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Saturday May 25th, 2024

Sri Lanka DFCC Bank rating watch negative kept in soft-peg collapse: Fitch

ECONOMYNEXT- Fitch Ratings said it was keeping a Rating Watch negative on Sri Lanka’s DFCC Bank amid a currency crisis that has triggered dollar shortages and sovereign default while there are also mounting bad loans.

The Rating Watch Negative “reflects the potential for the bank’s creditworthiness to deteriorate relative to other entities on our Sri Lankan national rating scale,” Fitch said.

“This is because of heightened stress on the bank’s funding and liquidity, and its exposure to the sovereign via investment in foreign-currency instruments that raise risks to its overall credit profile.

“We believe that the sharp rise in inflation, depreciation of the local currency, and other factors can distort the bank’s underlying financial position in the current operating environment.”

Sri Lanka is gripped by the worst currency crisis in the history of the island’s intermediate regime central bank. Sri Lanka’s economists got the ability to trigger a balance of payments deficits and currency crises with the setting up of a soft-pegged central bank in 1950.

In 2022 the rupee collapsed to 360 to the US dollar from 200 as an attempt was made to float the currency with a surrender rule.

Fitch said the bank’s foreign-currency funding and liquidity position was significantly challenged and vulnerable to sudden shocks amid weaker credit sentiment though the bank was successful in securing USD150 million of term funding in 2021, Fitch said.

“We believe further access to such funding would be difficult, similarly to peers, given the sovereign’s debilitated credit profile,” the agency said.

As customer repayment capacity weakens due to the economic conditions Fitch said, it expects DFCC’s impaired (stage 3) loan ratio to increase in the near to medium term.

” Impaired loans at end-2021 were 6.2% of total assets together with a further 2.2% of assets in US dollar-denominated sovereign bonds and Sri Lanka Development bonds, the share of which is estimated to have reduced in 1H22,” the rating agency said.

The agency said that sovereign default together with increasing economic challenges poses significant downside risks to DFCC’s profitability, to the extent that the bank may become structurally unprofitable.

“Earnings pressure is already evident in the bank’s operating profit/risk-weighted asset ratio that declined to 0.6% by end-1Q22 (end-2021: 1.7%) as credit costs eroded 83% of the bank’s pre- impairment profits”

The full statement is reproduced below:

Fitch Maintains DFCC Bank’s National Rating of ‘A+(lka)’ on Watch Negative

Fitch Ratings – Colombo – 28 Jul 2022: Fitch Ratings has maintained DFCC Bank PLC’s National Long-Term Rating of ‘A+(lka)’ on Rating Watch Negative (RWN). Fitch has also maintained DFCC’s senior and subordinated debt ratings of ‘A+(lka)’ and ‘A-(lka)’, respectively, on RWN.

KEY RATING DRIVERS

RWN Maintained: The RWN on DFCC’s National Long-Term Rating reflects the potential for the bank’s creditworthiness to deteriorate relative to other entities on our Sri Lankan national rating scale. This is because of heightened stress on the bank’s funding and liquidity, and its exposure to the sovereign via investment in foreign-currency instruments that raise risks to its overall credit profile.

We believe that the sharp rise in inflation, depreciation of the local currency, and other factors can distort the bank’s underlying financial position in the current operating environment.

Foreign Currency Liquidity Constraints: We believe DFCC’s foreign-currency funding and liquidity position is significantly challenged and vulnerable to sudden shocks amid weaker credit sentiment. The bank was successful in securing USD150 million of term funding in 2021, but we believe further access to such funding would be difficult, similarly to peers, given the sovereign’s debilitated credit profile.

Weakening Operating Environment: Our assessment of Sri Lankan banks’ operating environment (OE) reflects the pressure on the banks’ already stressed credit profile following the sovereign’s default on its foreign-currency obligations. It also captures the rapid deterioration in the broader economy, including increased interest rates, high inflation, and acute currency depreciation. The economic slump has limited DFCC’s operational flexibility.

Increasing Asset-Quality Pressure: Fitch expects DFCC’s impaired (stage 3) loans ratio to increase in the near to medium term as borrower repayment capacity weakens due to the rapidly deteriorating economic conditions. The bank’s exposure to the government’s foreign currency-denominated instruments, although small relative to peers, adds to asset-quality pressure. Impaired loans at end-2021 were 6.2% of total assets together with a further 2.2% of assets in US dollar-denominated sovereign bonds and Sri Lanka Development bonds, the share of which is estimated to have reduced in 1H22.

