Fitch affirms HDFC at 'BBB+(lka)'

Fitch Ratings 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 million 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 percent 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 percent) 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 percent growth, 31 percent 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 percent 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 percent of loans at 9M10) to mitigate this.