HNB shines as first bank to get international credit rating

Hatton National Bank Plc., yesterday received an international credit rating B1 from Moody’s Investors Service, thereby becoming the first local bank to achieve this feat. Interestingly the rating is also on par with sovereign rating of Sri Lanka.

Commenting on the rating HNB Managing Director and CEO Rajendra Theagarajah said: “We are delighted to announce that HNB has been assigned an international rating by Moody’s which is on par with the sovereign rating of B1 of Sri Lanka.”

“This is the first ever international rating obtained by a Sri Lankan Bank. We would like to thank Barclays Capital and Citi Bank the joint advisors to the rating for the excellent support extended throughout the process,” Theagarajah added.

In its official announcement Moody’s Investors Service said it has assigned following debt and deposit ratings to Hatton National Bank, with a stable outlook.

The detailed ratings assigned are: Local currency deposits:  B1/NP; Foreign currency deposits: B2/NP; Foreign currency senior unsecured debt: B1; and Foreign currency issuer rating: B1

Moody’s has also assigned E+ bank financial strength rating (BFSR), mapping to a base line credit assessment (BCA) of b1 with a stable outlook.

This is the first assignment of international ratings for HNB. These ratings and outlooks take into account the balance of strengths and weaknesses characterising HNB’s credit profile on a standalone basis, as well as our assumptions on the probability of Government support in times of stress, which we assess as moderate. At E+ / b1, our support assumption does not result in any rating uplift.

HNB’s business model is geared towards lending to corporates and small and medium-sized enterprises, though it has a diversified portfolio of retail clients and products. Its credit profile is characterised by a significant domestic franchise, with a market share of approximately 10% and an extensive network of branches and ATMS distributed throughout the country. From this platform, HNB has steadily generated strong profitability while building and maintaining above-average capitalisation levels relative to other similarly-rated banks rated in the Asia-Pacific region. At the same time, the bank is inherently vulnerable to the cyclicality typically associated with emerging markets, which exposes it to periodic asset quality pressure, as evidenced by its non-performing loan record. Also, for a bank exposed to such risk, we consider its provision coverage to be low.

Although net interest margins were under pressure during 2011, they remained high at nearly 5%. HNB also reported a relatively strong pre-provision income level of 3.7% and a return on average risk-weighted assets of 2.6% in 2011. Going forward, we expect HNB’s strong profitability to continue as a result of the investments it has made in recent years to expand its reach through the country by materially increasing its branches and ATMs. This should also help improve its efficiency (cost to income) ratio, which currently stands at a relatively high level of close to 60%.

At 13% of risk-weighted assets, HNB’s core Tier 1 capitalisation levels at end-2011 would allow it to sustain an adverse downside scenario, and the banks’ continued profitability level and internal capital generation policy should contribute to safely maintain capital above 10% going forward, even when assuming a 20% risk-weighted asset growth.

On the other hand, the bank’s standalone rating of b1 takes into account the high level of non-performing loans, which is only partly offset by the bank’s elaborate risk management framework. HNB’s asset quality indicators compare weakly to its Asia-pacific peers in the same rating category. Gross non-performing loans are high at 4.56%, whereas provision coverage is low at 49%.

Although the bank has implemented risk management processes, which include clearly laid out limits and controls established on the basis of forward-looking internal ratings and dynamic risk-return analysis, the asset quality indicators could rapidly deteriorate in a cyclical downturn given the rapid credit growth during 2010 and 2011. The unavoidable rapid increase provisioning that would result when considering the low base from which these provisions would start would pressure the banks profits.

HNB’s rating outlook could be lowered if the core Tier 1 capital ratios drop to below 10% and net NPL ratio exceeds 2.5%. If the profitability drops to under 1.5% of risk-weighted assets and weighs on internal capital generation, then the ratings would be under pressure.

To be upgraded, HNB will need a combination of two factors: a demonstrated resilience of its core financial ratios over time; and an upgrade of the Government rating against which it would otherwise be constrained.

The foreign currency senior unsecured debt rating of B1 factors in the moderate level of systemic support from the Government, which is also rated B1 for foreign currency debt. As part of Moody’s joint default analysis model, Moody’s considers Sri Lanka to be a medium support country. In assessing the probability and likelihood of external support, Moody’s took into account the systemic importance of the bank, as well as the willingness and capacity of the Government to provide support, including the non-fiscal measures that could be deployed to support a bank, if needed.

Established in 1888 and headquartered in Colombo, HNB had assets of LKR388.59 billion at end-December 2011.

The principal methodologies used in rating HNB were Bank Financial Strength Ratings: Global Methodology published in February 2007 and Incorporation of Joint-Default Analysis into Moody’s Bank Ratings: A Refined Methodology published in March 2007. Please see the Credit Policy page on www.moodys.com for a copy of the methodologies.