ECONOMYNEXT – Fitch Ratings has confirmed Sri Lanka-based Hatton National Bank PLC’s National Long-Term Rating at ‘A(lka)’ with a stable outlook, saying the economy was stabilizing but it also had the highest exposure to defaulted sovereign bonds.
HNB’s high risk profile, similar to peers, stems from its large exposure to sovereign risk, via the defaulted foreign-currency denominated sovereign bonds which at 10 percent of assets by end 2023, was the highest among local banks.
Provisions were 52 percent of the ISB exposure.
Another 33 percent of assets iwere rupee-denominated treasury securities, all of which make the bank vulnerable to the sovereign’s repayment capacity and liquidity position.
HNB’s bad loans were 6 percent of assets.
“Fitch expects HNB’s impaired (stage 3) loans to decrease in the near to medium term, buttressed by the improvement in borrower repayment capacity alongside the economic recovery and Fitch’s anticipated expansion in the bank’s loan book,” Fitch said.
“This is despite the parate suspension that is in effect until 15 December 2024.”
High internal capital generation through retained profits and gains from currency appreciation had boosted HNB’s regulatory Tier 1 ratio to 14.7 percent by end-2023 (2022: 11.4 percent).
That said, we estimate the bank’s underlying capital buffers to be lower by around 100bp if a 100 percent risk weighting were applied (currently 20 percent) on these defaulted bonds.
The full statement is reproduced below:
Fitch Affirms Hatton National Bank at ‘A(lka)’; Outlook Stable
Fitch Ratings – Colombo – 06 Jun 2024: Fitch Ratings has affirmed Sri Lanka-based Hatton National Bank PLC’s (HNB) National Long-Term Rating at ‘A(lka)’. The Outlook is Stable. At the same time, Fitch has affirmed HNB’s Sri Lankan rupee senior unsecured debt at ‘A(lka)’. The ratings on the bank’s proposed and outstanding Sri Lankan rupee subordinated debt have been affirmed at ‘BBB+(EXP)(lka)’ and ‘BBB+(lka)’, respectively.
KEY RATING DRIVERS
Intrinsic Profile Drives Rating: HNB’s National Long-Term Rating reflects its own financial strength, which is highly influenced by the bank’s exposure to the sovereign’s weak credit profile (Long-Term Foreign-Currency Issuer Default Rating (IDR): RD; Long-Term Local-Currency IDR: CCC-) and the ongoing sovereign debt restructuring, which has put pressure on HNB’s financial profile, particularly capitalisation and funding. The rating also reflects HNB’s superior domestic franchise as Sri Lanka’s fourth-largest commercial bank.
Restructuring Delays Hinder Progress: Sri Lankan banks’ operating environment (OE) continues to show signs of stabilisation, supporting the recovery in banks’ operational flexibility. There are sustained improvements in reported headline macroeconomic indicators, but persistent delays in the completion of the sovereign debt restructuring could impede the progress made so far, in Fitch’s view.
Exposure to Sovereign Risks: HNB’s high risk profile, similar to peers, stems from its large exposure to sovereign risk, via the defaulted foreign-currencydenominated sovereign bonds (end-2023: 10% of assets) and a further 33% of assets in rupee-denominated treasury securities, all of which make the bank vulnerable to the sovereign’s repayment capacity and liquidity position. HNB has the highest exposure to sovereign bonds among local banks.
Sovereign Default Affects Asset Quality: HNB’s asset quality metrics are burdened by its large holdings in defaulted foreign-currency-denominated sovereign bonds, in addition to loan quality stresses already facing the bank (6% of assets). Fitch expects HNB’s impaired (stage 3) loans to decrease in the near to medium term, buttressed by the improvement in borrower repayment capacity alongside the economic recovery and Fitch’s anticipated expansion in the bank’s loan book. This is despite the parate suspension that is in effect until 15 December 2024.
Sovereign Risk Pressures Capital: The sovereign’s external debt restructuring, including the defaulted sovereign bonds, and the rupee-denominated government securities, weigh on HNB’s capitalisation metrics. High internal capital generation through retained profits and gains from currency appreciation bolstered HNB’s regulatory Tier 1 ratio to 14.7% by end-2023 (2022: 11.4%). That said, we estimate the bank’s underlying capital buffers to be lower by around 100bp if a 100% riskweighting were applied (currently 20%) on these defaulted bonds.
Risks to Earnings Manageable: The bank’s operating profit/risk-weighted assets ratio improved to 5.9% by end-1Q24, due primarily to lower credit costs, which more than offset the decrease in the net interest margin (1Q24: 5.5%, 2023: 7.0%).
We expect the bank’s profitability metrics to normalise as the yield benefit from its high-yielding government securities tapers off. This is despite the potential for oneoff losses from the restructuring of sovereign bonds, should these outstrip existing provisions (52% of the balance sheet exposure).
Funding and Liquidity Risks Persist: We believe HNB’s funding and liquidity stresses have eased relative to the crisis period, on both the foreign and local currency fronts given more favourable external sector flows and the bank’s focus on liquidity preservation, as reflected in higher liquidity coverage ratio. However, improvements in foreign-currency liquidity remain susceptible to sudden changes in creditor sentiment. The bank’s ability to access foreign-currency wholesale funding remains constrained by the sovereign’s weak credit profile, similar to peers.
Economic Conditions Supports New Lending: Fitch expects Sri Lanka’s stabilising macroeconomic environment to support HNB’s ability to generate and defend business volumes, but the bank’s business profile remains constrained by the high risks in the OE. Fitch also expects the resumption in lending in the sector, albeit
modest, to enhance HNB’s share of assets in net loans, which fell to 47% by end1Q24 (2022: 56%) on muted lending opportunities and increased liquidity preservation.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
The bank’s National Rating is sensitive to a change in the bank’s creditworthiness relative to other Sri Lankan issuers.
Deterioration in HNB’s key credit metrics beyond our base-case expectations relative to peers would also increase downward pressure on the bank’s rating, which is driven by its intrinsic financial strength.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
Positive rating action on the sovereign may lead to an upgrade in the bank’s rating.
A sustained improvement in the bank’s key credit metrics beyond our base-case expectations relative to peers, could also lead to an upgrade of the bank’s rating.
OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS
Senior Debt: HNB’s outstanding senior unsecured debentures are rated at the same level as its National Long-Term Rating in accordance with Fitch’s criteria. This is because the issue ranks equally with the claims of the bank’s other senior unsecured creditors.
Subordinated Debt: HNB’s Basel III-compliant Sri Lankan rupee subordinated debt is rated two notches below the National Long-Term Rating anchor. This reflects Fitch’s baseline notching for loss severity for this type of debt and our expectation of poor recoveries. There is no additional notching for non-performance risks, as the notes do not incorporate going-concern loss-absorption features.
OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES
The senior and subordinated debt ratings will move in tandem with the bank’s National Long-Term Rating.
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. (Colombo/Jun6/2024)