ICRA Lanka reaffirms the issuer rating of Bank of Ceylon
ICRA Lanka Limited has reaffirmed the issuer rating of Bank of Ceylon (BOC or the Bank) at [SL]AAA (pronounced SL triple A) with a Negative outlook.
The rating reaffirmation continues to factor in the 100% Government of Sri Lanka (GoSL) ownership, which provides a strong likelihood of sovereign support and BOC’s leading position in the Sri Lankan banking industry. The outlook remains Negative due to weak asset quality which is further impacted due to Covid-19 pandemic. The Bank’s asset quality deteriorated with gross NPA ratio increasing to 5.35% in Jun-19 vis-à-vis 4.79% as of Dec-19 due to the weak macroeconomic conditions as a result of the pandemic. Consequently, the Bank has granted loan moratorium to ~15% of the total loan portfolio as in Jun-20 which is expected to exert pressure on its asset quality. Further, the Bank’s capitalisation remained moderate as it reported a Core Capital Ratio of 10.61% and Total Capital Adequacy Ratio of 14.70% in Jun-20 as compared to the regulatory requirement of 9.00% and 13.00%, respectively. However, ICRA Lanka noted the reduction of regulatory core capital requirement by 100 basis points till 2021 by the regulator for the domestic significantly important banks, which has provided comfort on the capital profile of the Bank in the near term. With more than 1% buffer over the regulatory capital requirements, the ability of the Bank to absorb any further asset quality shocks has marginally improved. ICRA Lanka however expects timely and adequate equity infusion by the GoSL to maintain the capitalisation profile.
The rating factors in its established franchise, healthy deposit profile and comfortable liquidity position with liquidity coverage ratio (LCR, for domestic currency) at 270.00% as in Jun-20. The rating also noted a moderation in earnings profile with return on assets (RoA) at 0.45% in H1CY2020 as compared to 0.99% in CY2019 due to LKR 6.0 Bn day one loss adjustment made on interest income in H1CY2020. The above, however exerts further pressure on the overall credit profile of the Bank. The steady improvement of these indicators would be crucial from a rating perspective.
The Negative outlook reflects the weakening of the asset quality and profitability indicators due to the pandemic. The outlook may be revised to ‘Stable’ in case of a steady improvement in the asset quality profile, while maintaining a comfortable earnings profile and a capital profile with steady maintenance of the capital buffers above regulatory capital requirement. ICRA Lanka believes that BOC will continue to benefit from timely and adequate capital support from GoSL.
Key rating drivers
100% government owned, systematically important bank with a long track record and established franchise; BOC is a licensed commercial bank, 100% owned by the government of Sri Lanka. The Bank is the largest commercial bank in Sri Lanka with systematic importance which provides a strong likelihood sovereign support. BOC accounts for about 21% of the aggregate advances and about 26% of the aggregate deposits of all licensed commercial banks (LCBs) in Sri Lanka as on June 30, 2020. The Bank also operates 581 branches covering all the regions in Sri Lanka. BOC’s net advances in CY2019 grew by 9.00% YoY (24.00% YoY in CY2018) which was higher than the 4.94% YoY growth reported by the LCB industry during the same period. The growth was mainly driven by lending to State owned Enterprises (“SoE”) in CY2019 to fund infrastructure development projects. During 6MCY2020, advances grew by 24.70% YoY; which came from direct lending to the Government. The rating factors the Bank’s position as one of the key lenders to the GoSL and State-owned entities (SOE), which accounts for significant exposure in the lending portfolio.
Healthy deposit profile although moderation in share of low cost CASA deposits; BOC’s main funding source is its public deposits which contribute close to 88% of the total borrowings as in Jun-20. The deposit profile consists of a comfortable mix of both local and foreign currency deposits, aided by the Bank’s well-established branch network and dominant position in the remittance business. However, the Bank’s current account savings account (CASA) ratio moderated to 32% as in Dec-19 from 43% in Dec-16. The decline in CASA ratio was higher than the decline witnessed by the LCB industry, which declined to 33% in Dec-19 from 39% in Dec-16. This trend was mainly due to depositors moving their funds to Fixed Deposits which offered higher yields. As a result, BOC’s term deposits reported a higher growth of 17% Y-o-Y as compared to CASA growth of 6% as in Dec-19. During the H1CY2020, the Bank reported a CASA of 32% as compared to the systematic level of 34%. Consequently, the Bank’s cost of deposits gradually increased over the last five years from 4.41% in CY2015 to 6.72% in CY2019.
Comfortable liquidity position; The Bank’s liquidity profile remained comfortable with the additional liquidity created with the reduction of Statutory Reserve Ratio (“SRR”) from 5.00% to 2.00% by the Central Bank of Sri Lanka since Mar-20 as a relief measure to face the after-shocks of the pandemic. This resulted in a positive short term (less than 12 months) cumulative maturity mismatch of 8.55% in Jun-20 (1.71% in Jun-19) as compared to 4.74% in Mar-20. The Liquidity Coverage Ratio (all currencies) was comfortably maintained at 157% (regulatory requirement 90%) and Liquid Asset Ratio (Domestic Currency) stood at 31% (regulatory requirement 20%) in Jun-20.
