Fitch Ratings has maintained the Rating Watch Negative (RWN) on Amana Bank PLC's National Long-Term Rating of 'BB+(lka)'.

Key Rating Drivers

Downside Risks Significant: The RWN on Amana's National Long-Term Rating reflects potential for deterioration in the bank's creditworthiness relative to other entities on the Sri Lankan national ratings scale, given the heightened stress on the bank's funding and liquidity, which raises risks to its overall credit profile.

We believe that the sharp rise in inflation, depreciation of the local currency and other economic stresses can distort the bank's underlying financial position in the current operating environment.

Weakening Operating Environment: Our assessment of Sri Lankan banks' operating environment (OE) reflects the pressure on the banks' already stressed credit profiles following the sovereign's default on its foreign-currency obligations. It also captures the rapid deterioration in the broader economy, including increased interest rates, very high inflation and acute currency depreciation. The economic stress has limited Amana's operational flexibility.

Economic Volatility Weighs on Business Model: We believe that Amana's business profile, like that of most domestic peers, is highly vulnerable to the intensifying risks in the domestic market, given the high concentration of its business on the weak and unstable Sri Lankan economy. This, in turn, could limit the bank's ability to generate and defend business volume while controlling risks.

High Risk Profile: Amana's elevated risk profile, similar to local peers, is mainly the result of the very challenging OE. In addition, Amana has material exposure to high-risk SME and retail customer segments that have weak credit quality, although it has no exposure to distressed government securities. That said, we believe that the bank is not immune to the second-order effects of any risks to the banking sector, given the sector's considerable exposure to the sovereign's weak credit profile.

Rising Pressure on Credit Quality: Fitch expects Amana's impaired (stage 3) loan ratio to rise sharply in the near to medium term as borrower repayment capacity weakens following the rapid deterioration of the economy. That said, the rise in the ratio will depend on the extent of economic instability, the bank's impaired-loan recognition policies and exchange rate volatility, among others.

Profitability to Deteriorate: Fitch expects Amanas profitability to remain under significant pressure in the near to medium term due to higher credit and operational costs. The bank's operating profit/risk-weighted asset (RWA) ratio improved marginally to 1.8% in 1H22 from 1.6% in 2021, but it remained lower than the peer bank median of 2.1%. Cost pressures are likely to increase due to high inflation.

Capital Impairment Risk: Pressure on Amana's capitalisation stems primarily from its loan portfolio as the bank does not hold any sovereign foreign-currency securities, which are in default. Fitch expects increased asset-quality risks and weaker earnings retention to exert significant pressure on the bank's capitalisation metrics in the near term. The bank's reported common equity Tier 1 ratio decreased to 13.4% by end-1H22 from 13.7% at end-2021.

Strained Foreign-Currency Liquidity: We believe Amana's foreign-currency funding and liquidity position is under stress and vulnerable to sudden shocks. The bank's ability to seek funding through wholesale, institutional and foreign-currency funding is highly stretched due to the sovereign's default on its foreign-currency obligations, and the bank has had to rely on limited flows of remittances and exporter proceeds to meet its foreign-currency obligations.

Rating Sensitivities

Factors that could, individually or collectively, lead to negative rating action/downgrade:

The RWN reflects rising risks to the bank's rating from funding stresses, which could lead to a multiple-notch downgrade. We expect to resolve the RWN once the impact on the issuer's credit profile becomes more apparent, which may take more than six months. Developments that could lead to a multiple-notch downgrade include: -

funding stress that impedes Amana's repayment ability

significant banking-sector intervention by the authorities that constrains the bank's ability to service its obligations

a temporary negotiated waiver or standstill agreement following a payment default on a material financial obligation

Fitch's belief that Amana has entered into a grace or cure period following non-payment of a material financial obligation.

A downgrade of the sovereign's Long-Term Local-Currency Issuer Default Rating (CCC and under criteria observation) could also lead to a downgrade of the bank's rating.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

There is limited scope for upward rating action given the RWN.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

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