Fitch assigns Bank of Ceylon 'BB-' IDRs

Fitch Ratings has assigned Bank of Ceylon (BoC) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) of 'BB-' with Stable Outlooks. Fitch has also assigned BOC a 'b+' Viability Rating (V/R). Simultaneously, BoC's National Long-Term rating and its outstanding subordinated debentures have been affirmed at 'AA+(lka)' with a Stable Outlook and 'AA(lka)'.

Fitch has also assigned BoC's proposed senior unsecured USD-denominated notes an expected rating of 'BB-(exp)', same as its Foreign Currency IDR.

The size and tenor of the notes are yet to be determined. The final rating is contingent upon receipt of final documents conforming to information already received.

BoC's IDRs and National Long-Term ratings reflect Fitch's expectation of support from the government of Sri Lanka (GoSL, 'BB-'), if required, given its quasi sovereign status, high systemic importance and role as one of the main bankers to the government.

Any change in Sri Lanka's sovereign ratings would likely be reflected in the ratings of BoC.

The V/R reflects BoC's domestic franchise being underpinned by its sovereign linkages and extensive branch network, as well as its weak capitalisation, improving profitability, increasing loan/deposit ratio and concentration in the state sector (GoSL and state entities).

While BoC's IDRs and National Long-Term rating are closely correlated with Sri Lanka's sovereign rating, an upgrade of BoC's National Long-Term rating could result from a demonstration of preferential support for BoC.

The V/R could be upgraded if BoC enhances its capital buffer substantially (including a high loan loss reserve coverage), the loan-deposit ratio is maintained/sustained at 80percent - 85 percent and or supplemented by medium term wholesale funding, and operating performance and asset quality remain stable.

The V/R could be downgraded if capital buffer weakens from continued high asset growth, or if a large asset quality downturn from domestic/external macroeconomic shocks leads to capital impairment.

BoC has established a strong domestic deposit franchise, as reflected in a high current and savings accounts deposit ratio (51percent at end-2011).

Nevertheless, aggressive 45percent loan growth in FY11, driven by increased lending to the state and certain private sector business segments, sharply increased its loan/deposit ratio to 95 percent (FY10: 74 percent). Management is challenged to reduce this ratio to the target 85 percent, amid increased competition for deposits and expected continued strong credit growth.

Fitch notes that the high credit growth, alongside high dividend payouts in the past two years and no fresh capital injection since FY07, has weakened BoC's capitalisation.

Tier 1 capital and capital adequacy ratios were reported at 9.3% and 12.8%, at end-2011, compared with 11.4 percent and 15.2 percent at end-2010; Although these are well above the local regulatory requirements of 5 percent and 10 percent, but are inflated by the zero-risk weighted exposures to the state sector and gold-backed loans as per local regulatory guidelines. Equity/asset ratio remains low at 5.1 percent at end-2011, although marginally improved from 4.3 percent at end-2010.

Fitch notes that BoC's profitability remains low, although return on assets improved to 1.45 percent in 2011 (2010: 1.08 percent) mainly from reduced effective taxes due to the reduction in tax rates in Sri Lanka and from reduction/reversal of general provision as per the Central Bank of Sri Lanka guidelines.

BoC's large exposure to the state sector and local corporates (that are perceived as lower risk in the local market) has resulted in its net interest margins (2011: 3.70 percent, 2010: 3.64 percent) being historically lower than peers, while its operating cost base is also high.