Correction: Fitch Downgrades NDB; Affirms 8 Sri Lanka Banks, Negative Outlook on DFCC, Sampath

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Fitch Ratings Singapore/ Colombo 18 August 2016: This announcement replaces the version published on 22 June 2016 to correct the Support Rating of DFCC Bank PLC to ’5′ instead of ’4′ and the rating action on the Support Rating to “downgrade” instead of “affirmed”.

Fitch Ratings has downgraded National Development Bank PLC’s (NDB) National LongTerm Rating to ‘A+(lka)’ from ‘AA(lka)’. The ratings on eight other Sri Lanka banks have been affirmed. The agency also revised the Outlook on DFCC Bank PLC’s (DFCC) and Sampath Bank PLC’s (Sampath) National LongTerm Ratings to Negative.

The LongTerm Issuer Default Ratings (IDRs) on National Savings Bank (NSB) and Bank of Ceylon (Bank of Ceylon) have been affirmed at ‘B+’ and their National LongTerm
Ratings have been affirmed at ‘AAA(lka)’ and ‘AA+(lka)’, respectively. The Outlooks on the IDRs of NSB and Bank of Ceylon have been maintained at Negative while the Outlooks on their National LongTerm Ratings have been maintained at
Stable. Fitch has also affirmed the National LongTerm Rating of People’s Bank (Sri Lanka) (People’s Bank) at ‘AA+(lka)’ with a Stable Outlook.

Furthermore, Fitch has affirmed the National LongTerm Rating of Commercial Bank of Ceylon PLC (CB) at ‘AA(lka)’, Hatton National Bank PLC (HNB) at ‘AA(lka)’, and Seylan Bank PLC (Seylan) at ‘A(lka)’.

DFCC’s Support Rating Floor (SRF) was revised to ‘B’ from ‘B’.

A full list of rating actions is included at the end of this rating action commentary.

KEY RATING DRIVERS
IDRS, NATIONAL RATINGS AND SENIOR DEBT
The rating actions follow Fitch’s periodic review of the large banks peer group.

Fitch downgraded its assessment of Sri Lankan banks’ operating environment to ‘b+’ from ‘bb’ and assigned a negative outlook. Fitch believes operating conditions have become more challenging as signalled by the downgrade of the sovereign rating to ‘B+’ from ‘BB’ in February 2016 and expects increased volatility to add pressure on the banks’ credit metrics.

However, Fitch maintains a stable outlook for the Sri Lankan banking sector for 2016, as a material deterioration in the sector’s credit profile is not expected in the shortterm. Fitch believes the underlying operating conditions supporting sector performance are likely to remain intact and pressure on the economic environment is likely to be contained through tighter monetary policy.

The operating environment is a key rating driver for the Sri Lankan banking sector. It constrains the Viability Rating (VR) of some banks, as it is rare for a VR to be assigned significantly above the sovereign rating, however well banks score on other factors.

Banks With Long-Term
Ratings Driven by Sovereign-Support The IDRs and National Long-Term Ratings of NSB and Bank of Ceylon, and the National Long-Term Rating of People’s Bank, reflect Fitch’s expectation of extraordinary support from the sovereign (B+/Negative).

Fitch believes state support for NSB stems from its policy mandate of mobilising retail savings and primarily investing them in government securities. The National Savings Bank Act contains an explicit deposit guarantee and Fitch is of the view that the authorities would support, in case of need, the bank’s depositors and senior unsecured creditors to maintain confidence and systemic stability. Fitch has not assigned a VR to NSB, as it is considered to be a policy bank.

Fitch expects support for Bank of Ceylon and People’s Bank to stem from their high systemic importance, quasi-sovereign status, role as key lenders to the government and full stateownership.

The Negative Outlook on Bank of Ceylon’s and NSB’s IDRs reflect the Negative Outlook on the sovereign’s rating. The Outlook on Bank of Ceylon’s, NSB’s and People’s Bank’s National LongTerm Ratings is Stable as their national ratings reflect the banks’ creditworthiness relative to the best credit in Sri Lanka. The ratings of Bank of Ceylon, NSB and People’s Bank are unlikely to be affected unless
Fitch’s expectations of sovereign support change.

