Fitch Ratings has upgraded Bank of Ceylon's (BOC) Long-Term Foreign Currency Issuer Default Rating (IDR) to 'CCC-' from 'CC'. At the same time, the Rating Watch Negative (RWN) on the Viability Rating (VR) has been removed and the VR upgraded to 'ccc-' from 'cc'. Fitch has also affirmed the Short-Term IDR at 'C' and the Government Support Rating (GSR) at 'ns'.
BOC's Local-Currency IDR and National Ratings were not considered in this review.
Key Rating Drivers
Lower Risk of Failure: The removal of the RWN and the upgrade of the VR reflects our view that risk of failure - as per Fitch's Bank Rating Criteria - stemming from capital deficiencies has declined significantly. The action reflects the advanced stages of the government's efforts to restructure the debt granted to a state-owned entity. We do not expect the estimated losses from this restructuring to be sufficiently large to require extraordinary support to restore viability.
BOC's VR of 'ccc-' is highly influenced by our operating environment assessment, as it is likely to constrain the intrinsic credit profile through its effect on financial and non-financial key rating factors. The upgrade of the Foreign Currency IDR is driven by the upgrade of its VR, and both remain above Sri Lanka's Foreign Currency IDR. This reflects our view of a lower risk that the authorities will impose restrictions on the bank servicing its foreign-currency obligations despite the sovereign being in default.
Declining Capital-Impairment Risks: The restructuring of loans granted to a state-owned entity that have now been assumed by the government, is nearing completion. We view the agreed terms as more favourable for BOC than initially anticipated, thereby reducing the risk of material capital erosion for the bank. On account of this, we have revised upwards BOC's capitalisation and leverage score to 'ccc-' from 'cc'.
Sovereign Risk Drives Risk Profile: The upward revision in BOC's risk profile assessment to 'ccc-' from 'cc' reflects easing risk-profile constraints as the sovereign debt restructuring - including loans extended to a state-owned entity - draws to a conclusion. The risk profile assessment on BOC continues to reflect its large exposures to the weak sovereign - estimated at nearly 60% of assets. We expect BOC's exposure to the sovereign to moderate in the medium term as private-sector lending opportunities expand.
Asset Quality to Improve: Fitch revised upwards BOC's asset quality score to 'ccc-' from 'cc', in line with our assessment of the risk profile. This reflects our view that asset-quality metrics - encompassing both loans and non-loan exposures - stem largely from its risk profile which is predominantly exposed to the sovereign. BOC's impaired (stage 3) loans ratio deteriorated to 13.6% by end-3Q24 (end-2023: 12.6%), mostly on account of the loan book contraction, but we expect a meaningful improvement in 2025 due to better economic conditions and an expanding loan book.
Funding and Liquidity Risks Ease: The upward revision in BOC's Funding and Liquidity score to 'ccc-' from 'cc' reflects the improvement - albeit still weak - in local- and foreign-currency funding and liquidity profile relative to the crisis period, thanks to favourable external sector flows and the bank's focus on liquidity preservation. We believe this to have reduced the likelihood of bank failure due to liquidity stress. We expect the restoration of the sovereign's creditworthiness, following a successful debt restructuring, to provide BOC with access to foreign-currency wholesale funding.
Declining Risks to Profitability: Downside risks to BOC's profitability has diminished following the announcement of the final restructuring terms of the sovereign bonds as well as the state-linked borrowing. The bank's core profitability metric - operating profit/risk weighted assets - improved to 3.7% in 9M24 (2023: 3.1%), and we expect this to increase further by end-2024 upon the conclusion of the state-owned entity's debt restructuring.
OE Improvement Linked to Sovereign: Fitch expects any improvement in the sovereign's credit profile, following successful debt restructuring, to be credit positive for our assessment of the Sri Lankan banks' operating environment (OE), given the strong link between sovereign financial health and banks' operating conditions. The economic reforms undertaken since the crisis period have led to sustained improvements in headline macroeconomic indicators in Sri Lanka, reducing systemic risks and supporting the banks' operating flexibility.
Rating Sensitivities
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
Fitch would downgrade BOC's Long-Term Foreign- and/or Local-Currency IDRs if we perceive there is an increased likelihood that the bank would default on - or seek a restructuring of - its senior foreign- and/or local-currency obligations to non-government creditors.
Potential capital erosion that increases failure risk could lead to a downgrade of BOC's VR. A default on senior obligations to third party, non-government creditors may be viewed by Fitch as a "bank failure" and could lead to the VR being downgraded to 'f'.
A downgrade of the VR may not necessarily lead to a downgrade of the Long-Term Foreign- and Local-Currency IDRs, unless the VR downgrade is a result of increased default risk stemming from funding and liquidity stresses.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
An upgrade of BOC's Long-Term Foreign- and Local-Currency IDRs and VR would most be likely to result from an improvement in the sovereign's credit profile and the operating environment assessment, which could occur after the successful restructuring of the sovereign's external debt.
A sustained improvement in the sovereign's financial flexibility may lead to a reconsideration of state support, leading to an upgrade of the bank's GSR.
VR ADJUSTMENTS
The operating environment score of 'ccc-' is below the 'b' category implied score due to the following adjustment reason: sovereign rating (negative).
The business profile score of 'ccc-' is below the 'b' category implied score due to the following adjustment reason: business model (negative).
BOC 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.
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.
ESG Considerations
Bank of Ceylon has an ESG Relevance Score of '4' for Financial Transparency. This reflects our view that the recent regulatory forbearance measures announced by the Central Bank of Sri Lanka could distort the true solvency and liquidity position of the bank, thereby limiting financial transparency. This has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.
Bank of Ceylon has an ESG Relevance Score of '4' for Governance Structure due to ownership concentration, with a 100% state shareholding and several related-party transactions with the state and state-owned entities, which has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision.
