOC
The IDR of BOC is at the same level as its Viability Rating and Support Rating Floor. Fitch expects extraordinary support for BOC to stem from its quasi-sovereign status, its role as one of the key lenders to the government, full state ownership and high systemic importance.

BOC’s Viability Rating is highly influenced by our view of its operating environment and reflects its thin capitalisation (common equity Tier 1 (CET1): 10.1% at end-9M19) and asset-quality pressure (gross non-performing loan ratio for the bank: 5.4% at end-9M19; 2018: 3.6%).

This is partly balanced by a stronger domestic funding franchise than that of most sector peers; BOC had a 21.1% share of banking-sector deposits at end-9M19.

NSB
The IDRs of NSB are driven by our expectation of modest sovereign support, as indicated by its Support Rating Floor, which is aligned with the sovereign’s IDR.

Fitch has not assigned a Viability Rating to NSB, as it is a policy bank. Fitch believes extraordinary state support for NSB stems from its policy mandate of mobilising retail savings and investing them in government securities.

The NSB Act contains an explicit deposit guarantee and Fitch is of the view that authorities would support the bank’s depositors and senior unsecured creditors to maintain confidence and stability in the system.

DFCC
DFCC’s IDRs and National Long-Term Rating are driven by its Viability Rating, which is highly influenced by our view of its operating environment.

It also reflects above-average capitalisation (Fitch Core Capital ratio of 15.9% at end-June 2019), which compensates for the risks stemming from its developing commercial-bank franchise, deteriorating asset quality (gross non-performing loans ratio: 4.8% at end-9M19, 2018: 3.3%) and weak earnings.

The Negative Outlook on the IDR stems from the Negative Outlook on the sovereign rating and the effect on the operating environment should the sovereign’s credit profile deteriorate further.

The Negative Outlook on DFCC’s National Long-Term Rating reflects our view that the bank’s capital buffers, despite its above-average capitalisation, may not be able to sufficiently counterbalance pressure from the weakening operating environment on its already-weak profitability and funding profile relative to that of peers rated ‘AA-(lka)’.

DFCC’s Sri Lanka rupee-denominated senior unsecured debt is rated at the same level as its National Long-Term Rating, as the debentures rank equally with other senior unsecured obligations.

The Negative Outlook on the ratings of banks whose ratings are driven by state support reflects the Negative Outlook on the sovereign. The Negative Outlook also reflects the constraint placed on the Viability Ratings of BOC, DFCC and the intrinsic credit profile of PB and CB through the operating environment.

SUBORDINATED DEBT

The old-style Basel II Sri Lanka rupee-denominated subordinated debt of BOC, DFCC, CB and HNB and the Basel III compliant Tier 2 Sri Lanka rupee-denominated subordinated debt of DFCC, CB and HNB and are rated one notch below their National Long-Term Ratings to reflect subordination to senior unsecured creditors.

The Basel III compliant debentures include a non-viability trigger upon the occurrence of a trigger event, as determined by the Monetary Board of Sri Lanka.

SUPPORT RATING AND SUPPORT RATING FLOOR

BOC and NSB’s Support Rating of ‘4’ and Support Rating Floors of ‘B’ reflect the state’s ability and propensity to provide support given the banks’ high importance to the state and high systemic importance.

DFCC’s Support Rating of ‘5’ and Support Rating Floor of ‘No Floor’ reflect Fitch’s assessment that state support may be possible, but timely sovereign support cannot be relied upon in light of the sovereign’s weakened financial ability.

Furthermore, the bank’s franchise is small, with a market share of around 3% of system assets, against 8%-11% for the larger private banks.

RATING SENSITIVITIES

IDRS, VIABILITY RATINGS, NATIONAL RATINGS AND SENIOR DEBT

Changes to Sri Lanka’s sovereign rating or Fitch’s perception of state support for the banks could result in a change in the banks’ IDRs, National Long-Term Ratings and/or in the Outlook on BOC, NSB and PB.

