Fitch upgrades BOC to ‘AA+(lka)’

Fitch Ratings Lanka has upgraded Bank of Ceylon’s (BOC) National Long-Term rating to ‘AA+(lka)’ from ‘AA(lka)’. The Outlook is Stable. A full list of rating actions is provided at the end of this commentary.

The upgrade reflects Fitch’s view of the Sri Lanka government’s(GOSL) increased capacity to support BOC, if required, as indicated by the upgrade of Sri Lanka’s Issuer Default Rating to ‘BB-’ in July 2011 (for more information, please refer to the rating action commentary, published on July 18, 2011).

The ratings reflect Fitch’s expectation of support, underpinned by the bank’s importance to the state, full-state ownership and its high systemic importance to the Sri Lankan banking sector; however, the probability of support is viewed to be moderate. As BOC’s ratings are driven by expectations of state support, a change to Sri Lanka’s sovereign rating may change BOC’s ratings. An upgrade may also result from a demonstration of preferential support to the bank.

The proposed debenture issue is rated one notch below BOC’s National Long-Term rating reflecting its debt-like features.

The debentures will have a maturity of five years with principal repayment as a bullet payment on maturity. Coupon payments will be semi-annual and annual at fixed and floating rates, and do not contain any deferral clauses. The debentures are to be listed on the Colombo Stock Exchange alongside BOC’s other listed and rated debentures.

BOC has a robust franchise in Sri Lanka, derived from its state ownership and consequent reputation for stability that serves as a competitive strength. The franchise derives further strength from BOC being Sri Lanka’s largest bank (one-fifth of banking sector assets, loans and deposits at end-2010), as well as from its widely distributed presence and strong customer reach.

Supported by its franchise, BOC benefits from a large share (53% of deposits at end-2010) of current and savings accounts in its deposit mix.

The bank also has the largest foreign currency-denominated deposit base supported by remittance flows from residents working outside the country. Consequently, BOC enjoys a low-cost of funds. However, the bank’s exposure to customer segments that are less flexible in terms of pricing has resulted in a low net interest margin (3.6% in 2010).

Balance-sheet and off-balance-sheet exposure to the state (GOSL and state entities) represented 44% and 16% of assets, respectively, at end-2010. Fitch expects exposure to the state to remain high given BOC’s strong links with the latter.

BOC’s gross non-performing loan (NPL) ratio declined to 3.5% at end-2010 from 5.7% at end-2009. The gross NPL ratio adjusted for state sector exposures also decreased to 5.3% from 8.3% though remained higher than ‘AA(lka)’-rated peers. This resulted from an absolute reduction in NPLs and strong loan book expansion on the back of a broader economic upturn. Fitch believes that strong growth could elevate credit risk, and that close monitoring is required to limit asset quality deterioration.

BOC’s core and total capital adequacy ratios (CARs) decreased to 10.0% and 13.1% at H111 from 11.3% and 15.2% at end-2010 due asset growth. In this context, the bank plans to boost its Tier 2 capital base in Q411.