Asset quality pressure expected to continue in the medium-term following the pandemic; BOC’s asset quality deteriorated since 2018 as a result of poor performance in the construction and agriculture sectors which affected the corporate and SME segments of the Bank. The Bank’s gross NPA increased from 3.62% in Dec-18 to 4.79% in Dec-19, it further increased to 5.35% in Jun-20. The Bank’s gross NPA remained marginally above the LCB sector’s average of 5.27% in Jun-20. The weak asset quality was mainly driven by few construction companies which became non-performing. The pandemic has resulted in further pressure on the collections. Based on concessions announced by the Government, the Bank has granted loan moratorium to ~15% of the total loan portfolio as in Jun-20. ICRA Lanka believes that the present macroeconomic conditions will further pressurise the asset quality of the Bank when the moratorium period ends in Sep-20. Also, ICRA Lanka noted that the Bank’s solvency ratio (Net NPA/ Networth) deteriorated to 24.9% in Jun-20 from 22.7% in June -19, although the same has remained lower than the LCB sector’s average of 40.7% in Jun-20.
Moderate capitalisation levels; As in Jun-20, common equity Tier I including capital conservation buffer – CCB ratio was 10.61% (regulatory requirement 9.00%) and common equity Tier I including CCB and surcharge on domestic systematically important banks was 14.70% (regulatory requirement 13.00%). The capital ratios improved with LKR 5 Bn (0.42% of risk weighted assets in Jun-20) Tier I complied perpetual debenture issued in Jul-20. ICRA Lanka estimates that BOC would require additional capital of around LKR 18 Bn to meet the regulatory requirement while maintaining a 1% capital buffer for the next three years, assuming 10%-12% growth in RWAs under a worse-case scenario. However, due to the systemic importance of the Bank, ICRA Lanka expects timely capital support from GoSL, as demonstrated in the recent past (GoSL infused LKR 5 Bn each to BOC during CY2017 and CY2018). Going forward, maintenance of adequate buffers (at least 1%) over and above the minimum capitalisation requirements (Tier-I and overall CAR) would be critical from a rating perspective.
Muted profitability indicators due to the pandemic; The Bank’s yield on advances improved to 11.45% in CY2019 as compared to 11.23% in CY2018 due to expansion in high yielding segments (Retail and SME) of the portfolio. In H1CY2020, the yield on advances moderated to 9.92% due to the LKR 6 Bn day one loss adjustment made on the interest income factoring the impact of the moratorium. The cost of interest-bearing funds marginally increased to 6.68% in CY2019 as compared to 6.60% in CY2018 and has reduced to 6.55% in H1CY2020 in line with the policy rate cuts by the regulator. The Bank’s net interest margins (NIMs) improved to 3.20% in CY2019 as compared to 3.11% in CY2018 and the margins sharply declined to 2.47% in H1CY2020 due to the adjustments for the moratorium’s impact. Further, the cost to income ratio of the Bank improved to 43.34% in H1CY2020 as compared to 47.29% in CY2019 (47.27% in CY2018) in line with the cost control measures adopted by the Bank during the pandemic. The Credit Cost increased to 1.22% in H1CY2020 as compared to 0.79% in CY2019 (0.71% in CY2018) as a result of significant credit risk envisaged by the Bank post the pandemic. BOC’s, RoA moderated to 0.45% in H1CY2020 as compared to 0.99% in CY2019 and 0.92% in CY2018. ICRA Lanka noted that the Bank’s ROA remained lower than the system average of 0.97% in H1CY2020. Further weakening of the asset quality would exert pressure on the profitability of the Bank. ICRA Lanka notes that significant improvement in the NIMs and control on credit cost would be crucial to maintain a healthy earnings profile over the medium term.
Analytical approach: For arriving at the ratings, ICRA has applied its rating methodologies as indicated below.
Links to applicable criteria: ICRA Lanka’s Credit Rating Methodology for Banks
About the entity:
BOC is the largest licensed commercial bank in Sri Lanka; 100% owned by the Government of Sri Lanka. The Bank with assets of over LKR 2.68 trillion accounts for approximately 21% of the total banking sector assets as of Jun-20. BOC was incorporated in August 1939 under the Bank of Ceylon Ordinance No. 53 of 1938. Currently, BOC operates with over 581 branches including 3 overseas branches in Maldives, Chennai and Seychelles. The Bank also operates a subsidiary in the UK – Bank of Ceylon (UK) Limited. The BOC group has 10 subsidiaries and 4 associate companies that are involved in NBFI operations, property development and leisure.
During the CY2019, BOC reported profit after tax (PAT) of LKR 23,098 Mn on a total asset base of LKR 2,415 Bn as compared to a PAT of LKR 19,479 Mn on a total asset base of LKR 2,268 Bn in the previous financial year. For 6MCY2020, BOC reported a PAT of LKR 5,783 Mn on a total asset base of LKR 2,681 Bn compared to a PAT of 6,948 Mn on a total asset base of LKR 2,233 Bn.
Key financial indicators (audited)
Rating history for last three years:
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