Fitch Ratings has upgraded Bank of Ceylon’s (BOC) long-term foreign- and local-currency issuer default ratings (IDRs) to ‘CCC+’ from ‘CCC-’.

The ratings do not have an Outlook because of the high volatility at this rating level, in line with Fitch’s rating definitions.

Fitch has also upgraded BOC’s viability rating (VR) to ‘ccc+’ from ‘ccc-’, affirmed its short-term IDR at ‘C’ and its government support rating (GSR) at ‘ns’.

BOC’s national long-term rating of ‘A(lka)’/Stable was not considered in this review.

The rating actions follow the upgrade of Sri Lanka’s long-term foreign-currency IDR to ‘CCC+’, from ‘RD’, and local-currency IDR to ‘CCC+’, from ‘CCC-’, on 20 December 2024.

The upgrade of BOC’s IDRs is driven by the upgrade of its VR, which stems from the improvement in Sri Lanka’s credit profile following the completion of a debt restructuring.

Fitch believes that this has reduced sovereign-related stress on Sri Lankan banks’ operating environment (OE) as well as on BOC’s financial and non-financial factors, supporting the improvement in BOC’s overall credit profile.

BOC’s ratings are closely linked to the sovereign’s credit profile given its large exposure to the domestic economy, government securities and lending to the broader public sector.

The upward revision in the Sri Lankan banks’ OE score to ‘ccc+’, from ‘ccc-’, primarily stems from the sovereign’s enhanced credit profile after the successful debt restructuring.

Economic reforms implemented since the start of the crisis in 2022 have stabilised the economy, reducing macro-financial stability risks to the banking sector.

Fitch expects the improvement to be sustained, supported by its estimated economic growth of 4.1% in 2024 and an average of 3.6% over 2025-2026.

Moreover, Fitch has revised BOC’s business profile score to ‘b-’ from ‘ccc-’ following the revision in the OE score and the bank’s continued strong market position as the largest bank in Sri Lanka, accounting for 22% of sector assets.

Fitch expects BOC’s ability to generate and defend business volume and earnings to be bolstered by the OE improvement as well as the bank’s strong local franchise.

Meanwhile, the easing of the sovereign’s default risk and the improved OE underpin the revision in BOC’s risk profile score to ‘ccc+’ from ‘ccc-’. BOC’s risk profile continues to reflect its large exposure to the sovereign, which we estimate at nearly 60% of assets, comprising loan and non-loan exposures.

Fitch expects BOC’s sovereign exposure to moderate in the medium term as private-sector lending opportunities expand, but the exposure will remain a key driver of its risk profile.

The revision in BOC’s asset-quality score to ‘ccc+’ from ‘ccc-’ reflects our view that asset quality is broadly aligned with the sovereign’s creditworthiness due to the bank’s large exposure.

Loan book contraction has exacerbated BOC’s impaired (stage 3) loan ratio, which deteriorated to 13.6% by end-3Q24 (end-2023: 12.6%) but we expect a meaningful improvement as borrower repayment capacity is enhanced further.

Reduced risks to BOC’s structural profitability following the successful completion of the sovereign’s external debt restructuring support Fitch’s revision of the bank’s earnings and profitability score to ‘b-’ from ‘ccc-’.

Fitch expects profitability to be highly correlated with economic and interest rate cycles since sovereign-related issues are largely resolved.

Fitch believes the conclusion of the government’s efforts to restructure a state-owned entity’s debt will provide a boost to BOC’s operating profit/risk-weighted asset ratio from the 3.7% at end-9M24.

Moreover, Fitch believes the reduced risk of a sovereign default and the stabilising economy alleviates solvency risks for BOC.

This underpins the upward revision in the bank’s capitalisation and leverage score to ‘ccc+’ from ‘ccc-’. The score reflects the vulnerability of BOC’s capital to sovereign risks via sovereign bonds and rupee-denominated government securities in addition to capital-impairment risks on its loan book, including to state and state-owned entities.

Furthermore, Fitch has revised BOC’s funding and liquidity score to ‘ccc+’ from ‘ccc-’ to reflect the anticipated improvement in the bank’s funding and liquidity profile, particularly on foreign currency, due to the sovereign’s reduced default risks.

Fitch expects the restoration of the sovereign’s creditworthiness to provide BOC with access to foreign-currency wholesale funding, which was once a key source of funding for the bank.

Meanwhile, the GSR of ‘No Support’ reflects Fitch’s assessment that there is no reasonable assumption of government support for the bank.

Fitch believes the sovereign’s ability to provide extraordinary support, particularly in foreign currency, remains constrained, despite the higher sovereign rating, given the challenges to the state’s financial flexibility and the size of the banking sector relative to the economy.

This is despite the sovereign’s strong propensity to extend support to the bank due to its high systemic importance and full state ownership.

(Fitch Ratings)