Fitch takes rating actions on Sri Lanka financial institutions on Sovereign downgrade

Fitch Ratings has downgraded the Issuer Default Ratings (IDR) of Bank of Ceylon (BOC) and National Savings Bank (NSB) to ‘B+’ from ‘BB-’ and downgraded the IDRs of People’s Leasing & Finance PLC’s (PLC) IDRs to ‘B’ from ‘B+’. The IDRs of DFCC Bank PLC (DFCC) were affirmed at ‘B+’. The Outlooks on all the IDRs are Negative to reflect the Negative Outlook on the sovereign.

Fitch took the rating actions after it downgraded the Sri Lankan sovereign to ‘B+’ from ‘BB-’ and assigned a Negative Outlook on 29 February 2016. 

Fitch has also assigned Recovery Ratings of ‘RR4’ to the US dollar senior unsecured notes issued by BOC and NSB to reflect average recovery prospects. At the same time Fitch affirmed the Recovery Rating on DFCC’s US dollar senior unsecured notes at ‘RR4’. The National Ratings of BOC, NSB, DFCC and PLC have not been reviewed at this time.

Fitch maintains a stable sector outlook for the Sri Lankan banking sector for 2016 as we do not expect the sector’s credit profile to deteriorate materially even though operating conditions could become more challenging. The operating environment remains a key rating driver for the Sri Lankan banking sector given its potential volatility.

A full list of rating actions is at the end of this rating action commentary.

Key rating driversIDRS, VRS and senior debt

The downgrades of the IDRs on BOC and NSB are driven by the state’s reduced ability to provide support while Fitch’s expectation of the state’s propensity to provide support remains unchanged.

Fitch expects the state to extend support to BOC because of its high systemic importance, quasi-sovereign status, role as a key lender to the government and full government ownership. 

The state is likely to provide support for NSB because of its policy mandate of mobilising retail savings and primarily investing them in government securities. The ratings of all foreign-currency denominated senior debt issued by BOC and NSB have been downgraded by one notch to reflect the downgrades of the IDRs.

BOC’s Viability Rating (VR) is at the same level as its support-driven IDR. The VR captures its thin capitalisation and weak asset quality, which are counterbalanced by its strong domestic funding franchise that is underpinned by its state linkages. 

Fitch has not assigned a VR to National Savings Bank as it is a policy bank.

PLC’s ratings continue to reflect Fitch’s view that its parent, the state-owned and systemically important People’s Bank (Sri Lanka) (AA+(lka)/Stable), has a high propensity but limited ability to provide extraordinary support to PLC, if required. People’s Bank’s propensity to support PLC remains unchanged and stems from its 75% shareholding in PLC, their common brand and PLC’s position as a strategic subsidiary of the bank. People’s Bank’s reduced ability to provide support is reflected in the sovereign’s rating.

DFCC’s IDRs are driven by its intrinsic strength as indicated by its ‘b+’ VR. The Negative Outlook, however, reflects Fitch’s approach of generally capping bank ratings at the sovereign rating level due to the likely adverse impact on its credit profile from the Sri Lankan sovereign’s deteriorating credit profile and increasing risks in the domestic operating environment. DFCC’s VR captures its adequate capitalisation and developing commercial banking franchise.

The ratings on DFCC’s senior debt have been affirmed in line with the affirmation of the bank’s Long-Term Foreign-Currency IDRs as the notes rank equally with the bank’s other senior unsecured obligations.

Support Ratings and Support Rating Floors

The downgrade of the Support Ratings (SRs) and Support Rating Floors (SRFs) of BOC and NSB follows the downgrade of the sovereign’s ratings as this indicates the state’s reduced ability to provide support and consequently, limited probability that timely support would be extended to the banks. This is despite Fitch’s expectation of the government’s propensity to provide support to the banks has not reduced given their high importance to the government and high systemic importance.

The SR of DFCC has been affirmed at ‘4’ to reflect its moderate size and systemic significance and linkages with the sovereign through indirect ownership. The bank continues to have a lower SRF of ‘B’ relative to state-owned and more systemically important banks.

Rating sensitivitiesIDRS, VRS and senior debt

Any changes in Sri Lanka’s sovereign rating or the perception of state support to BOC could result in a change in its IDRs. Further deterioration in the operating environment that is reflected in the decline in the bank’s key credit metrics could also negatively affect the Viability Rating (VR) of BOC. BOC’s IDRs would be downgraded only if Fitch were to downgrade its VR and Support Rating Floor (SRF).

Similarly for NSB, the expectation of state support remains the primary rating driver, and as such any change in Sri Lanka’s sovereign rating or the perception of state support to NSB could result in a change in its IDRs.

An upgrade of DFCC’s ratings would be contingent on a materially stronger commercial banking franchise while maintaining strong credit metrics. 

However, DFCC’s ratings are unlikely to be upgraded to higher than the sovereign rating. DFCC’s ratings could be downgraded if there is a sustained and substantial increase in risk appetite that could materially weaken its capital position. 

Further deterioration in the operating environment could also negatively affect the ratings.

PLC’s IDRs will be sensitive to changes in the sovereign rating, which reflects People’s Bank’s ability to provide support to its subsidiary. PLC’s ratings are also sensitive to People’s Bank’s propensity to provide support due to changes in PLC’s strategic importance to its parent.

The assigned senior debt ratings are primarily sensitive to changes in the entities’ Long-Term IDRs.

The Recovery Ratings are sensitive to Fitch’s assessment of potential recoveries for creditors in case of default/non-performance.

Support Ratings and Support Rating Floors

The banks’ Support Ratings and SRFs are sensitive to the sovereign’s ability and propensity to provide support, as expressed in any change in the sovereign ratings of Sri Lanka.

The rating actions are as follows:BOC

Long-Term Foreign-Currency IDR downgraded to ‘B+’ from ‘BB-’; Outlook Negative

Long-Term Local-Currency IDR downgraded to ‘B+’ from ‘BB-’; Outlook Negative

Short-Term Foreign-Currency IDR affirmed at ‘B’

Viability Rating affirmed at ‘b+’

Support Rating downgraded to ‘4’ from ‘3’

Support Rating Floor revised to ‘B+’ from ‘BB-’

US dollar senior unsecured notes downgraded to ‘B+’ from ‘BB-’; Recovery Rating assigned at ‘RR4’

National Savings Bank

Long-Term Foreign-Currency IDR downgraded to ‘B+’ from ‘BB-’; Outlook Negative

Long-Term Local-Currency IDR downgraded to ‘B+’ from ‘BB-’; Outlook Negative

Short-Term Foreign-Currency IDR affirmed at ‘B’

Support Rating downgraded to ‘4’ from ‘3’

Support Rating Floor revised to ‘B+’ from ‘BB-’

US dollar senior unsecured notes downgraded to ‘B+’ from ‘BB-’; Recovery Rating assigned at ‘RR4’

DFCC

Long-Term Foreign-Currency IDRs affirmed at ‘B+’; Outlook Negative

Long-Term Local-Currency IDRs affirmed at ‘B+’; Outlook Negative

Short-Term Foreign-Currency IDR affirmed at ‘B’

Viability Rating affirmed at ‘b+’

Support Rating affirmed at ‘4’

Support Rating Floor affirmed at ‘B’

US dollar senior unsecured notes affirmed at ‘B+’; Recovery Rating affirmed at ‘RR4’

People’s Leasing & Finance PLC

Long-Term Foreign-Currency IDR downgraded to ‘B’ from ‘B+’; Outlook Negative

Long-Term Local-Currency IDR downgraded to ‘B’ from ‘B+’; Outlook Negative