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

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Fitch Ratings has maintained People’s Bank’s (Sri Lanka) (PB) National Long-Term Rating of ‘AA-(lka)’ on Rating Watch Negative (RWN).

The RWN on PB’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 stress on bank’s funding and liquidity, and also its significant exposure to the sovereign via foreign-currency lending and, to a lesser extent the 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. Tight foreign-currency liquidity in the financial system continues to weigh on PB’s ability to service its foreign-currency obligations, including off-balance-sheet trade finance liabilities, in a timely manner. We Fitch also believe that the weakened sovereign credit profile has constrained the access of state banks, including PB, to foreign-currency funding in the near-to-medium term.

PB’s foreign-currency loan/deposit ratio of 186% at end-1Q22 is significantly higher than  the median of 74% for ‘AA-(lka)’ rated peers, reflecting the bank’s heavy reliance on  wholesale funding to support government and state-owned enterprises’ (SOE) foreign currency funding needs. PB’s local-currency liquidity is stable (local-currency loan/deposit ratio of 79.7% at end-1Q22), supported by muted loan growth and access to the Central Bank of Sri Lanka’s (CBSL) liquidity window.

Fitch assessment of Sri Lankan banks’ operating environment (OE) reflects the pressure on the 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 PB’s operational flexibility. Fitch expect PB’s impaired-loan ratio to rise in 2022 and 2023, similar to the sector, due to the worsening OE. While recently announced concessions for affected borrowers could limit the growth in impaired loans, we believe it could mask the true credit quality of the bank. Fitch believe that PB is unlikely to be able to  sustain the fall in its impaired-loan ratio, based on SLFRS 9 stage 3 loans/gross loans, to  8.7% by end-2021 from 9.5% at end-2020. PB’s loan-loss provisions cover 62% of impaired loans, higher than the average of 54% over 2018-2020, but low relative to larger private peers.

PB’s high risk profile is reflected in its significant exposure to the weakened Sri Lankan sovereign, which has defaulted on its foreign-currency obligations.  Its sizeable non-state exposure, including retail and SME customers, also raises the bank’s risk profile as Fitch believes that these segments are more vulnerable in the current economic downturn. The government and SOEs accounted for nearly half PB’s loan book at end 2021, indicating high concentration risk and PB’s dependence on the state’s financial profile.

An increase in credit costs, contraction in net interest income, muted loan growth and increased taxation are likely to squeeze PB’s earnings and profitability, as with peers. Rising inflation could also increase the bank’s operating costs.  PB’s operating profit/risk-weighted asset (RWA) ratio rose to 4.8% by end-1Q22 from 4.3% at end-2021, as interest income grew faster than interest expenses. However, Fitch  believe this is unlikely to be sustained for the rest of 2022 as we expect a sharp increase in  credit costs and deposit rates to be reprised upwards amid fierce competition for liquidity.