HDFC Bank placed on ‘Rating Watch Negative’

Fitch Ratings has placed Housing Development Finance Corporation Bank of Sri Lanka’s (HDFC Bank) national long-term rating of ‘BBB(lka)’on ‘Rating Watch Negative’ (RWN).

The agency also placed HDFC Bank’s senior secured and senior unsecured debentures, rated at ‘BBB(lka)’, on RWN.

The RWN reflects the risk that the state (B+/Stable), as major shareholder, will not raise the bank’s capital to meet the minimum Rs.5 billion capital requirement by January 1, 2018, in which case Fitch will downgrade the rating to reflect the bank’s weaker intrinsic strength. 

The requirement has been in force since 2016 and Fitch would see a further delay as an indication that creditors may no longer be able to rely on sovereign support in a timely manner, notwithstanding HDFC Bank’s unchanged linkages with the state.

HDFC’s rating reflects Fitch’s expectation that the bank would receive extraordinary support from the sovereign, if required. Our assessment captures the state’s 51 percent effective holding, of which the National Housing Development Authority directly owns 49 percent, the bank’s quasi-policy role in supporting housing-development initiatives, as well as HDFC Bank’s low systemic importance.

Fitch estimates that it would take HDFC Bank more than four years to generate the required capital from retained earnings. Its profitability, in terms of return on assets, has been declining because net-interest margins have been contracting due to higher funding costs stemming from the bank’s short-tenor deposit base, which reprices regularly and its high-cost business model.

The bank’s profitability, funding and liquidity could also be affected by business restrictions imposed by the Central Bank of Sri Lanka (CBSL). Fitch expects HDFC Bank’s asset and liability mismatches to persist due to its longer-tenor loan book and short-tenor deposit base. Its deposit base is also highly concentrated.

Housing loans, mainly to low- and middle-income customers, continue to dominate the bank’s loan book, accounting for 81 percent at end-1Q17 (2014: 91 percent). 

Housing loans to members of the Employees’ Provident Fund (EPF), which are secured against members’ EPF balances, accounted for 24 percent of the bank’s total loans. Non-performing loans (NPL) to EPF members are higher than for the rest of the bank’s portfolio, but the CBSL annually reimburses HDFC Bank for EPF-backed loans in arrears for more than three months. The reported gross NPL ratio remained high 18.8 percent or 8.9 percent excluding EPF-backed loans, at end-1Q17.
The bank’s outstanding debentures are rated in line with its national long-term rating and rank equally with the claims of other senior unsecured creditors. Fitch has not provided any rating uplift for the collateralisation on the senior secured debentures as their recovery prospects are considered to be average and comparable with those of the unsecured notes in a developing legal system.