The US Dollar senior unsecured notes issued by NSB and Bank of Ceylon are rated at the same level as the banks’ LongTerm Foreign-Currency IDRs, as the notes rank equally with other senior unsecured obligations. The notes have a Recovery Rating of ‘RR4′.

Bank of Ceylon’s VR reflects its thin capitalisation and weak asset quality. This is counterbalanced by its strong domestic funding franchise, which is underpinned by its state linkages. Fitch considers state support as Bank of Ceylon’s primary rating driver, even though its VR is at the same level as its SRF.

The National Long-Term Rating of Seylan reflects Fitch’s expectation of state support due to its state shareholding, which came about in the aftermath of the bank’s crisis in December 2008, and higher share of banking sector deposits relative to some peers. Seylan has a lower support-driven rating due to
its smaller market share compared with larger peers. Fitch believes Seylan’s standalone financial strength has improved, reaching the same level as it support-driven rating.

Seylan’s senior debt is rated at the same level as its National Long-Term Rating, as the debentures rank equally with other senior unsecured obligations.
Banks With LongTerm Ratings Driven by Intrinsic Strength The downgrade of NDB’s National LongTerm Rating reflects the decline in its capitalisation alongside continued strong loan growth, and weaker profitability. Fitch’s expectation that the bank’s higher risk appetite could dilute the benefit of a capital infusion has been incorporated in the rating action. NDB’s ratings reflect its satisfactory asset quality, weaker franchise and lower capitalisation relative to higherrated
peers.

The Outlook on DFCC’s National LongTerm Rating has been revised to Negative to reflect weakening capital buffers that stem from weaker asset quality metrics, increased loan growth and below-average internal capital generation. The Negative Outlook on DFCC’s IDR reflects Fitch’s approach of generally capping bank ratings at the sovereign rating level. This is because of the likely adverse impact on the
bank’s credit profile from the sovereign’s deteriorating credit profile and increasing risks in the domestic operating environment. DFCC’s VR captures its developing commercial banking franchise and still-high capitalisation. Its weaker asset quality compared with betterrated peers weighs on its rating.

DFCC’s US dollar notes are rated at the same level as its LongTerm ForeignCurrency
IDR. The notes have a Recovery Rating of ‘RR4′. DFCC’s Sri Lanka rupeedenominated
senior debt is rated at the same level as its National LongTerm Rating, as the debentures rank equally with other senior unsecured obligations.

Sampath’s Outlook has been revised to Negative as Fitch expects the bank’s capitalisation to worsen beyond previous expectations. Fitch does not believe Sampath can sustain its capitalisation purely through retained earnings. The bank’s ratings reflect its lower capitalisation and higher risk appetite
relative to peers, which counterbalance its satisfactory asset quality and improving franchise. The bank’s regulatory Tier 1 capitaladequacy ratio continued to deteriorate and stood at 7.6% by endMarch 2016 (end2015: 8%; end2014: 9%).

The National LongTerm Rating of CB reflects its measured risk appetite relative to peers, strong funding profile, solid domestic franchise and sound performance. The ratings reflect Fitch’s expectation that its nondomestic operations will remain small.

The National LongTerm Rating of HNB reflects its strong domestic franchise, satisfactory capitalisation and strong performance, counterbalanced by a higher risk appetite as seen through sustained high loan growth that has put pressure on its funding and liquidity profile. HNB’s senior debentures carry the same
rating, as they rank equal with other unsecured obligations.

SUPPORT RATING AND SUPPORT RATING FLOOR
The SRs and SRFs of privately owned DFCC reflect its relative lower systemic importance, in Fitch’s view.

The SR and SRFs of NSB and Bank of Ceylon reflect the state’s ability and propensity to provide support to the banks given their high importance to the government and high systemic importance.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
NDB’s, DFCC’s, Sampath’s, Bank of Ceylon’s, Seylan’s, CB’s and HNB’s oldstyle
Basel II Sri Lanka rupeedenominated subordinated debt is rated one notch below their National LongTerm Ratings to reflect the subordination to senior unsecured creditors.

