ICRA Lanka revises the ratings of Bank of Ceylon
|Instrument||Rated Amount (LKR Mn)||Rating Action|
|Issuer Rating||NA||Revised to [SL]AA (Negative) from [SL]AAA on watch with Negative implications|
|Basel III Compliant Additional Tier I Capital Bond Programme- 2020||10,000||Revised to [SL]A+ (hyb) (Negative) from [SL]AA (hyb) on watch with Negative implications|
|Basel III Compliant Additional Tier I Capital Bond Programme- 2021||3,350||Revised to [SL]A+ (hyb) (Negative) from [SL]AA (hyb) on watch with Negative implications|
|Basel III Compliant, Tier II Subordinated Debenture Programme||5,400||Revised to [SL]AA- (Negative) from [SL]AA+ on watch with Negative implications|
ICRA Lanka Limited has revised the Issuer Rating of Bank of Ceylon (“BOC”/” the Bank”) to [SL]AA (pronounced as S L Double A). ICRA Lanka has also revised the issue rating of Basel III Compliant, Unlisted, Unsecured, Subordinated, Perpetual, Additional Tier I (AT1) Capital Bond Programmes of LKR 10,000 Mn and LKR 3,350 Mn, respectively to [SL]A+ (hyb) (pronounced as S L A plus hybrid). The letters ‘hyb’ in parenthesis suffixed to a rating symbol stand for ‘hybrid’, indicating that the rated instrument is a hybrid subordinated instrument with equity-like loss-absorption features, which may translate into higher levels of rating transition and loss severity vis-à-vis conventional debt instruments. Furthermore, ICRA Lanka has also revised the LKR 5,400 Mn Basel III Compliant, Tier II Subordinated Debenture Programme of the Bank to [SL]AA- (pronounced as S L Double A minus). The outlook on the ratings are revised to Negative from rating on watch with Negative implications.
The revision in BOC’s ratings takes into consideration the intensified risk in the banking sector of Sri Lanka; particularly the impact from the suspension of repayments of foreign-currency debt by the CBSL, the sovereign rating downgrades by the international rating agencies which has limited the Bank’s foreign currency funding and elevated the foreign-currency refinancing risk. The revision of ratings also factors in the envisaged rise in slippages from Q2CY2022 due to the business disruption from fuel shortage, power outage and various other macro-challenges; majority of these challenges intensified during early April 2022. While the mark-to-market impact from the sharp interest rate hike by 700 bps in April 2022 and 100 bps in July 2022 is limited on the bank’s treasury investment portfolio, ICRA Lanka expects the core margins to be affected due to deposit repricing.
The significant increase in the impairment charges in Q1CY2022 (LKR 55 Bn in Q1CY2022 compared to LKR 4.8 Bn in Q1CY2021) and the sharp devaluation of the rupee which elevated risk-weighted assets pertaining to foreign currency loans and investments resulted in a moderation of the Bank’s capital profile. BOC’s Tier 1 capital ratio moderated to 11.90% in March 31, 2022 from 14.25% in December 31, 2021 as against the regulatory requirement of 10.00%. ICRA Lanka notes the measures implemented by the Central Bank of Sri Lanka (CBSL) to support the Banking sector which includes the flexibility to draw down the Capital Conservation Buffer (“CCB”) upto 2.5%, however, expects the same would diminish the capital buffers available for future use especially in the current year wherein the economy is expected to face further challenges from the worsening macro parameters. Further, ICRA Lanka does not envisage much capital support from the GoSL, given the stretched fiscal outlook. BOC also faces concentration risk in terms of its high exposure to direct state lending which includes some of the large State-Owned Entities (SOEs).
ICRA Lanka does not envisage much stress in terms of the local currency liquidity especially given the sizeable amount of liquidity absorbed back into the financial sector post the sharp increase in the systemic rates by 700 bps in April 2022. Bank of Ceylon’s extensive branch network with 581 branches and its legacy as one of the oldest Banks in the country helps attracting sufficient local-currency liquidity.
The negative outlook reflects the envisaged weakening of asset quality indicators from Q2CY2022 on account of the current state of the economy while the capital buffers are also expected to remain stretched. The negative outlook also reflects the tight dollar liquidity faced by BOC, along with rest of the peer banks. The outlook may be revised to ‘Stable’ in case of a steady improvement in its capital profile with healthy buffers over the regulatory requirements while also improving and maintaining healthy asset quality indicators and liquidity profiles.
