Fitch Ratings : Another downgrade to a SL state bank

June 27, 2022 at 10:57 AM

Fitch Ratings has downgraded the rating of Sri Lanka’s Bank of Ceylon’s foreign currency rating to ‘Restricted Default’ from ‘CC’.

The downgrade comes after the rating agency earlier downgraded the sovereign rating to RD after the country defaulted on most of its external debt.

“Fitch Ratings has been made aware of missed payments on BOC’s foreign-currency obligations which underpins our rating action. We believe the foreign-currency funding and liquidity profile is highly stretched, and also believe this is exacerbated by the sovereign’s debilitated credit profile,” it said in a statement.

Full statement:

Fitch Ratings has downgraded Bank of Ceylon’s (BOC) Long- and Short-Term Foreign Currency (FC) Issuer Default Ratings (IDRs) to ‘RD’ (Restricted Default) from ‘CC’ and ‘C’, respectively.

Fitch has also downgraded the Viability Rating (VR) to ‘f’ from ‘cc’, and removed the ratings from Rating Watch Negative (RWN). The rating actions are in accordance with Fitch’s rating definitions.

At the same time, Fitch has maintained BOC’s Long-Term Local-Currency (LT LC) IDR of ‘CCC’ on RWN as well as it’s National Long-Term Rating of ‘AA-(lka)’.

KEY RATING DRIVERS

Fitch Ratings has been made aware of missed payments on BOC’s foreign-currency obligations which underpins our rating action on its LT FC IDR, ST FC IDR, and VR. We believe the foreign-currency funding and liquidity profile is highly stretched, and also believe this is exacerbated by the sovereign’s debilitated credit profile (Long-Term Foreign-Currency IDR of ‘RD’ and Long-Term Local-Currency IDR of ‘CCC’). Please see “Correction: Fitch Downgrades Sri Lanka to ‘RD’”.

Local-Currency Ratings Unchanged: BOC’s LT LC IDR takes into consideration that the risk of local-currency restrictions being imposed is lower than that of foreign-currency restrictions, should there be any, due to the sovereign having defaulted on its foreign-currency obligations. It reflects our view of the sovereign’s current and likely continued access to local-currency funding. The bank has so far maintained access to local-currency liquidity, such as via the Central Bank of Sri Lanka (CBSL).

The RWN on BOC’s National-Long Term Rating reflects the RWN on its LT LC IDR and also the potential for the bank’s creditworthiness relative to other Sri Lankan national scale ratings to deteriorate, given the potential stress on the bank’s funding and liquidity, and also its significant exposure to the sovereign and broader public sector that raises its risk profile.

Funding and Liquidity are Weakest Link: BOC’s ability to honour its senior, foreign currency obligations has been significantly impeded by the sovereign’s worsening credit profile which has limited the bank’s access to foreign currency funding and liquidity. We believe that any foreign-currency liquidity flows from the state or the CBSL are unlikely to be forthcoming, given the sovereign’s default status and precarious reserve position.

Rupee liquidity has also tightened following the bank’s excessive lending to the state in 2021, but we expect local-currency liquidity to be much more manageable than foreign currency, supported by BOC’s strong domestic franchise as well as its ability to access the CBSL liquidity.

OE Remains Challenging: The current operating environment (OE) score of ‘ccc’/negative reflects the pressure on the Sri Lankan banks’ OE and their already stressed credit profiles following the sovereign’s default on its foreign-currency obligations. The score also captures the rapid deterioration in the broader macroeconomic environment which has limited BOC’s operational flexibility. The negative outlook on the OE score reflects significant near- to medium-term downside risks presented by the weakening sovereign credit profile.

Economic Instability Pressures Business Profile: We have maintained BOC’s business profile score at ‘ccc’/negative to reflect the vulnerability of the bank to heightened risks in the domestic market, which affects its ability to generate and defend business volume. As such, BOC’s business profile score is constrained by our assessment of the OE. The negative outlook captures pressure on the business profile stemming from the OE and, ultimately, the sovereign.

Significant Exposure to Sovereign: We maintain BOC’s risk profile score at ‘cc’/negative, to reflect BOC’s significant exposure to the sovereign’s weak credit profile via its loan book exposures, off-balance sheet liabilities, as well as its investment securities making the bank vulnerable to the sovereign’s repayment capacity and liquidity position. The negative outlook reflects downside risk to the risk profile from the OE and sovereign.

Asset Quality Weaker than Private Peers: BOC’s underlying asset quality is significantly weaker relative to its private counterparts on account of its large exposure to the sovereign and broader public sector, as reflected in the ‘cc’ score. The score also reflects rising pressure on its non-state loan exposures as corporate and household balance sheets deteriorate significantly amidst worsening macroeconomic conditions. The negative outlook reflects our view of downside risk to the asset-quality score from its exposure to the sovereign and the OE.

Core profitability Under Pressure: We have lowered BOC’s earnings and profitability score to ‘ccc’/negative from ‘ccc+’/negative, underpinned by our view that the difficult OE is likely to constrain the bank’s earnings and profitability. We believe that the sovereign default and ensuing macroeconomic challenges increase the possibility of BOC becoming structurally unprofitable. The negative outlook on the score is due to the downside risk from the potential economic fallout.

Significant Pressure on Capital: We maintain a capitalization and leverage score at ‘ccc’/negative, as we believe that capital deficiencies may arise in a very likely scenario that the bank has to absorb a haircut on its foreign-currency government securities exposure, thus requiring a capital injection. This is in conjunction with the heightened constraints on accessing capital, given the sovereign’s weak ability to provide support. The negative outlook reflects downside risk to capitalization and leverage in a scenario of increased sovereign stress, particularly on local currency. (NewsWire)