Fitch affirms Construction Guarantee Fund’s ‘BB(lka)’ National IFS Rating

Fitch Ratings affirmed Sri Lanka-based Construction Guarantee Fund’s (CGF) National Insurer Financial Strength (IFS) Rating of ‘BB(lka)’. The Outlook is Stable.
The rating agency said CGF’s performance exhibits a strong correlation with government construction activity, as the company offers guarantees and related services to small and medium-sized contractors involved in government projects. 

“The government’s weak fiscal position has resulted in fewer new construction contracts, the suspension of existing projects and payment delays to contractors. This has affected CGF through a drop in premium income and a higher risk of claims by employers,” the agency said.

Fitch said the underwiring performance is expected to remain weak over 2024-2025 on low business volume. Premium income plummeted by 87 percent in 2023 to Rs.13 million on low guarantee volume amid a sluggish local construction sector, while claim costs increased by 10 percent and administration costs rose by 38 percent on investment-related withholding tax hikes. Consequently, Fitch calculates CGF to have incurred an underwriting loss of Rs.107 million in 2023, from a profit of Rs.16 million in 2022.

The company says the majority of outstanding guarantees do not carry claim risk, as they are extensions of existing guarantees granted for administrative purposes. Meanwhile, earnings were buoyed by a 61 percent rise in investment income on higher interest rates, with net profit reaching Rs.333 million (2022: Rs.285 million). Return on equity was 16 percent and averaged 17 percent in the last three years.

Fitch said it believes investment and liquidity risks have eased following the positive rating action on the Sri Lankan sovereign’s Local-Currency IDRs as well as on Fitch-rated Sri Lankan bank and non-banking financial institutions.

CGF adopts a conservative investment mix, with around 78 percent of invested assets held in cash and term deposits at state-owned Bank of Ceylon (Long-Term Foreign-Currency IDR: CC, National Long-Term Rating: A(lka)/Stable) at end-2023. Treasury bills accounted for the remainder.
Net guarantee risk exposure/total capital was 0.5x at end-2023 (2022: 0.4x). CGF’s gross guarantee liabilities have fallen to Rs.1.5 billion, from a peak of Rs.12.0 billion in 2020, due to lower volume of new guarantees and a discontinuation of some projects. Total claim initiations since inception have been low, at Rs.150 million or 7.2 percent of end-2023 equity. Capital is supported entirely by internally generated net surplus.