Key rating drivers
100% GoSL owned, systematically important bank, with a long track record and established franchise; BOC is a 100% government of Sri Lanka owned (GoSL) licensed commercial bank in the country and is also the largest commercial bank in the country with an asset base of LKR 4,201 Bn as on March 31, 2022. It is also one of the four systematically important banks in Sri Lanka. Bank of Ceylon’s net lending portfolio and total asset base accounted for about 26% and 28%, respectively of the overall LCB sector as on March 31, 2022. BOC is also the first bank in the country to surpass the LKR 4 Tn asset base. It is one of the two state-owned LCBs in the country and therefore is a key lender to the GoSL and State-Owned Entities (SOEs). ICRA Lanka continues to monitor the concentration risk resulting from the same due to Bank’s sizeable exposures.
Established Bank with an extensive branch network and a healthy share of CASA deposits; Set up in 1939, BOC is one of the oldest banks in the country. It possesses a wide branch network of 581 branches as on March 31, 2022. BOC also has 1,400+ touch points via ATMs/CDMs and CRMs. In addition to this extensive reach across Sri Lanka, BOC operates three branches in Chennai, Maldives and Seychelles, a limited-service branch in Hulhumale & a fully-owned subsidiary in London, U.K. The bank’s main funding source is its public deposits which accounted to about 80% of the total funding as on March 31, 2022. BOC has a comfortable mix of both local currency deposits and foreign currency deposits. Being a dominant player in the remittance business, BOC reported a healthy share of foreign currency deposits at 22% of the Bank’s total funding as on March 31, 2022 compared to 17% as on December 31, 2021. However, ICRA Lanka is cognisant of the challenges posed to the foreign currency Asset Liability Mismatch (ALM) resulting from the suspension of the repayment of foreign currency debt by the CBSL, challenged counterparty relationship with foreign lenders due to the sovereign rating downgrade and also from the ongoing forex shortage in the country. BOC reported a healthy share of CASA deposits (Current & Savings deposit) at 33.91% of total deposits as on March 31, 2022, compared to 35.66% as on December 31, 2021.
Foreign-currency funding profile will remain stretched; local-currency liquidity likely to remain somewhat comfortable; Post the announcement of the foreign currency debt suspension plan by CBSL on April 2022, the international rating agencies downgraded the sovereign rating of Sri Lanka. On account of this, the major banks in the country including BOC was significantly impacted on its counterparty dealings and thereby affecting its dollar liquidity. BOC also has sizeable investments in dollar-denominated government securities. It is also the largest holder of Sri Lanka Dollar Bonds (SLDBs) amongst the Banks in the country. As on March 31, 2022, BOC had LKR 147 Bn invested in SLDBs and LKR 46 Bn in International Sovereign Bonds (ISBs) which in total accounts for 92% of the Bank’s Networth and 4.6% of the total asset base of the Bank. Although excluded from the debt restructuring plan, ICRA Lanka does not drive much comfort from the sizeable investments in SLDBs by BOC due to the extremely weak foreign currency position of the country.
Over the past two years, the liquidity position of BOC has deteriorated especially with the Bank having to access short-term repo market for its liquidity needs. As on March 31, 2022, short-term borrowings (excluding deposits) accounted to 70% of the total borrowings compared to around 15% as on March 31, 2020. ICRA Lanka notes that the cumulative Asset Liability Mismatch (ALM) for less than 1 year bucket stood negative over the past two years (-8.05% as on March 31, 2022 and -2.45% as on March 31, 2021) as compared to positive 4.74% as on March 31, 2020. However, ICRA Lanka does not expect much pressure in terms of local currency funding and liquidity going forward due to the sharp interest rate increase which attracted sizeable rupee liquidity back to the financial sector.
Weak capitalisation profile with diminishing regulatory capital buffers; BOC reported a decline in Tier 1 capital ratio to 11.90% as on March 31, 2022, from 14.25% as on December 31, 2021 (regulatory requirement of 10.00%). The total capital ratio of the Bank stood at 14.93% as on March 31, 2022, moderated from 17.77% as on December 31, 2021 (regulatory requirement of 14.00%). The capital buffers across the Banking sector diminished in Q1CY2022 due to several reasons. A sharp increase in the risk-weighted assets (RWAs) mainly due to currency devaluation which impacted BOC as it holds a sizeable foreign currency loan book (32% of the gross loan portfolio) and a sizeable foreign currency investment book. In addition to this, additional impairment charges which is a resultant of the local currency devaluation impacted the capital position of the Bank. BOC incurred LKR 19.4 Bn impairment due to exchange rate effect on the foreign loans while incurring LKR 8.6 Bn on foreign currency denominated sovereign instruments. In addition to that, increase in the Expected Credit Loss (ECL) to 12% from 10% for ISBs has also impacted the Tier 1 capital of the Bank. ICRA Lanka takes note of the measures implemented by the CBSL to support the Banking sector which includes the flexibility to draw down the Capital Conservation Buffer (“CCB”) upto a maximum of 2.5%, however, the same would diminish the capital buffers available for future use especially in the current year wherein the economy is expected to face challenges from worsening macro parameters.
