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Sri Lanka Bank of Ceylon’s SOE exposure up, ‘BB’ rating confirmed: Fitch

Mar 28, 2013 (LBO) - Sri Lanka's state-run Bank of Ceylon had high exposure to the state enterprise with Ceylon Petroleum Corporation making up 20 percent, though some of the loans were guaranteed, Fitch Ratings said. Bank of Ceylon's capitalization has weakened with dividend payouts by dividend payouts, and high loan growth.

"While slowing loan growth and higher SOE exposure (zero risk weight for state guarantee) may help BOC to negotiate the difficulty in the interim, timely capital injections from the State remains critical to BOC's future capitalisation," Fitch said.

Fitch Ratings had given a 'BB'- rating to a planned 5-year dollar denominated bond of state-run Bank of Ceylon, while confirming the lender's 'BB-' rating with a stable outlook.

The full statement is reproduced below:

Fitch Affirms Bank of Ceylon's 'BB-' IDRs

Fitch Ratings-Colombo/Mumbai/Singapore-28 March 2013: Fitch Ratings has affirmed Bank of Ceylon (BOC)'s Long-Term (LT) Foreign Currency (FC) and Local Currency (LC) Issuer Default Ratings (IDRs) at 'BB-' with a Stable Outlook. The agency has also affirmed BOC's Viability Rating (VR) at 'b+' and its National LT rating at 'AA+(lka)' with a Stable Outlook. BOC's Support rating and Support Rating Floor have also been affirmed at '3' and 'BB-' respectively, the latter at the same level as the sovereign.

Fitch has also assigned BOC's proposed senior unsecured USD-denominated notes an expected rating of 'BB-(EXP)', same as its FC IDR given that the notes are expected to rank equally with the bank's senior unsecured creditors. The proposed notes will have a maturity of five years, while semi-annual coupon payments will be at a fixed rate. The final rating is contingent upon receipt of final documents conforming to information already received. A full list of rating actions is provided at the end of this commentary.

Key Rating Drivers

BOC's LT IDRs are driven by the Government of Sri Lanka's (the State) high propensity and limited ability to provide support to the bank under extraordinary situations. In Fitch's view, the State's high propensity stems from BOC's systemic importance as the largest bank in the country (accounting for nearly 20% of banking system deposits and assets), its quasi-sovereign status, its role as a key lender to the Government and full government ownership, while the State's limited ability is reflected in the 'BB-'/Stable Sovereign rating.

BOC's VR - which is one notch lower than the LT IDR - reflects the growing pressures particularly in terms of its weakening capitalisation and deteriorating asset quality, which may experience further deterioration in the near term. While BOC's strong domestic franchise remains a strength from a funding perspective, near-term funding challenges will likely remain, considering the high loans-to-deposits ratio (LDR) amid rising interest rates.

BOC's loan book has a high exposure to the State and State owned entities (SOE) and while a sizeable portion of the exposure is state guaranteed, the resulting concentration risk is significant. For e.g. Ceylon Petroleum Corporation itself accounts for nearly 20% of BOC's total exposure. Notwithstanding state exposures, BOC's gross non-performing loan (NPL) ratio weakened to 2.8% (FY11: 2.1%) in FY12 owing to one-off event risks such as floods and drought (in Q412) and the Maldives' political turmoil.

BOC's capitalisation (Tier 1 Capital Adequacy Ratio, 2012:9%, 2011:9.3%) - which is already impacted by high dividend pay-outs (FY12: 38.4%, FY11: 34%) - has been steadily weakening. High loan growth, deteriorating net NPL-equity (FY12: 15%) and the absence of fresh capital injection since 2007 remain the key reasons. While slowing loan growth and higher SOE exposure (zero risk weight for state guarantee) may help BOC to negotiate the difficulty in the interim, timely capital injections from the State remains critical to BOC's future capitalisation.

The dip in BOC's low-cost deposits ratio (FY12: 44%, FY11: 51%) was broadly in line with the industry trend. Given the intense competition for deposits and high credit demand from the State, Fitch believes that BOC's endeavor to reduce its LDR to around 90% may not be possible in the near term.

Rating Sensitivities

Any change in Sri Lanka's Sovereign rating or the perception of state support to BOC could result in a change in BOC's IDRs and National Ratings. Visible demonstration of preferential support for BOC will be instrumental to an upgrade of its National LT Rating.

The VR remains under pressure and could be downgraded if a sharp asset-quality downturn is not complemented by timely re-capitalization from the state. An upgrade to VR, though unlikely in the near-term, will be triggered by consistent improvement in both asset quality parameters and capital levels and supported by BOC's ability to lower loan-deposits ratio overtime.

BOC is the largest bank in terms of assets in Sri Lanka and has a wide domestic presence across Sri Lanka. BOC has 13 subsidiaries and five associates and has branches in Chennai, India and Male (Maldives); and a fully-owned subsidiary, Bank of Ceylon (UK) Ltd, in the UK.

A full list of BOC's ratings:

Long-term Foreign- and Local-Currency IDRs: affirmed at 'BB-'; Outlook Stable

Viability Rating: affirmed at 'b+'

Support Rating: affirmed at '3'

Support Rating Floor: affirmed at 'BB-'

USD senior unsecured notes: affirmed at 'BB-'

Proposed USD senior unsecured notes: assigned at 'BB-(exp)'

National Long-Term rating: affirmed at 'AA+(lka)' ; Outlook Stable

Outstanding subordinated debentures: affirmed at 'AA(lka)'.

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