– We have lowered our long-term sovereign credit rating on Sri Lanka by one= notch to ‘B’, reflecting reduced prospects of reform under the fractious political environment, which we expect to be protracted. The country’s external financing conditions has also deteriorated as a weak rupee and high yields constrain the government’s access to international capital markets. – In our view, a slow economy, fractious political environment, and the sovereign’s weakened external position have led to heightened economic risk for Sri Lankan financial institutions. – We are lowering the long-term issuer credit rating on NSB and PLC to ‘B’ from ‘B+’. -At the same time, we are affirming the long-term issuer credit rating on DFCC Bank at ‘B’. We are also affirming the ‘B’ short-term ratings on the three Sri Lankan financial institutions. – The outlook on the long-term rating for all these entities are stable, reflecting the stable outlook on the sovereign. SINGAPORE (S&P Global Ratings) Dec. 4, 2018–S&P Global Ratings said today that it had lowered its long-term issuer credit rating on National Savings Bank (NSB) and People’s Leasing & Finance PLC (PLC) to ‘B’ from ‘B+’. At the same time, we affirmed the long-term issuer credit rating on DFCC Bank at ‘B’. The outlooks on the long-term ratings are stable. In addition, we affirmed our ‘B’ short-term issuer credit rating on all the three entities. We also lowered the issue rating on NSB to ‘B’ from ‘B+’; PLC has no outstanding debt securities. We lowered the long-term issuer credit rating on NSB and PLC to reflect S&P Global Ratings’ view that the Sri Lankan banking sector is facing escalated stress following political turmoil, slowdown in pace of reforms, and slower economic growth than we expected. We affirmed the ratings on DFCC despite the higher risk from the operating environment because the bank’s capital assessment already captures these risks at the current rating level. We lowered the sovereign rating on Sri Lanka based on our assessment that the current political standoff has weakened the sovereign’s external financing conditions and reduced the likelihood that further reforms will improve Sri Lanka’s macroeconomic fundamentals and institutionalize sustainable policy frameworks over the next 12-18 months. The downgrade also factors in weakening of the sovereign’s external position given that weak rupee and rising bond yields have reduced the government’s ability to access international capital markets. We also believe that the Sri Lankan government no longer has the financial ability to provide extraordinary support to its banking system in a stress scenario. We consider it unlikely that Sri Lankan financial institutions would be immune to rising credit pressure on the sovereign and the broader operating environment. In our view, this weakened external position of the sovereign has heightened imbalances in the operating environment for the banks. We expect the external financing pressure faced by the sovereign to hurt the broad economy, including the banking system. This accentuates the economic risk for banks in Sri Lanka. Continued high loan growth at about 16% (annualized) for first half of 2018, despite the economy slowing down sharply to 3.3% (in 2017), adds to the imbalance. We have witnessed increasing credit stress for banks in Sri Lanka, partly due to lower-than-expected GDP growth. The asset quality for these banks has deteriorated more than we expected. The banks’ nonperforming loans (NPLs) rose to 3.6% by end-August 2018, from 2.5% at end-2017 (compared with our expectation of 3%-3.2% by end-2018). Slower GDP growth, a depreciating rupee, and rising interest rates have partly contributed to this increase. Given the heightening economic risk, we expect NPLs to rise further to 4.5%-5% over the next 12-18 months, but remain within our tolerance level for a BICRA 9 system. The increased economic risk would also require banks to maintain higher risk-adjusted capital to take care of the additional risk in the system. Sri Lankan banks are already seeing higher pricing for their external funding, which could negatively affect their profitability. We believe the large state-owned banks may be required to tap the external markets at higher costs to finance the sovereign’s bond repayments. In a low-probability and high-impact downside scenario, if the political turmoil escalates or prolongs, uncertainty could spread to the banking sector and cause funding stress or liquidity outflows. PEOPLE’S LEASING & FINANCE PLC The rating on PLC reflects the credit profile of the People’s Bank group, of which PLC is a core entity. The rating on PLC is equalized with the group’s credit profile. We have revised PLC’s stand-alone credit profile (SACP) to ‘b’ due to the worsening operating environment. PLC’s dependence on wholesale funding and its concentration in commercial vehicle financing also constrain the rating. The company’s moderate capital and earnings temper these weaknesses. The stable outlook on PLC reflects our expectation that PLC will remain a core entity of the People’s Bank group at least for the next 12 months because commercial vehicle leasing will remain a large and profitable business for the group. We don’t see any upside potential for the rating over the next 12 months. We may downgrade PLC if the People’s Bank group’s capitalization reduces substantially. NATIONAL SAVINGS BANK The rating on NSB reflects our view that the Sri Lankan government will almost certainly provide extraordinary support to the bank in a stress situation. We have revised NSB’s SACP to ‘b’ from ‘b+’, due to the worsening operating environment. Our assessment of the SACP benefits from the bank’s superior funding and liquidity metrics. A statutory guarantee on 100% of deposits and a requirement to invest 60% of deposits in government securities support the bank’s liquidity and funding. NSB’s low risk-adjusted capital ratio tempers the strength. The stable outlook on NSB reflects the outlook on its parent, the government of Sri Lanka. We expect the bank’s critical role and link to the government to remain unchanged over the next 12 months. The most likely change (up or down) to our rating and outlook on NSB will be from a change in the creditworthiness of the government of Sri Lanka. DFCC BANK The rating on DFCC reflects the Sri Lanka-based bank’s limited deposit base and weak capitalization. DFCC’s satisfactory business position, earnings, and asset quality temper these weaknesses. We assess the bank’s SACP as ‘b’. Our stable outlook on DFCC Bank reflects our view that the bank will maintain its credit profile despite tough operating conditions in Sri Lanka over the next 12 months. We may lower the rating on DFCC if the bank’s risk-adjusted capital ratio declines below 3%. This could happen if DFCC’s profitability is lower or if its loan growth exceeds our expectations. We are unlikely to upgrade DFCC over the next 12 months.
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