Capital Buffers Under Pressure: Fitch expects increased asset-quality risks, and weaker earnings retention alongside bloated risk-weighted assets from the Sri Lankan rupee’s sustained depreciation, which will exert significant pressure on the bank’s capitalisation metrics in the near term. This is despite the bank’s lower exposure to foreign currency-denominated government securities than that of peers. Capital raising continues to be a challenge for the bank, as seen in its recently concluded rights issue that was undersubscribed.

Credit Costs to Erode Earnings: We believe that sovereign default together with increasing economic challenges poses significant downside risks to DFCC’s profitability, to the extent that the bank may become structurally unprofitable. Earnings pressure is already evident in the bank’s operating profit/risk-weighted asset ratio that declined to0.6% by end-1Q22 (end-2021: 1.7%) as credit costs eroded 83% of the bank’s pre-impairment profits.

Economic Volatility Weighs on Business Model: We believe that DFCC’s business profile, like most domestic peers, is highly vulnerable to the intensifying risks in the domestic market, given the high concentration of its business profile on the weak and unstable Sri Lankan economy. This could limit the bank’s ability to generate and defend business volume. The rapidly deteriorating OE is likely to derail the bank’s aspiration of reaching LKR1 trillion asset base by 2025.

High-Risk Profile: DFCC’s elevated risk profile, similar to local peers, stems from its main exposure to high-risk customer segments with weak credit quality, as reflected in the ‘ccc’/negative OE.

This is further exacerbated by DFCC’s exposure to the government’s foreign currency-denominated instruments, albeit lower relative to peers, making the bank vulnerable to the sovereign’s repayment capacity and liquidity position.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

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 issuer’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 DFCC’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 material financial obligation;

– Fitch’s belief is that DFCC has entered into a grace or cure period following non-payment of a material financial obligation.

A downgrade of the sovereign’s Long-Term Local-Currency Issuer Default Rating (CCC)could also lead to a downgrade of the bank’s rating.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

There is limited scope for upward rating action given the RWN

OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS

SENIOR DEBT

DFCC’s outstanding senior unsecured debentures are rated at the same level as its National Long-Term Rating under Fitch’s criteria. This is because the debt ranks equally with the claims of the bank’s other senior unsecured creditors.

SUBORDINATED DEBT

DFCC’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 expectations of poor recoveries.

There is no additional notching for non-performance risks, as the notes do not incorporate going-concern loss-absorption features.

OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES

The senior and subordinated debt ratings will move in tandem with the bank’s National Long-Term Rating.

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Sri Lanka power outages from falling trees worsened by unfilled vacancies: CEB union

HEAVY WINDS: Heavy rains and gusting winds have brought down trees on many location in Sri Lanka.

ECONOMYNEXT – Sri Lanka’s power grid has been hit by 300,000 outages as heavy winds brought down trees, restoring supply has been delayed by unfilled vacancies of breakdown staff, a union statement said.

Despite electricity being declared an essential service, vacancies have not been filled, the CEB Engineers Union said.

“In this already challenging situation, the Acting General Manager of CEB issued a circular on May 21, 2024, abolishing several essential service positions, including the Maintenance Electrical Engineer in the Area Engineer Offices, Construction Units, and Distribution Maintenance Units,” the Union said.

“This decision, made without any scientific basis, significantly reduces our capacity to provide adequate services to the public during this emergency.

“On behalf of all the staff of CEB, we express our deep regret for the inconvenience caused to our valued customers.”

High winds had rains have brought down trees across power lines and transformers, the statement said.

In the past few day over 300,000 power outages have been reported nationwide, with some areas experiencing over 30,000 outages within an hour.

“Our limited technical staff at the Ceylon Electricity Board (CEB) are making extraordinary efforts to restore power as quickly as possible,” the union said.

“We deeply regret that due to the high volume of calls, there are times when we are unable to respond to all customer inquiries.

“We kindly ask consumers to support our restoration teams and to report any fallen live electrical wires or devices to the Electricity Board immediately without attempting to handle them.

The union said there were not enough workers to restore power quickly when such a large volume of breakdowns happens.

“We want to clarify that the additional groups mentioned by the minister have not yet been received by the CEB,” the union said.

“Despite the government’s designation of electricity as an essential service, neither the government, the minister in charge, nor the CEB board of directors have taken adequate steps to fill the relevant vacancies or retain current employees.

“We believe they should be held directly responsible for the delays in addressing the power outages due to the shortage of staff.”

