Fitch downgrades BOCs Long-Term Foreign-Currency Issuer Default Rating

COLOMBO (News 1st);  Fitch Ratings, the credit rating agency has downgraded the Bank of Ceylon's (BOC) Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'CC', from 'CCC'. Issuing a press release, Fitch stated that the rating does not carry an Outlook because of the high volatility at this rating level, in line with Fitch's rating definitions. Fitch has also downgraded BOC's Viability Rating (VR) to 'cc', from 'ccc', and has affirmed the Long-Term Local-Currency IDR at 'CCC'. BOC's National Long-Term Rating of 'AA-(lka)' was not considered in this review. In line with the updated Bank Rating Criteria, we have assigned a Government Support Rating (GSR) of 'No Support' to BOC and withdrawn the Support Rating and Support Rating Floor, as they are no longer relevant to our coverage following the publication of our updated Bank Rating Criteria on 12 November 2021. KEY RATING DRIVERS IDRs and VIABILITY RATING The rating actions follow Fitch's downgrade of Sri Lanka's Long-Term Foreign-Currency IDR to 'CC' from 'CCC' and the affirmation of the sovereign's Long-Term Local-Currency IDR at 'CCC' on 17 December 2021. See Fitch Downgrades Sri Lanka's Long-Term Foreign-Currency IDR to 'CC'. The downgrade of BOC's Long-Term Foreign-Currency IDR is driven by the downgrade of its VR. The downgrade of the VR reflects the risks to the bank's standalone creditworthiness, especially from its foreign-currency funding and liquidity position. The VR is below the implied score of 'ccc+', as we believe BOC's funding and liquidity profile, which we score at 'cc'/negative, has a greater influence on the VR than the weighting would suggest. This reflects our view of heightened risks to the stability of BOC's foreign-currency funding and liquidity stemming from the deterioration in the sovereign's foreign-currency credit profile. Heightened foreign-currency funding and liquidity risks could be reflected in more challenging access to and the rising cost of foreign-currency funding. We believe there is a greater possibility of restrictions being imposed on BOC's ability to service its foreign-currency obligations in the event of a sovereign default, which drives the negative outlook on the factor score. Funding dollarisation remained moderate in 9M21 and mostly stemmed from foreign-currency deposits, which stood at 23% of total deposits. We maintain the operating environment (OE) score at 'ccc'/negative, as the downgrade of the sovereign's Long-Term Foreign-Currency IDR has not significantly weakened our view of the OE. The score already incorporates Sri Lanka's weak economic environment and sovereign profile, which may limit the bank's operating flexibility. The negative outlook on the OE score reflects the significant near-to-medium term downside risk presented by the weakening sovereign credit profile, as spill-over effects could impact economic performance. We expect the economy to expand in 2022, albeit at a slower pace of 2.0%, from an estimated 3.6% in 2021. We have reassessed BOC's business profile score to 'b-'/negative, from 'b+'/stable, given the weak OE and the potential impact on the bank's ability to generate and defend business volume. The score is above the VR and OE score, as it takes into account BOC's dominant domestic market position as Sri Lanka's largest bank, accounting for around 20% of sector assets. The negative outlook captures potential pressure on BOC's business profile stemming from the OE and, ultimately, the sovereign. We maintained BOC's risk profile at 'ccc'/negative, as we believe the score already factors in BOC's enlarged exposure to the sovereign and broader public sector through increased loan book exposure to the state and state-owned entities. Our assessment also captures BOC's investments in government securities, particularly those denominated in foreign currency, at 6.7% of assets at end-2020. The negative outlook reflects downside risk to the risk profile from the OE and weak sovereign. We maintained BOC's asset quality score at 'ccc'/negative, which already incorporates the weak OE and the bank's risk appetite. BOC's impaired-loan ratio of 9.8%, based on stage 3 loans as of 9M21 (2020: 10.3%), continued to benefit from strong loan growth and regulatory forbearance. The negative outlook reflects our view of downside risk to the asset-quality score from non-loan exposure in the form of government-issued foreign-currency securities. We maintained BOC's earnings and profitability score at 'b-'/negative, which captures elevated risk through increased earnings volatility amid the challenging OE, although we do not envisage BOC becoming structurally unprofitable for a sustained period. Operating profit/risk-weighted assets recovered to 3.8% in 9M21, after dropping to 2.0% in 2020 following a sharp rise in loan impairment charges. The negative outlook on the score is due to the downside risk from potential economic fallout of any restructuring of the foreign -currency sovereign debt that might occur. We downgraded BOC's capitalisation and leverage score to 'ccc'/negative, from 'b-'/negative, as we believe BOC may require a capital injection should sovereign stress intensify and it has to absorb a haircut on its foreign-currency government securities exposure. This is in conjunction with the heightened constraints on accessing capital, given the sovereign's weak ability to provide support should BOC's capital need to be replenished. The negative outlook reflects downside risk to capitalisation and leverage in a scenario of increased sovereign stress. We affirmed BOC's Long-Term Local-Currency IDR as it takes into consideration that the risk of local-currency restrictions being imposed is lower than that of foreign-currency restrictions should the sovereign move towards default. It reflects our view of the sovereign's current and likely continued access to local-currency funding, and the treatment is consistent with Fitch's criteria under certain circumstances when the VR and the sovereign rating are both at very low levels. The bank has so far maintained access to local-currency liquidity, including through the Central Bank of Sri Lanka, indicating a lesser likelihood of default on local-currency obligations. GOVERNMENT SUPPORT RATING The GSR reflects our assessment that there is no reasonable assumption of government support being forthcoming. We believe the sovereign's ability to provide extraordinary support is severely constrained, as reflected in the sovereign rating, sovereign financial flexibility and the size of the banking sector relative to the economy, despite a high propensity for the sovereign to extend support to the bank due to its high systemic importance and full state ownership. RATING SENSITIVITIES Factors that could, individually or collectively, lead to negative rating action/downgrade: IDRs and VIABILITY RATING BOC's IDR would most likely be downgraded upon further pressure on the sovereign rating stemming from a default event. This could lead to foreign-currency restrictions being imposed, hindering BOC's ability to service its foreign-currency obligations, or a significant erosion of its capital buffers in the event of sizeable haircuts on sovereign debt. GOVERNMENT SUPPORT RATING The rating is already at its lowest level and thus has no downside risk. Factors that could, individually or collectively, lead to positive rating action/upgrade: IDR and VIABILITY RATING BOC's ratings are constrained by the sovereign rating. We do not anticipate developments that might lead to positive rating action in the near term, unless downward pressure on the sovereign rating abates. GOVERNMENT SUPPORT RATING The GSR is constrained by the sovereign rating. An upward revision is possible, provided the sovereign's ability to provide support significantly improves. However, we do not expect this in the near to medium term. VR ADJUSTMENTS The assigned VR is below the implied VR, reflecting a negative adjustment from the weakest link of BOC's funding and liquidity, which has a greater impact on the VR than what the weighting suggests. 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. BEST/WORST CASE RATING SCENARIO International scale credit ratings of Financial Institutions and Covered Bond 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. ESG CONSIDERATIONS BOC has an ESG Relevance Score of '4' for Governance Structure 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 impact on the credit profile, and is relevant to the ratings in conjunction with other factors. Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg