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Sri Lanka’s Bank of Ceylon rating downgraded to ‘B-‘ by Fitch

ECONOMYNEXT – Fitch Ratings has downgraded state-run Bank of Ceylon’s rating to ‘B-‘ from ‘B’, with a outlook after a sovereign rating cut saying the economy would contract 1 percent and the operating environment all banks would worsen.

“The ratings action follows the downgrade of the Sri Lankan sovereign rating on 24 April 2020, which reflects the impact of the escalating coronavirus pandemic on Sri Lanka’s economy,” Fitch said.

“We have revised our assessment of Sri Lankan banks’ operating environment to ‘b-‘/negative, from ‘b’/negative, primarily to reflect the heightened risk of doing business in the jurisdiction.

“Under Fitch’s base-case scenario, we forecast the world economy and the Sri Lankan economy to contract in 2020 by 3.9% and 1.0%, respectively.

“We expect banks’ financial profiles to come under stress from the increased challenges in the operating environment, and their key credit metrics are likely to be weaker than our previous expectations, notwithstanding regulatory reliefs.

The full statement is reproduced below:

Fitch Downgrades Bank of Ceylon on Sovereign Downgrade and Coronavirus Risks

Tue 05 May, 2020 – 19:45 ET

Fitch Ratings – Colombo – 05 May 2020: Fitch Ratings has downgraded Bank of Ceylon’s (BOC) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to ‘B-‘ from ‘B’.

The Outlook remains Negative. At the same time, Fitch has downgraded BOC’s Viability Ratings (VR) to ‘b-‘ from ‘b’, Support Rating to ‘5’ from ‘4’, and its Support Rating Floor to ‘B-‘ from ‘B’.

A full list of rating actions is at the end of this commentary.

The ratings action follows the downgrade of the Sri Lankan sovereign rating on 24 April 2020, which reflects the impact of the escalating coronavirus pandemic on Sri Lanka’s economy. For more details on the sovereign rating action, please see “Fitch Downgrades Sri Lanka to ‘B-‘; Outlook Negative”.

We have revised our assessment of Sri Lankan banks’ operating environment to ‘b-‘/negative, from ‘b’/negative, primarily to reflect the heightened risk of doing business in the jurisdiction.

Under Fitch’s base-case scenario, we forecast the world economy and the Sri Lankan economy to contract in 2020 by 3.9% and 1.0%, respectively. We expect banks’ financial profiles to come under stress from the increased challenges in the operating environment, and their key credit metrics are likely to be weaker than our previous expectations, notwithstanding regulatory reliefs.

We expect GDP growth of 4% for Sri Lanka in 2021, on the basis of a gradual recovery in tourism receipts beginning in late 2020. However, this forecast is subject to an unusually high degree of uncertainty and downside risk, depending on the evolution of the pandemic both within Sri Lanka and globally.

Correspondingly, the outlook for the operating environment assessment is maintained at negative – to reflect the possibility of further downside risks should the potential impact of the economic fallout from the coronavirus pandemic become more pronounced or linger.

KEY RATING DRIVERS

IDRs and VR

BOC’s IDR is driven by its VR of ‘b-‘, which is at the same level as its Support Rating Floor of ‘B-‘. The downgrade of the VR stems largely from our assessment of the operating environment which we believe continues to have a high influence on bank ratings through its impact on financial and non- financials rating factors.

The outlook for the IDR reflects the outlook on the operating environment assessment – which is maintained at negative to reflect the possibility of further downside risks due to the potential impact of the economic fallout from the coronavirus pandemic.

Furthermore, we have assigned negative outlooks to all of the financial metrics mid-point scores. The outlook on the bank’s asset-quality score of ‘b-‘ has been revised to negative from stable to reflect the deteriorating conditions.

BOC’s impaired-loans ratio based on stage 3 loans had already weakened to 10.7% by end- 2019 from 9.2% at end-2018, and we expect asset quality to come under more pressure than its domestic peers due to its state linkages.

