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Rating Action:

Moody's assigns B1 rating to Bank of Ceylon

17 Apr 2012

Singapore, April 17, 2012 -- Moody's Investors Service has assigned following debt and deposit ratings to Bank of Ceylon (BOC), with a stable outlook.

The detailed ratings assigned are:

Local currency deposits: B1/NP

Foreign currency deposits: B2/NP

Foreign currency senior unsecured debt: B1

Foreign currency Issuer rating: B1

Moody's has also assigned E+ bank financial strength rating (BFSR), mapping to a baseline credit assessment (BCA) of b2, with a stable outlook.

RATINGS RATIONALE

This is the first time Moody's is assigning international ratings for BOC. These ratings and outlook take into account the balance of strengths and weaknesses characterizing BOC's credit profile on a standalone basis, as well as Moody's assumptions for the probability of government support in times of stress, which Moody's assesses as very high. At E+/ b2, Moody's support assumption results in a one-notch rating uplift to the B1 local currency deposit rating.

The BFSR reflects BOC's leadership position in the domestic banking system that underpins its strengths in loan and deposit mobilization and stable profitability, which is supported by both lending and fee-based services. The rating also takes into account the bank's relatively weaker financial profile and risk positioning compared with other E+ Moody's-rated banks globally.

It reflects the bank's declining capital and liquidity buffers available to withstand systemic stresses as a result of its recent above-industry credit growth. Also, we view the bank, like its domestic peers, to be vulnerable to the unavoidable cyclicality inherent to emerging markets, which exposes it to periodic asset quality pressure. Also, for a bank exposed to such risk, we consider its provision coverage to be low.

Given its full ownership by the Sri Lankan government, its dominant market shares in domestic deposits and treasury activities, as well as past evidence of support received from the government, Moody's believes BOC is very important to the Sri Lankan banking system. These considerations have resulted in a one-notch uplift for its local currency deposit rating from its b2 BCA.

The stable outlook for the bank's ratings reflect Moody's expectation that its credit growth will moderate and become in line with the industry level over the next 12-18 months, and its capital and liquidity buffers will increase and be sufficient to withstand additional credit losses and systemic stresses at its current rating level.

BOC's loan mix is geared towards large corporations and government-related entities. Its retail and small and medium-sized enterprise (SME) portfolios are fairly sizable and it plans to grow these segments.

Its credit profile is characterized by its leadership position in the Sri Lankan banking system, with a market share of 21% in loans and deposits. It manages the majority of inward remittances and foreign exchange transactions in Sri Lanka, and operates the most extensive network of branches and ATMs distributed throughout the country. Leveraging this entrenched franchise and operating platform, BOC has steadily generated strong profitability and maintained better asset quality metrics than similarly-rated global peers.

Due to BOC's focus on lending to lower-yielding large corporations and government-related entities compared to retail and SMEs, its net interest margins have trended lower than its peers and the industry average.

Nonetheless, the bank has maintained stable margins which support its net interest income. Its fee-based income from its strong FX, inward remittances, and trade finance businesses has also consistently been a significant contributor to its overall profits.

At end-2011, pre-provision profits and net income were 4.9% and 3.5%, respectively, as a percentage of its risk-weighted assets. Compared to Moody's E+ rated banks globally, BOC fares better in terms of profitability.

BOC's asset quality has shown consistent improvement over the past three years, evidenced by the steady decline in nominal non-performing loans (NPL), NPL ratios and new NPL formation rates. At end-2011, its NPL ratio declined to 3.6%, from 5.4% at end-2010 and 8.4% at end-2009.

Similarly, new NPL formation rate slowed to 0.9% at end-2011, from 1.2% at end-2010 and 3.6% at end-2009. NPL write-offs were minimal as the bank focused on loan collection, recovery and restructuring.

While the bank has instituted an integrated risk-management framework and implemented risk management processes, which include clearly laid out credit approval processes, limits and controls, our scenario analysis indicates that its asset quality could rapidly deteriorate in a cyclical downturn, given the characteristics of the emerging market in which it operates in and its rapid credit growth during 2010 and 2011. Profits would be under pressure due to the unavoidable increase in provisions that would result while considering the low base from which these provisions started.

With these characteristics in mind, we assessed the capital and liquidity buffers available to protect the bank from systemic stresses. BOC's Tier 1 capital ratio has been steadily falling over the past three years.

At end-2011, its Tier 1 capital ratio stood at 9.3%, lower than 11.4% in 2010 and 12.0% in 2009. While its capital ratios have consistently remained above the local regulatory minimums (Tier 1 ratio of 5% and Total capital ratio of 10%), its capital levels have trended below the average industry level since 2009.

