Fitch Ratings has affirmed the National Long-Term Rating of People's Bank (Sri Lanka) (PB) at 'AA-(lka)'. The Outlook is Stable.
KEY RATING DRIVERS
PB's National Long-Term Rating is driven by its intrinsic credit strength. It balances a superior franchise and funding profile against weaker asset quality, profitability and capitalisation and higher risk appetite relative to similarly rated private-bank peers.
The operating environment in Sri Lanka continues to be challenging. Sri Lanka's real GDP contracted by 3.6% in 2020 as key economic sectors were severely disrupted due to the coronavirus pandemic and the related lockdowns. We expect economic growth to rebound by 3.8% in 2021 and 3.9% in 2022 but this will depend largely on the containment of new Covid-19 cases in the country. The outlook on the operating environment assessment is maintained at negative to reflect the potential for further risk stemming from the sovereign credit profile or pressure on domestic operating conditions beyond our expectation independent of changes in the sovereign rating.
Fitch expects PB's tight capital and liquidity positions, which are close to the regulatory minimums, to constrain further aggressive loan book expansion for the near to medium term. PB's gross loan book already expanded 21.5% in 2020 and 10.1% in 1Q21, with a major share of that lending being to the state and state-owned entities (SOEs). This resulted in PB's exposure to the Government of Sri Lanka and SOEs accounting for nearly half its loan book at end-1Q21 from 38% at end-2019, indicating high concentration risk and PB's dependency on the state's financial profile.
PB's high risk appetite is reflected in its significant exposure to the weak Sri Lankan sovereign. Its sizeable non-state exposure, including retail and SME customers also elevates the bank's risk appetite as we believe that these customer segments are more susceptible to the pandemic induced downturn.
Fitch believes that PB's capital levels are not commensurate with the bank's risk profile given the domestic systemically important bank status. PB's common equity Tier 1 (CET1) ratio declined to 10.7% by end-2020 (end-2019: 11.6%) as a result of net actuarial losses on its defined benefit plans (54% of PB's 2020 net income), leading to only marginal growth in retained earnings. We foresee a slight improvement in PB's CET1 ratio in the medium term as earnings retention outpaces risk-weighted asset growth due to a larger share of incremental lending being to the state and SOEs where risk weights are low. That said, the bank's ability to undertake aggressive lending to the state is also constrained by its low leverage ratio of 3.5% at bank level at end-1Q21 (2019: 4%), which was only marginally above the regulatory minimum of 3%, and low all currency liquidity.
PB's domestic funding profile is supported by its superior deposit franchise and state linkages. We expect controlled loan book expansion together will healthy deposit growth to ease pressure on the bank's overall loans to deposit ratio (1Q21: 99%) in the near to medium term. Even so, Fitch expects accessibility and pricing of foreign-currency (FC) funding to remain a challenge for PB, and domestic peers, as a result of the deteriorating sovereign credit profile. FC deposits accounted for just 11% of total deposits at end-1Q21. PB's FC loans/FC deposits ratio improved to 191% by end-1Q21 (1Q20: 309%) as the bank reduced foreign-currency lending from 1Q20 in light of funding challenges.
Fitch expects a deterioration in PB's asset quality metrics, particularly in the non-state lending portfolio as pandemic-related relief measures that were extended in 2021 are gradually unwound. PB's impaired loans ratio improved to 9.5% by end-2020 (2019: 10.2%) despite a 14% growth in stage 3 loans with much of the deterioration stemming from its subsidiary - People's Leasing & Company PLC (PLC, A+(lka)/Stable). PB's loan loss coverage is modest, covering around 56% of impaired loans at end-2020, a similar amount to the larger peers.
Fitch expects PB's core profitability metric - operating profit/risk-weighted assets to improve in 2021, owing to high loan growth in 2020 and 1Q21 together with downward deposit repricing, despite continued high credit costs at a similar level to 2020. In the medium term, constrained loan book growth due to capital and liquidity limitations could weigh on PB's profitability. Operating profit/risk-weighted assets rebounded to 4.7% in 1Q21 (2020: 2.9%), supported by rapid loan book growth and downward repricing of deposits, while credit costs were also lower compared with 2020 (1Q21: 18% of pre-impairment operating profits, 2020: 37%).
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- Upside to PB's National Long-Term Rating is limited in the near term due to our assessments of the sovereign credit profile and the operating environment.
Factors that could, individually or collectively, lead to negative rating action/downgrade: - Pressure on the National Rating of PB will most likely stem from a deterioration in Sri Lanka's sovereign rating, constraining PB's standalone credit profile, including the operating environment;
- A weaker assessment of the operating environment independent of changes in the sovereign rating, or a deterioration in their key credit metrics beyond our base-case expectations relative to peers, could also lead to downgrade of PB's rating.
PB has a 1.78% equity stake in Fitch Ratings Lanka Ltd. No shareholder other than Fitch, Inc. is involved in the day-to-day rating operations of, or credit reviews undertaken by, Fitch Ratings Lanka Ltd.