We have also lowered BOC’s earnings and profitability score to ‘b’ from ‘b+’, and assigned a negative outlook on the score to reflect the pressure on income generation through lower lending rates, depressed loan expansion and higher credit costs.

The outlook on the bank’s capitalisation and leverage score of ‘b’ has been revised to negative from stable to reflect the potentially higher capital-impairment risk. BOC’s capitalisation is already thin, with a CET1 ratio of 11.4% at end-2019, with the potential for its capital buffers to be reduced further if it draws down on its capital-conservation buffer.

The bank’s funding and liquidity score has been lowered to ‘b’ from ‘b+’, and the negative outlook maintained to reflect the increased challenges in the access to – and pricing of – foreign-currency funding, even though BOC is likely to benefit from its state linkages for local-currency funding.

SR and SRF

The Support Ratings and the Support Rating Floor of BOC are sensitive to perceived changes in the state’s ability and propensity to support BOC. The downgrade of the Support Rating Floor to ‘B-‘ from ‘B’ and the Support Rating to ‘5’ from ‘4’ reflects our assessment that while state support may be possible, the ability of the sovereign to provide timely support is reduced in light of the sovereign’s weakened financial flexibility and size of the banking sector relative to the economy.

We still assess there to be a high propensity for state support – given that BOC is the largest bank in Sri Lanka, accounting for around 20% of banking sector assets, and is classified as a bucket 2 D-SIB by the Central Bank of Sri Lanka. Its full state ownership and quasi-sovereign status further underscore the high propensity for state support. We believe that while BOC does not have a specified policy role, as a large state bank it is likely to support government policy objectives, and as such it may take a relatively greater role in intermediating many of the relief measures to cushion the impact of the economic fallout.

RATING SENSITIVITIES

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

IDRS and VR

A revision of the Outlook to Stable or an upgrade of BOC’s IDRs would most likely result from positive rating action on the sovereign, which could result in an upgrade of its SRF and also its VR if our assessment of the operating environment is raised. However, we believe that the prospect of an upgrade of BOC’s IDR is unlikely in the near term, given the pressure on the sovereign rating and operating environment.

SR and SRF

The Support Rating and the Support Rating Floor are constrained by the sovereign rating. An upgrade of
the sovereign rating is most likely to lead to an upgrade of the Support Rating and the Support Rating Floor.

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

IDRS and VR

BOC’s VR is most sensitive to deterioration in the operating environment, which could be triggered by a sovereign rating downgrade or a further weakening of its economy beyond our base-case expectation leading to additional weakening of its key credit metrics. In particular, BOC’s VR may also come under pressure if there is a continued decline in capitalisation resulting in an erosion of its capital buffers with a CET-1 ratio below 9%.

SR and SRF

BOC’s Support Rating is already at its lowest level. A downgrade of the sovereign rating would most likely lead to a downgrade of the Support Rating Floor

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Financial Institutions issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

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.

PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS

BoC’s SRFs are linked to the Sri Lanka sovereign rating of B-/Negative

ESG CONSIDERATIONS

Bank of Ceylon: 4; Governance Structure: 4

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of 3. ESG issues are credit neutral or have only a minimal credit impact on the transaction, either due to their nature or the way in which they are being managed by the transaction.

BOC has an ESG Relevance Score of 4 for Corporate Governance due to ownership concentration with a 100% state shareholding and several related-party transactions with the state and state-owned entities. This has a negative effect on the bank’s credit profile, and is relevant to the rating in conjunction with other factors.

For more information on our ESG Relevance Scores, visit www.fitchratings.com/esg

BOC has a 1.78% equity stake in Fitch Ratings Lanka Ltd. No shareholder other than Fitch, Inc. is involved in the day-to-day rating operations of, or credit reviews undertaken by, Fitch Ratings Lanka Ltd.