(Commonwealth)_ Fitch Ratings’ confirmation of the ‘BB(lka)’ National Insurer Financial Strength (IFS) Rating for Sri Lanka’s Construction Guarantee Fund (CGF) underscores the agency’s in-depth assessment of CGF’s operational performance and the prevailing business environment. This rating, coupled with a Stable Outlook, reflects the agency’s confidence in CGF’s ability to navigate challenges and maintain stability.
CGF’s operations are intricately linked to government construction initiatives, wherein it provides essential guarantees and support services to small- and medium-sized contractors involved in state projects. However, the company’s operational dynamics are significantly influenced by the broader fiscal landscape of the Sri Lankan government. The government’s weakened fiscal position has resulted in a reduction in the number of new construction contracts, the suspension of ongoing projects, and delays in payments to contractors. Consequently, CGF has experienced a notable decline in premium income, exacerbating the risk of claims by employers and adding pressure to its financial performance.
In response to these challenges, CGF is likely to employ strategic measures to mitigate risks and bolster its resilience. Such measures may include stringent risk assessment protocols, enhanced financial management practices, and proactive engagement with stakeholders. By proactively addressing the evolving needs of its clients and adapting to changing market conditions, CGF aims to uphold its reputation as a reliable guarantor and support the continued development of Sri Lanka’s construction sector.
In 2024-2025, underwriting performance is projected to remain weak due to the continued low business volume. The challenges persisted from the previous year, as evidenced by the substantial decline in premium income and the simultaneous increase in claim and administration costs. In 2023 alone, premium income plummeted by a staggering 87% to LKR13 million, while claim costs rose by 10% and administration costs surged by 38%. Consequently, CGF experienced a significant underwriting loss of LKR107 million during the same period. However, this setback was partially offset by a notable increase in investment income, which surged by 61%, ultimately boosting net profit to LKR333 million.
Fitch’s assessment indicates that investment and liquidity risks have somewhat eased following positive rating actions on Sri Lanka’s sovereign ratings and Fitch-rated financial institutions. CGF maintains a cautious investment approach, with approximately 78% of its invested assets held in cash and term deposits at the state-owned Bank of Ceylon. This conservative investment mix contributes to CGF’s resilience and stability amidst the challenging operating environment, providing a buffer against market volatility and uncertainties.
At the end of 2023, CGF maintains satisfactory capital adequacy, evidenced by its net guarantee risk exposure to a total capital ratio of 0.5x. Moreover, gross guarantee liabilities have notably decreased to LKR1.5 billion from a peak of LKR12.0 billion in 2020. Notably, the company’s capital base is entirely supported by internally generated net surplus.
Fitch assesses CGF’s company profile as ‘Moderate,’ which reflects its business profile and corporate governance practices. Being a state-owned entity, CGF benefits from a competitive advantage bolstered by the expertise of its trustees, encompassing both public and private sector institutions. However, CGF operates on a relatively small scale, with total assets and equity standing at LKR2.9 billion and LKR2.1 billion, respectively, by the close of 2023. The fund’s risk appetite is considered high, as it provides guarantees to high-risk contractors, particularly small- and medium-scale contractors without requiring collateral. CGF mitigates this risk by conducting a comprehensive screening of contractors’ technical and financial capabilities. The board of trustees has set a cash collateral requirement of 20% for advance payment bonds.
Fitch Ratings’ affirmation of CGF’s rating underscores its evaluation of the company’s performance within a challenging operational landscape and its proactive risk mitigation measures. Despite facing challenges such as weaknesses in underwriting performance and reliance on government construction activity, CGF sustains sufficient capitalization and liquidity levels.