Asset quality indicators likely to deteriorate in the medium term; BOC maintains a high impaired loans ratio which is mainly driven by construction sector stage 3 loans. As on March 31, 2022, BOC reported an impaired loans ratio of 5.5% as compared to 5.1% as on December 31, 2021. ICRA Lanka expects the overall asset quality of the bank to further weaken during 2HCY2022 as the extremely challenging operating environment has adversely affected Bank’s key exposure sectors. However, ICRA Lanka takes some comfort from the healthy provisioning coverage of BOC where the impairment (Stage 3) to stage 3 loans ratio stood at 51.62%.
Sizeable provisioning in Q1CY2022 impacted the Bank’s earnings profile, while profitability for CY2022 will remain subdued; With sharp devaluation in the local currency, BOC incurred impairment charges amounting to LKR 28 Bn (LKR 19.4 Bn impairment on foreign loans & LKR 8.6 Bn on foreign currency denominated sovereign instruments). Furthermore, BOC also incurred impairment due to changes in ECL for ISB and elevated credit risk and thereby reporting a total impairment charge of LKR 55 Bn for Q1CY2022 as compared to LKR 4.8 Bn in Q1CY2021. The credit cost (Provisioning/ATA) significantly increased to 5.50% in Q1CY2022 vis-à-vis 0.63% in Q1CY2021.
Other income/ATA rose to 3.27% in Q1CY2022 as compared to 0.66% in Q1CY2021. Other income included LKR 34 Bn exchange gain which is a result of the transactional foreign currency gains. BOC reported a Profit After Tax (PAT) of LKR 5,464 Mn in Q1CY2022 as against LKR 12,901 Mn in Q1CY2021 (LKR 37,590 Mn in CY2021). The Bank’s return ratios declined with return on assets (On PAT) at 0.55% in Q1CY2022 as compared to 1.68% in Q1CY2021. ICRA Lanka envisages the profitability of BOC to remain subdued in the medium term due to expected worsening of the economic conditions of the country which will result in further impairment charges. In addition, while the bank has more flexibility in-terms of asset repricing, the sharp increase in systemic interest rates will somewhat affect the core margins of the bank, due to the deposit repricing effect.
Analytical approach: For arriving at the ratings, ICRA has applied its rating methodologies as indicated below.
Links to applicable criteria: https://www.icralanka.com/rating-methodology-for-banks/
BOC is the largest bank in Sri Lanka (On asset base); 100% owned by the Government of Sri Lanka. The Bank has assets worth over LKR 4 trillion and accounts for approximately 28% of the total Licensed Commercial Banking (LCB) sector assets. BOC was incorporated in August 1939 under the Bank of Ceylon Ordinance No. 53 of 1938. At present, BOC operates with over 581 branches including 3 overseas branches in Chennai, Maldives and Seychelles, a limited-service branch in Hulhumale & a fully-owned subsidiary in London, U.K. BOC group has 9 subsidiaries and 4 associate companies that are involved in NBFI operations, property development and leisure.
During Q1CY2022, BOC reported a profit after tax (PAT) of LKR 5,464 Mn on a total asset base of LKR 4,201,409 Mn as compared to LKR 12,901 Mn PAT for Q1CY2021 on a total asset base of LKR 3,145,426 Mn. For CY2021, BOC reported a PAT of LKR 37,590 Mn on a total asset base of LKR 3,803,284 Mn.
Key financial indicators of Bank of Ceylon
|Net interest income||74,776||111,252||23,631||39,806|
|Profit after tax||17,765||37,590||12,901||5,464|
|Loans and advances (net)||1,988,409||2,413,762||2,166,063||2,430,684|
|Return on average Networth||11.89%||21.03%||31.55%||10.61%|
|Return on Assets (Based on PAT)||0.66%||1.11%||1.68%||0.55%|
|Capital adequacy ratio (BASEL III Tier 1)||11.22%||14.25%||11.11%||11.90%|
Rating history for last three years:
|Sachini Costa |
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