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Melco’s Nuwa hotel to open in Sri Lanka in mid-2025

ECONOMYNEXT – A Nuwa branded hotel run by Melco Resorts and Entertainment linked to their gaming operation in Colombo will open in mid 2025, its Sri Lanka partner John Keells Holdings said.

The group’s integrated resort is being re-branded as a ‘City of Dreams’, a brand of Melco.

The resort will have a 687-room Cinnamon Life hotel and the Nuwa hotel described as “ultra-high end”.

“The 113-key exclusive hotel, situated on the top five floors of the integrated resort, will be managed by Melco under its ultra high-end luxury-standard hotel brand ‘Nuwa’, which has presence in Macau and the Philippines,” JKH told shareholders in the annual report.

“Melco’s ultra high-end luxury-standard hotel and casino, together with its global brand and footprint, will strongly complement the MICE, entertainment, shopping, dining and leisure offerings in the ‘City of Dreams Sri Lanka’ integrated resort, establishing it as a one-of-a-kind destination in South Asia and the region.”

Melco is investing 125 million dollars in fitting out its casino.

“The collaboration with Melco, including access to the technical, marketing, branding and loyalty programmes, expertise and governance structures, will be a boost for not only the integrated resort of the Group but a strong show of confidence in the tourism potential of the country,” JKH said.

The Cinnamon Life hotel has already started marketing.

Related Sri Lanka’s Cinnamon Life begins marketing, accepts bookings

(Colombo/May25/2024)

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Sri Lanka to find investors by ‘competitive system’ after revoking plantations privatizations

ECONOMYNEXT – Sri Lanka will revoke the privatization of plantation companies that do not pay government dictated wages, by cancelling land leases and find new investors under a ‘competitive system’, State Minister for Finance Ranjith Siyambalapitiya has said.

Sri Lanka privatized the ownership of 22 plantations companies in the 1990s through long term leases after initially giving only management to private firms.

Management companies that made profits (mostly those with more rubber) were given the firms under a valuation and those that made losses (mostly ones with more tea) were sold on the stock market.

The privatized firms then made annual lease payments and paid taxes when profits were made.

In 2024 the government decreed a wage hike announced a mandated wage after President Ranil Wickremesinghe made the announcement in the presence of several politicians representing plantations workers.

The land leases of privatized plantations, which do not pay the mandated wages would be cancelled, Minister Siyambalapitiya was quoted as saying at a ceremony in Deraniyagala.

The re-expropriated plantations would be given to new investors through “special transparency”

The new ‘privatization’ will be done in a ‘competitive process’ taking into account export orientation, worker welfare, infrastructure, new technology, Minister Siyambalapitiya said.

It is not clear whether paying government-dictated wages was a clause in the privatization agreement.

Then President J R Jayewardene put constitutional guarantee against expropriation as the original nationalization of foreign and domestic owned companies were blamed for Sri Lanka becoming a backward nation after getting independence with indicators ‘only behind Japan’ according to many commentators.

However, in 2011 a series of companies were expropriation without recourse to judicial review, again delivering a blow to the country’s investment framework.

Ironically plantations that were privatized in the 1990s were in the original wave of nationalizations.

Minister Bandula Gunawardana said the cabinet approval had been given to set up a committee to examine wage and cancel the leases of plantations that were unable to pay the dictated wages.

Related

Sri Lanka state interference in plantation wages escalates into land grab threat

From the time the firms were privatized unions and the companies had bargained through collective agreements, striking in some cases as macro-economists printed money and triggered high inflation.

Under President Gotabaya, mandating wages through gazettes began in January 2020, and the wage bargaining process was put aside.

Sri Lanka’s macro-economists advising President Rajapaksa the printed money and triggered a collapse of the rupee from 184 to 370 to the US dollar from 2020 to 2020 in the course of targeting ‘potential output’ which was taught by the International Monetary Fund.

In 2024, the current central bank governor had allowed the exchange rate to appreciate to 300 to the US dollar, amid deflationary policy, recouping some of the lost wages of plantations workers.

The plantations have not given an official increase to account for what macro-economists did to the unit of account of their wages. With salaries under ‘wages boards’ from the 2020 through gazettes, neither employees not workers have engaged in the traditional wage negotiations.

The threat to re-exproriate plantations is coming as the government is trying to privatize several state enterprises, including SriLankan Airlines.

It is not clear now the impending reversal of plantations privatization will affect the prices of bids by investors for upcoming privatizations.

The firms were privatized to stop monthly transfers from the Treasury to pay salaries under state ownership. (Colombo/May25/2024)

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