Fitch affirms HDFC Bank at ‘BBB+(lka)’; Outlook Stable

Fitch Ratings said yesterday it has affirmed the Housing Development Finance Corporation Bank of Sri Lanka’s (HDFC) National Long-term rating at ‘BBB+(lka)’. The Outlook is Stable. At the same time, the agency has affirmed the ‘BBB+(lka)’ rating on the bank’s outstanding Rs. 195 m senior unsecured redeemable debentures.

HDFC’s ratings reflect its demonstrated ability to contain interest rate risk to an extent by re-pricing existing loans, despite the sizeable maturity mismatches between its assets and liabilities.

The ratings also factor in the Government of Sri Lanka’s (GOSL, the State) 51% ownership of the bank, as well as in the latter’s perceived importance to low- and middle-income housing, sizeable funds derived from the State and related entities, low ultimate credit risk of its housing loans, and inherent limitations in its current business model.

The ratings could be upgraded if there is a sustained improvement in HDFC’s maturity mismatches and sustained higher equity funding, as well as if it continues to re-price existing loans in a rising interest rate environment in a timely manner while maintaining healthy asset quality and profitability. The opposite of the above factors would result in a rating downgrade.

HDFC’s loan growth improved towards the end of 2010 (end-September 2010 (9M10): +1.8%) helped by the low interest rate environment and improving credit demand. Much of the growth stemmed from housing loans backed by borrowers’ employee provident fund balances (EPF loans, 13% growth, 31% of loans) while other loans declined.

EPF loans are more profitable for the bank, given that they require minimal appraisal and carry virtually no credit risk. However, over-reliance on EPF loans could increase pressure on the bank’s liquidity, as arrears on such loans (NPL ratio of 43% at 9M10) are refunded in full only once a year by the EPF. HDFC expects to improve its competitive position in housing loans backed by mortgages over property (59% of loans at 9M10) to mitigate this.

The bank’s profitability improved in 2010 as net interest margin widened and credit costs eased in an improving economic climate, helped by focused recoveries. Its return on assets (ROA) improved to an annualised 2.25% at end-9M10 (end-2009: 0.77%), more in line with an average of 2.83% between 2000 and 2006.

The long-term sustainability of ROA will depend upon HDFC’s ability to reduce its asset-liability mismatches and keep credit controls in check over the medium-term. This could prove challenging, in particular if much of the incremental growth is deposit-funded, unless market interest rates remain benign. HDFC’s capitalisation (equity/assets) improved to 12.00% at end-9M10 (end-2008: 10.63%, end-2009: 11.04%), but was still below an average of 16.76% between 2000 and 2006. In the absence of viable long-term fixed rate funds or re-finance borrowings to fund its housing loan portfolio, HDFC may require a larger equity cushion to reduce potential adverse effects that rising interest rates could pose to its credit profile.

HDFC was established as a building society in 1984, converted into a licensed specialised bank in 2003, and listed on the Colombo Stock Exchange in 2005. At end-9M10, HDFC group assets amounted to Rs. 15 b. The bank has a network of 27 branches, and employs over 400 staff.

Ajith resigns from HDFC Bank

Ajith Fernando has tendered his resignation from the Board of HDFC Bank.

The move, effective from 1 January 2011, is over personal reasons.  Ajith’s main venture Capital Alliance Holding Ltd. has recently sold out of HDFC Bank. It had around 2% stake in the Bank and Ajith was a shareholder director. He was appointed as Director of HDFC Bank in June 2004.

He is a Fellow of the Chartered Institute of Management Accountants UK and has a MA in Financial Economics from the University of Colombo.