RATING SENSITIVITIES
IDRS, NATIONAL RATINGS AND SENIOR DEBT
The banks’ credit profiles are sensitive to changes in the operating environment. Fitch may take negative rating action if the banks’ appetite for risktaking
and pressure on key credit metrics increases amid challenging operating conditions that raises capital impairment risks which are not counterbalanced through adequate capital buffers. Fitch may take positive rating action if stronger risk management and higher capital buffers enhance the resilience of the banks’ balance sheets, but this is only likely to happen in the medium term.

Banks With LongTerm Ratings Driven by Sovereign Support
Any change in the sovereign rating or perception of state support to NSB, Bank of Ceylon and People’s Bank could result in a change in their SRFs. Fitch may downgrade NSB’s National LongTerm Rating if there is a reduced expectation of state support through, for instance, the removal of preferential support,
or a substantial change in its policy role or deviation from mandated core activities indicating its reduced importance to the government. A downgrade of Bank of Ceylon’s IDRs will only result from a downgrade of its VR and SRF. Visible demonstration of preferential support for Bank of Ceylon and People’s Bank in
the form of an explicit guarantee may be instrumental to an upgrade of their National LongTerm Ratings.

NSB’s and Bank of Ceylon’s senior debt ratings are sensitive to changes in the banks’ LongTerm IDRs. The Recovery Ratings of NSB and Bank of Ceylon are sensitive to Fitch’s assessment of potential recoveries for creditors in case of default or nonperformance.

Bank of Ceylon’s VR may come under pressure if there is a continued decline in capitalisation through a surge in lending or further decline in asset quality alongside high dividend payouts. Further deterioration in the operating environment reflected in a decline in Bank of Ceylon’s key credit metrics could negatively affect its VR.

A downgrade of Seylan’s rating could result from a reassessment of state support and a material reversal in recent improvements to its asset quality, together with a weakening financial profile. In the absence of changes to Fitch’s support assessment, an upgrade of Seylan’s rating would be contingent on further improvements in its standalone profile through improved asset quality and provisioning, mainly stemming from recovery of legacy NPLs. Seylan should also maintain other credit metrics in line with higherrated peers to warrant an upgrade.
Seylan’s senior debt ratings will move in tandem with its National LongTerm
Rating.

Banks with LongTerm Ratings Driven by Intrinsic Strength

NDB’s National LongTerm Rating may be downgraded if the bank is not able to sustain its capitalisation at a level commensurate with its risk profile. Drivers for an upgrade are the quantum of a potential capital injection and its sensible deployment alongside the sustainability of a sufficient capital buffer to
counterbalance weaknesses in NDB’s credit profile. Fitch does not see upside potential for NDB’s ratings in the near term, as the bank is likely to face difficulty sustaining a capital buffer in line with higherrated peers due to its higher risk appetite and operating environmentrelated risks.

The Outlook on DFCC’s National LongTerm Rating may be revised to Stable if the bank can sustain capital buffers to sufficiently cushion its weaker asset quality amid higher operating environmentrelated risks and counterbalance its developing franchise relative to more established peers. Fitch expects project finance to remain integral to the bank’s business and, as such, expects the bank to maintain
higher capitalisation to offset the higher risk of this business.

DFCC’s IDRs and National LongTerm Rating could be downgraded if there is a sustained deterioration in its capitalisation or further weakening of the operating environment. DFCC’s RR is sensitive to Fitch’s assessment of potential recoveries for creditors in case of default or nonperformance.

A downgrade of Sampath’s National LongTerm Rating could result from a sustained decline in capitalisation, further increase in risktaking or a sharp decline in asset quality. Fitch would revise Sampath’s Outlook to Stable if there is a capital infusion and the bank maintains sufficient capital buffers commensurate with its risk profile and operating environmentrelated risks.

Enhanced resilience against a volatile operating environment could be positive for CB’s National LongTerm rating. The bank’s ratings could be downgraded if its ability to withstand cyclical assetquality deterioration declines due to lower earnings and capitalisation. In addition, any marked weakening in its deposit franchise and deviation from its measured risk appetite, both viewed by Fitch as key factors that differentiate CB from its lowerrated peers, would be negative.

