Fitch affirms HDFC Bank 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 bank's outstanding senior unsecured redeemable debentures at 'BBB+(lka)'.

The ratings reflect HDFC's demonstrated ability to contain interest rate risk by re-pricing its existing loans, despite a sizeable interest-rate mismatch between its assets and liabilities.

The ratings may be downgraded if there is continued deterioration in HDFC's maturity or interest-rate mismatches, or a continued erosion of capitalisation.

An inability to re-price existing loans in a timely manner when interest rates rise may also result in a downgrade. The bank's continued heavy reliance on Employee Provident Fund-backed loans (EPF loans) to drive its business, as witnessed in 2010 and in 9M11, may also result in negative rating pressure, as this would continue to burden liquidity.

Upside potential for the ratings is limited in the medium term due to the above risks.

HDFC's loan book grew 9.4% in 9M11 (8.5% in 2010), driven by residential housing loans and EPF housing loans.

EPF loans grew faster than other loan products and accounted for 40% of HDFC's loan book at end-9M11 (34% in 2010).

HDFC's capitalization has declined over the last 10 years alongside loan growth, with its equity and assets ratio falling to 11.3% at end-9M11 (2010: 11.7%).

Given that the bulk of HDFC's loan book is funded by short-term deposits, HDFC may require a large equity buffer to reduce any adverse effects that rising interest rates may bring to its credit profile.

Higher capitalisation may also be prudent in light of recent changes to the foreclosure rights of banks, which Fitch expects will prolong banks' recovery experience, weighing on profitability and asset quality.

HDFC was established as a building society in 1984, before converting into a licensed specialized bank in 2003, and listing on the Colombo Stock Exchange in 2005. HDFC is 51% owned by the Government of Sri Lanka.

At end-9M11, HDFC group assets amounted to LKR17bn. The bank has a network of 20 branches and employs over 400 staff.