Fitch downgrades Bank of Ceylon to ‘CCC’ on sovereign downgrade

BOC

Dec 08, 2020 (LBO) – Fitch Ratings has downgraded Bank of Ceylon’s (BOC) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) to ‘CCC’, from ‘B-‘.

The ratings do not carry an Outlook because of the potentially high volatility at this rating level, in line with Fitch’s rating definitions.

Fitch has also downgraded BOC’s Viability Rating to ‘ccc’ from, ‘b-‘, and has revised the Support Rating Floor to ‘No Floor’, from ‘B-‘. BOC’s National Long-Term Ratings were not considered in this review.

KEY RATING DRIVERS
IDR and VIABILITY RATING

The downgrade of BOC’s Long-Term IDR and Viability Rating stems from the 27 November 2020 downgrade of the sovereign IDR to ‘CCC’, from ‘B-‘, and our assessment of the operating environment. BOC’s Long-Term IDR is driven by the bank’s intrinsic strength, as expressed by its Viability Rating. The ratings are constrained by the sovereign IDR.

We believe the operating environment (‘ccc’/negative) continues to have a high influence on bank ratings, as it affects the level of risk of doing business and banks’ financial and non-financials rating factors. Our assessment reflects that risks are skewed to the downside given the sovereign’s weakened credit profile and the impact of the coronavirus pandemic. We expect GDP to contract by 6.7% in 2020 and to begin recovering in 2021 by 4.9%, partly driven by the low-base effect. Our forecasts are subject to a high degree of uncertainty regarding the evolution of the pandemic globally and in Sri Lanka. The downgrade and negative outlook on risk appetite and most of the financial profile factors reflect the downside risks to borrowers’ credit worthiness and the stability of the bank’s financial metrics stemming from the operating environment.

We lowered BOC’s risk appetite score to ‘ccc’/negative to reflect heightened risk from its significant exposure to the sovereign and non-state exposures that could be susceptible to deteriorating operating conditions. We believe the bank’s exposure to state and state-related entities could rise in the near to medium term, as it may be asked to take the lead in supporting businesses and individuals affected by the pandemic. BOC’s loans rose by 25% in 9M20; a much higher increase than the sector average of 10% and that of private-sector peers.

BOC’s asset quality score of ‘ccc’/negative is aligned with its risk appetite score and reflects our expectation of higher impairment ratios. It also reflects our belief that its asset quality may come under more pressure than that of domestic peers. We expect underlying asset-quality stress to build from already elevated levels despite relief measures, such as restructuring under loan-repayment moratoriums, which have largely halted the recognition of credit impairment thus far.

We lowered BOC’s earnings and profitability score to ‘b-‘/negative, despite higher-than-sector loan expansion, as pre-provision operating profit may not be able to provide sufficient headroom if credit costs outpace income growth.

We also lowered BOC’s funding and liquidity score to ‘b-‘/negative due to rising challenges in accessing and pricing foreign-currency funding, even though BOC is likely to benefit from its state linkages and entrenched domestic deposit franchise for local-currency funding. BOC has the largest foreign-currency deposit base in Sri Lanka and has significant foreign-currency denominated non-deposit funding.

We maintained the bank’s capitalisation and leverage score at ‘b-‘/negative, reflecting the heightened constraints on accessing capital given the state’s weak ability to provide support should BOC’s capital need to be replenished, since it is a fully state-owned bank. BOC’s exposure to the state sector bolsters its reported ratios, which are mostly risk-weighted at 0%. Still, its core capitalisation remains thin, and its capital buffers may reduce further if it uses its capital-conservation buffer of 1%, as permitted by the Central Bank of Sri Lanka under the country’s pandemic-related relief measures.

Support Rating and Support Rating Floor

The revision of the Support Rating Floor to ‘No Floor’ and the affirmation of the Support Rating of ‘5’ reflects our opinion that extraordinary sovereign support for the bank cannot be relied upon. We believe the sovereign’s ability to provide extraordinary support is severely constrained by its weakened financial flexibility, the size of the banking sector relative to the economy and high vulnerability to large banking system losses in the downturn, despite a high propensity for the sovereign to extend support to its bank.

RATING SENSITIVITIES
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 given the pressure on the sovereign rating and the deteriorating operating environment.

SUPPORT RATING and SUPPORT RATING FLOOR

BOC’s Support Rating and Support Rating Floor are constrained by the sovereign rating. An upward revision of the ratings is possible provided the sovereign’s ability to provide support improves materially. However, we do not expect this in the near to medium term.

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

IDR and VIABILITY RATING

BOC’s IDRs and Viability Rating could be downgraded upon further pressure on the sovereign rating, indicating increased risk of a sovereign default. We expect operating conditions to deteriorate significantly under such a scenario, with heightened risk for BOC’s financial profile and a downgrade of its ratings. A lack of access to foreign-currency funding that restricts the bank’s operations or a significant deterioration in loan quality that erodes the bank’s capital base could also lead to a downgrade.

SUPPORT RATING and SUPPORT RATING FLOOR

The ratings are already at their lowest level and thus have no downside risk.