Importantly, although the bank recorded strong profits in both years, it was unable to replenish capital internally at the same rate as it grew its loans to maintain capital levels.

Moody's believes BOC's current capital level is insufficient to protect it from insolvency pressures in the event of an economic downturn. In an adverse stress scenario in which asset quality deteriorates to 2009 levels -- with gross NPL ratio peaking at 8.4% over the past five years and profits declining broadly by 10% -- BOC's Tier 1 capital ratio could fall to 4% based on its 2011 financials.

Like other banks in Sri Lanka, BOC's deposit growth has not been able to keep pace with its credit growth. However, while its liquidity profile has in the past trended in line with the industry, its loan-to-deposit ratio significantly exceeded the industry's average in 2011. At end-2011, its overall loan-to-deposit ratio deteriorated to 98.7%, from 77.0% a year ago, compared with 85% for the industry for the same period. Similarly, its foreign currency loan-to-deposit ratio deteriorated to 89.5% at end-2011, from 61.0% a year ago.

Its rating outlook could be revised to negative if its core Tier 1 capital ratio drops to less than 9% and/or loan-to-deposit ratio exceeds 100%. Also, if its net income drops to below 3% of risk-weighted assets and weighs on internal capital generation, then its ratings would be under pressure.

In order for its standalone ratings to be upgraded, BOC would need a sustained recovery of its capital and liquidity buffers, as reflected for instance in a core Tier 1 capital ratio of more than 10% and a loan-to-deposit ratio of less than 85% over six consecutive quarters.

The foreign currency senior unsecured debt rating of B1 factors in the very high level of systemic support from the government, which is also rated B1 for foreign currency debt. As part of Moody's joint default analysis model, Moody's considers Sri Lanka to be a medium support country.

In assessing the probability and the likelihood of external support, Moody's took into account the systemic importance of the bank, as well as the willingness and capacity of the government to provide support, including the non-fiscal measures that could be deployed to support a bank, if needed.

The rating is subject to the receipt of final documentation, with terms and conditions that do not deviate materially from the preliminary documents already reviewed by Moody's.

Established in 1939 and headquartered in Colombo, BOC had assets of LKR856.4 billion (USD7.5 billion) at end-December 2011.

PRINCIPAL METHODOLOGIES

The methodologies used in this rating were Bank Financial Strength Ratings: Global Methodology published in February 2007, and Incorporation of Joint-Default Analysis into Moody's Bank Ratings: Global Methodology published in March 2012. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

REGULATORY DISCLOSURES

Although this credit rating has been issued in a non-EU country which has not been recognized as endorsable at this date, this credit rating is deemed "EU qualified by extension" and may still be used by financial institutions for regulatory purposes until 30 April 2012. Further information on the EU endorsement status and on the Moody's office that has issued a particular Credit Rating is available on www.moodys.com.

For ratings issued on a program, series or category/class of debt, this announcement provides relevant regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides relevant regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides relevant regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

Information sources used to prepare the rating are the following: parties involved in the ratings, public information, and confidential and proprietary Moody's Investors Service information.

Moody's considers the quality of information available on the rated entity, obligation or credit satisfactory for the purposes of issuing a rating.

Moody's adopts all necessary measures so that the information it uses in assigning a rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see the ratings disclosure page on www.moodys.com for general disclosure on potential conflicts of interests.

Please see the ratings disclosure page on www.moodys.com for information on (A) MCO's major shareholders (above 5%) and for (B) further information regarding certain affiliations that may exist between directors of MCO and rated entities as well as (C) the names of entities that hold ratings from MIS that have also publicly reported to the SEC an ownership interest in MCO of more than 5%. A member of the board of directors of this rated entity may also be a member of the board of directors of a shareholder of Moody's Corporation; however, Moody's has not independently verified this matter.

Please see Moody's Rating Symbols and Definitions on the Rating Process page on www.moodys.com for further information on the meaning of each rating category and the definition of default and recovery.

Please see ratings tab on the issuer/entity page on www.moodys.com for the last rating action and the rating history.

The date on which some ratings were first released goes back to a time before Moody's ratings were fully digitized and accurate data may not be available. Consequently, Moody's provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Simon Chen
Analyst
Financial Institutions Group
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (65) 6398-8308

Stephen Long
MD - Financial Institutions
Financial Institutions Group
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Releasing Office:
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (65) 6398-8308

Moody's assigns B1 rating to Bank of Ceylon
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