An upgrade of HNB’s National LongTerm Rating is contingent on the bank achieving sustained improvements in its financial profile, in particular in terms of its funding, and a moderation of its risk appetite. A rating downgrade could result from a significant increase in risktaking and operating environmentrelated
risks, unless sufficiently mitigated through capital and financial performance.
Further weakening of HNB’s liquidity position could also negatively affect its rating.

SUPPORT RATING AND SUPPORT RATING FLOOR
Reduced propensity of the government to support systemically important banks could result in a downgrade in the assigned SRs and SRFs, but Fitch sees this to be unlikely in the mediumterm. A change in the sovereign’s ratings could also lead to a change in the SRs and SRFs of the banks.

SUBORDINATED DEBT
Subordinated debt ratings will move in tandem with the banks’ National LongTerm
Ratings.

FULL LIST OF RATING ACTIONS

The rating actions are as follows:

National Development Bank PLC:
National LongTerm Rating downgraded to ‘A+(lka)’ from ‘AA(lka)’; Stable Outlook
Basel II compliant subordinated debentures downgraded to ‘A(lka)’ from ‘A+(lka)’

DFCC Bank PLC:
LongTerm ForeignCurrency IDR affirmed at ‘B+’; Negative Outlook
LongTerm LocalCurrency IDR affirmed at ‘B+’; Negative Outlook
ShortTerm ForeignCurrency IDR affirmed at ‘B’
National LongTerm Rating affirmed at ‘AA(lka)’; Outlook revised to Negative from Stable
Viability Rating affirmed at ‘b+’
Support Rating downgraded to ’5′ from ’4′
Support Rating Floor revised to ‘B’ from ‘B’
US dollar senior, unsecured notes affirmed at ‘B+’; Recovery Rating at ‘RR4′
Sri Lanka rupeedenominated senior unsecured debentures affirmed at ‘AA(lka)’ Basel II compliant Sri Lanka rupeedenominated subordinated debentures affirmed at ‘A+(lka)’

Sampath Bank PLC:
National LongTerm Rating affirmed at ‘A+(lka)’; Outlook revised to Negative from Stable Basel II compliant outstanding subordinated debentures affirmed at ‘A(lka)’

National Savings Bank:
LongTerm ForeignCurrency IDR affirmed at ‘B+’; Negative Outlook
LongTerm Local Currency IDR affirmed at ‘B+’; Negative Outlook
ShortTerm ForeignCurrency IDR affirmed at ‘B’
National LongTerm Rating affirmed at ‘AAA(lka)’; Stable Outlook
Support Rating affirmed at ’4′
Support Rating Floor affirmed at ‘B+’
US dollar senior unsecured notes affirmed at ‘B+’; Recovery Rating at ‘RR4′

Bank of Ceylon:
LongTerm ForeignCurrency IDR affirmed at ‘B+’; Negative Outlook
LongTerm LocalCurrency IDR affirmed at ‘B+’; Negative Outlook
ShortTerm ForeignCurrency IDR affirmed at ‘B’
National LongTerm Rating affirmed at ‘AA+(lka)’; Stable Outlook
Viability Rating affirmed at ‘b+’
Support Rating affirmed at ’4′
Support Rating Floor affirmed at ‘B+’
US dollar senior unsecured notes affirmed at ‘B+’; Recovery Rating at ‘RR4′
Basel II compliant Sri Lanka rupeedenominated subordinated debentures affirmed at ‘AA(lka)’

People’s Bank (Sri Lanka):
National LongTerm
Rating affirmed at ‘AA+(lka)’; Outlook Stable

Seylan Bank PLC:
National LongTerm
Rating affirmed at ‘A(lka)’; Stable Outlook

Sri Lanka rupeedenominated senior unsecured debentures affirmed at ‘A(lka)’
Basel II compliant subordinated debentures affirmed at ‘BBB+(lka)’

Commercial Bank of Ceylon PLC:
National LongTerm Rating affirmed at ‘AA(lka)’; Stable Outlook
Basel II compliant outstanding subordinated debentures affirmed at ‘AA(lka)’

Hatton National Bank PLC:
National LongTerm Rating affirmed at ‘AA(lka)’; Stable Outlook
Sri Lanka rupeedenominated senior unsecured debentures affirmed at ‘AA(lka)’
Basel II compliant outstanding subordinated debentures affirmed at ‘A+(lka)’