Fitch maintains HNB’s National Rating of ‘AA-(lka)’ on Watch Negative

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Fitch Ratings has maintained Hatton National Bank PLC’s (HNB) National Long-Term Rating of ‘AA-(lka)’ on Rating Watch Negative (RWN). Fitch has also maintained HNB’s senior and subordinated debt ratings of ‘AA- (lka)’ and ‘A(lka)’, respectively, on RWN.

The RWN on HNB’s National-Long Term Rating reflects the potential for the bank’s creditworthiness relative to other entities on the Sri Lankan national ratings scale to deteriorate, given the heightened stress on the bank’s funding and liquidity and its significant exposure to the sovereign via investment in foreign-currency instruments that raises risks to its overall credit profile. Fitch believes that the sharp rise in inflation, depreciation of the local currency and other factors can distort the bank’s underlying financial performance in the current operating environment.

Fitch believes that the sovereign default and macroeconomic challenges could adversely affect HNB’s earnings and profitability in the near to medium. Earnings pressure is already evident in the substantial increase in impairment charges (62% of 1Q22 pre-impairment profits) on account of loan and non- loan exposures. However, the exchange gains from its foreign-currency denominated assets have partly mitigated the increased credit costs.

Fitch believes that capital deficiencies could arise in a very likely scenario that the bank has to absorb a haircut on its foreign-currency government securities. Weak internal capital generation, mark-to-market losses and loan quality deterioration combined with bloated risk-weighted assets from the rupee’s sustained depreciation will exert significant pressure on the bank’s capitalization metrics in the near term, in our view.

Fitch believes that HNB’s business profile is highly vulnerable to the intensifying risks in the domestic market, which could limit the bank’s ability to generate and defend business volume. HNB’s business profile could be differentiated by its superior domestic franchise as the fourth-largest commercial bank in Sri Lanka, with 8% of sector assets at end-2021, if the macroeconomic environment remains a higher level of stability.

Fitch also believes HNB’s foreign-currency funding and liquidity position is prone to sudden changes amid already weak creditor sentiment, similar to peers. HNB’s access to foreign-currency funding is severely limited given the sovereign’s stretched credit profile, while the bank’s foreign-currency liquidity has been significantly impeded by the sovereign’s default on its foreign-currency debt given the bank’s large holding of foreign-currency government securities.

Fitch assessment of Sri Lankan banks’ operating environment (OE) reflects the pressure on the Sri Lankan banks’ already stressed credit profiles following the sovereign’s default on its foreign-currency obligations. It also captures the rapid deterioration in the broader macroeconomic environment, including increased interest rates, high inflation and acute currency depreciation, which has limited HNB’s operational flexibility.

Fitch expects the worsening OE to destabilise  corporate and household balance sheets, leading to a marked increase in impaired (stage  3) loans in the near to medium term. Recently announced concessions for affected borrowers may limit the growth in impaired loans, which we believe could mask the true credit quality of the bank. HNB’s large exposure to foreign-currency government instruments adds to its asset-quality woes. At end-2021, impaired loans accounted for 5% of total assets, with another 11% of assets in foreign-currency government securities.

HNB’s elevated risk profile, similar to local peers, stems from its large exposure to high-risk customer segments with weak credit quality as reflected in the ‘ccc’/negative OE score. This is exacerbated by HNB’s large exposure to foreign-currency instruments issued by the government, which made up 11% of its assets at end-2021, making the bank vulnerable to the sovereign’s repayment capacity and liquidity position.