ECONOMYNEXT – Fitch Ratings said it was confirming a national long-term ‘A-(lka)’rating on Sri Lanka’s Seylan Bank Plc with a stable outlook, amid an improvement in operating environment, indicated by headline macroeconomic indicators.
Fitch said it expected a modest increase in Seylan’s proportion of net loans to total assets (60.0% at end-1Q24) in the near- to medium-term, as lending resumes, comparable with its peers.
“We expect a modest increase in Seylan’s proportion of net loans to total assets (60.0% at end-1Q24) in the near- to medium-term, as lending resumes, comparable with its peers.”
The full statement is reproduced below:
Fitch Affirms Seylan Bank at ‘A-(lka)’; Outlook Stable
Fitch Ratings – Colombo – 22 Jul 2024: Fitch Ratings has affirmed Sri Lanka-based Seylan Bank PLC’s (Seylan) National Long-Term Rating at ‘A-(lka)’. The Outlook is Stable. Fitch also affirmed Seylan’s Sri Lankan rupee-denominated outstanding subordinated debt at ‘BBB(lka)’.
KEY RATING DRIVERS
Intrinsic Profile Drives Rating: Seylan’s National Long-Term Rating reflects its own financial strength, which is influenced by the bank’s exposure to the sovereign’s weak credit profile (Long-Term Foreign-Currency Issuer Default Rating (IDR): RD; LongTerm Local-Currency IDR: CCC-) and the ongoing sovereign debt restructuring, which had been putting pressure on Seylan’s credit profile. The rating also reflects Seylan’s modest domestic franchise as Sri Lanka’s seventh-largest commercial bank.
Stabilising OE: Sri Lankan banks’ operating environment (OE) continues to show signs of stabilisation, as evident in sustained improvements in reported headline macroeconomic indicators, supporting the recovery in banks’ operational flexibility.
Further improvement to the banks’ OE remains contingent on successful execution of the sovereign’s external debt-restructuring exercise alongside the restoration of the sovereign’s creditworthiness, given the strong link between sovereign financial health and banks’ operating conditions.
Economy Supports Lending: We anticipate the improvements in macroeconomic conditions to support Seylan’s capacity to generate and maintain business volumes.
However, the bank’s business profile continues to be affected by the weak domestic operating environment. We expect a modest increase in Seylan’s proportion of net loans to total assets (60.0% at end-1Q24) in the near- to medium-term, as lending resumes, comparable with its peers.
Sovereign Risk Remains: Seylan’s risk profile assessment continues to be affected by its exposure to the weak sovereign and economic environment. Defaulted foreign-currency sovereign bonds represented 1.7% of its assets at end-2023, with impairments of 52% held against them. Furthermore, local-currency-denominated treasury securities accounted for 21% of assets, comprising 56% in treasury bonds and 44% in treasury bills at end2023. This makes the bank susceptible to the sovereign’s repayment ability and liquidity status.
Impaired Loans to Decline: We expect Seylan’s impaired (stage 3) loans ratio to decline gradually over the medium term – given the bank’s recovery efforts, improvements in borrowers’ repayment capacity due to economic stabilisation, and moderate loan-book growth. This is reflected in the modest improvement in the ratio to 13.8% in 1Q24 from 14.3% at end-2023 (end-2022:12.6%). That said, the impaired-loans ratio remains higher than the industry average of 12.8% (end-2023: 12.8%).
Reduced Risks to Profitability: We believe that downside risk to profitability from the restructuring of sovereign bonds has declined, and any additional impairment, if necessary, will be manageable due to the existing provisions on the holdings. We expect Seylan’s operating profit/risk-weighted assets (end-1Q24: 4.7%, 4-year average 2.1%) to moderate over the medium term, due to the decline in interest rates and the increased risk density from the rising share of loans in assets. However, we expect these to be partially offset by lower credit costs.
Manageable Risks to Capital: We believe that the downside risk to capital from the bank’s exposure to defaulted sovereign bonds is manageable, considering the announced restructuring terms, given that the bank held provisions covering 52% of this exposure at end-2023. Its regulatory common equity tier 1 (CET1) capital ratio was 13.0% at end1Q24 (excluding 1Q24 profit), below the industry average of 14.2%.
Funding and Liquidity Risks Ease: Seylan’s funding and liquidity stress has eased on both the foreign and local-currency fronts relative to the crisis period, due to favourable external sector flows and the bank’s focus on liquidity preservation, as reflected in its higher liquidity coverage ratio. We believe these developments have reduced the risk of bank failure. However, Seylan’s funding and liquidity profile, particularly in foreign currency, remains susceptible to sudden changes in creditor sentiment driven by adverse changes to the sovereign’s credit profile, similar to peers.
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.
A deterioration in Seylan’s key credit metrics beyond our base-case expectations relative to peers would also lead to increased downward pressure on the 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 rating. A sustained improvement in key credit metrics beyond our base-case expectations relative to peers, could also lead to an upgrade.
OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS SUBORDINATED DEBT
Seylan’s Sri Lankan rupee-denominated outstanding 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 expectations 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 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.
Additional information is available on www.fitchratings.com (Colombo/Jul24/2024)