ECONOMYNEXT – Fitch Ratings said it was confirming an ‘A(lka)’ national rating of Sri Lanka’s People’s bank, along with a negative rating watch.
The full statement is reproduced below
Fitch Maintains People’s Bank’s National Rating of ‘A(lka)’ on Watch Negative
Fitch Ratings – Colombo – 13 Jun 2023: Fitch Ratings has maintained the Rating Watch Negative (RWN) on the ‘A(lka)’ National Long-Term Rating of People’s Bank (Sri Lanka) (PB).
KEY RATING DRIVERS
RWN Maintained: The RWN on PB’s National Long-Term Rating reflects the potential for the bank’s creditworthiness relative to other entities on the Sri Lankan national ratings scale to deteriorate. This reflects heightened near-term downside risks to its credit profile from potential capital and funding stress, as the default risk on its domestic debt increases while access to foreign-currency funding remains constrained.
Debt Restructuring Weighs on OE: The impending restructuring of the Sri Lankan sovereign’s domestic debt, in addition to foreign debt, and the ensuing risks to the broader economic environment could exacerbate risks to banks’ already stressed credit profiles, further hindering operational flexibility. The negative outlook on the operating environment (OE) reflects downside risks that would stem from further deterioration in economic conditions.
OE Risks Pressure Business Profile: PB’s business profile reflects its elevated vulnerability to heightened risks in the domestic market, which continue to affect its ability to generate and defend business volumes. The bank curtailed lending amid tight liquidity, along with the deterioration in the sovereign’s credit profile, led to the bank’s share of net loans falling to 59.7% of total assets by end-1Q23 (2021: 70.3%).
High Sovereign Exposure: PB’s risk profile is affected by its significant exposure to the sovereign’s weak credit profile, which accounted for over half of the bank’s total assets via loans, off-balance sheet liabilities and investments, albeit having reduced from end-2021 levels. This makes PB vulnerable to the sovereign’s repayment capacity and liquidity position.
Asset-Quality Stress: PB’s impaired-loan ratio is the highest among Fitch-rated large Sri Lankan banks. The ratio, which includes some of the loans to state-related entities being classified as stage 3, rose to 17.4% of gross loans at end-2022 (end-2021:8.7%). We believe the bank’s asset-quality metrics will remain highly conditioned by its large sovereign-linked exposures through its loans and off-balance-sheet liabilities. PB’s large holdings of local-currency-denominated government securities also exacerbate risks to asset quality.
Earnings Face Significant Risks: Fitch believes the sovereign default on foreign- currency debt and prevailing macroeconomic challenges increase the possibility of the bank becoming structurally unprofitable for a sustained period. This is despite a moderate improvement in operating profit/risk-weighted assets to 3.5% at end-1Q23 (end-2022: 3.2%), supported by impairment reversals on its foreign-currency loan book owing to exchange rate appreciation.
Debt Restructuring Could Weaken Capitalisation: PB’s regulatory common equity Tier 1 (CET1) ratio stood at 12.6% at end-1Q23. The bank faces elevated risks to its capital buffers due to its large sovereign holdings and a high share of unprovided impaired loans. We believe the sovereign’s potential domestic debt restructuring could have a significant effect on PB’s solvency, and it may necessitate recapitalisation to restore viability in the absence of regulatory forbearance.
Funding and Liquidity Pressures: We believe PB’s overall funding and liquidity position is prone to sudden changes amid weak creditor sentiment, similar to its peers. Stress on foreign-currency liquidity has somewhat eased. Nonetheless, the bank’s access to foreign-currency wholesale funding remains constrained by the sovereign’s weak credit profile. Any local-currency debt restructuring could elevate funding and liquidity stresses, and could raise the likelihood of restrictions being placed on banks’ ability to service their obligations.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
The bank’s National Rating is sensitive to a change in the bank’s creditworthiness relative to other Sri Lankan issuers.
We expect to resolve the RWN once the impact on the bank’s credit profile becomes more apparent, which may take longer than six months.
Potential triggers that could lead to a downgrade include:
– funding stress that impedes the bank’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 large financial obligation
– Fitch’s belief that the bank has entered into a grace or cure period following non- payment of a large financial obligation
A downgrade of the sovereign’s Long-Term Local-Currency Issuer Default Rating could also lead to a downgrade of the bank’s rating.
A deterioration in PB’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 on the National Rating, given the RWN.
The resolution of the Rating Watch with an affirmation could be driven by our view that risks from funding stresses have abated, both for PB as well as the sector, to the extent that we believe the banks’ ability to service their obligations in local and foreign currency is not hindered.
PB has a 1.78% equity stake each 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.