BOC
A downgrade of BOC’s IDRs and National Long-Term Rating would most likely result from negative rating action on the sovereign, which could constrain the bank’s Viability Rating through a weakening in the operating environment and weaken the state’s ability to support the bank.

This would result in a lower Support Rating and Support Rating Floor.

BOC’s Viability Rating is most sensitive to deterioration in the operating environment, leading to sustained weakening of BOC’s key credit metrics.

The Viability Rating may also come under pressure if there is a continued decline in capitalisation.

NSB

A lower expectation of state support through the state’s weakened ability to provide support, a substantial change in NSB’s policy role or a deviation from mandated core activities, indicating the bank’s reduced importance to the state, could trigger a rating downgrade.

DFCC

DFCC’s ratings are constrained by the sovereign rating. The Outlook on DFCC’s National Long-Term Rating may be revised to Stable if the bank can sustain capital buffers to sufficiently cushion its weaker asset quality amid higher operating environment-related risks.

An inability to sustain capital buffers that counterbalance increased operating environment risk alongside a weaker franchise could pressure the bank’s IDRs and National Long-Term Rating.

The senior debt ratings will move in tandem with the National Long-Term Rating.

SUBORDINATED DEBT

Subordinated debt ratings will move in tandem with the National Long-Term Rating.

The subordinated debt ratings are also sensitive to divergence between the final Bank Rating Criteria, when published, and the current Exposure Draft.

SUPPORT RATING AND SUPPORT RATING FLOOR

The state’s lower ability signalled through a lower sovereign rating, and propensity to support systemically important banks, could result in a downgrade for BOC and NSB’s Support Ratings and Support Rating Floors.

DFCC’s Support Rating and Support Rating Floor are sensitive to the sovereign’s ability to provide support.

The rating actions are as follows:

BOC:

Long-Term Foreign-Currency IDR affirmed at ‘B’; Outlook revised to ‘Negative’ from ‘Stable’

Long-Term Local-Currency IDR affirmed at ‘B’; Outlook revised to ‘Negative’ from ‘Stable’

Short-Term Foreign-Currency IDR affirmed at ‘B’

Viability Rating affirmed at ‘b’

Support Rating affirmed at ‘4’

Support Rating Floor affirmed at ‘B’

National Long-Term Rating affirmed at ‘AA+(lka)’; Outlook revised to ‘Negative’ from ‘Stable’

Basel II compliant Sri Lanka rupee-denominated subordinated debentures affirmed at ‘AA(lka)’

NSB:

Long-Term Foreign-Currency IDR affirmed at ‘B’; Outlook revised to ‘Negative’ from ‘Stable’

Long-Term Local-Currency IDR affirmed at ‘B’; Outlook revised to ‘Negative’ from ‘Stable’

Short-Term Foreign-Currency IDR affirmed at ‘B’

Support Rating affirmed at ‘4’

Support Rating Floor affirmed at ‘B’

National Long-Term Rating affirmed at ‘AA+(lka)’; Outlook revised to ‘Negative’ from ‘Stable’

DFCC:

Long-Term Foreign-Currency IDR affirmed at ‘B’; Outlook revised to ‘Negative’ from ‘Stable’

Long-Term Local-Currency IDR affirmed at ‘B’; Outlook revised to ‘Negative’ from ‘Stable’

Short-Term Foreign-Currency IDR affirmed at ‘B’

Viability Rating affirmed at ‘b’

Support Rating affirmed at ‘5’

Support Rating Floor affirmed at ‘No Floor’

National Long-Term Rating affirmed at ‘AA-(lka)’; Outlook revised to ‘Negative’ from ‘Stable’

Sri Lanka rupee-denominated senior unsecured debentures affirmed at ‘AA-(lka)’

Basel II compliant Sri Lanka rupee-denominated subordinated debentures affirmed at ‘A+(lka)’

Basel III compliant Sri Lanka rupee-denominated subordinated debentures affirmed at ‘A+(lka)’. (Colombo/Jan22/2020)