(The following statement was released by the rating agency)
Nov 29 - Fitch Ratings Lanka has downgraded the Housing Development Finance Corporation Bank
of Sri Lanka's (HDFC) National Long-Term Rating to 'BBB(lka)' from 'BBB+(lka)'. The
Outlook is Stable. Its LKR195m outstanding senior unsecured redeemable debentures have also been
downgraded to 'BBB(lka)' from 'BBB+(lka)'.
The downgrade reflects the bank's inability to swiftly re-price its existing
housing loan portfolio to avert deterioration in profits as market interest
rates started to rise since end-2011. This failure of timely re-pricing has
further accentuated the interest rate risk inherent in HDFC's balance sheet due
to maturity mismatches between its assets and liabilities.
The current rating and Stable Outlook reflect Fitch's expectations that the
Government of Sri Lanka, with over 51% ownership of HDFC, is likely to provide
support to the bank under extreme circumstances if required. This is based on
the bank's linkages with the state, and its quasi-policy role in supporting the
government's initiatives towards low- and middle-income housing.
The state's ownership stake in HDFC is almost entirely held via the National
Housing Development Authority - a state-owned corporation that is tasked with
formulating and implementing the national housing policy. HDFC's board is
appointed by the Ministry of Finance, and seven out of a total of nine board
members are senior public servants, representing key ministries and state-owned
corporations, most of which are related to housing and construction. A majority
of HDFC's clientele consists of low and middle-income consumers who have limited
access to traditional bank credit.
HDFC's profitability weakened sharply in the nine months to September 2012
(9M12), driven by increasing borrowing costs in line with rising market interest
rates. Consequently HDFC's return on assets (ROA) fell to an annualised 0.07% at
end-9M12 (end-2011: 1.77%). The bank increased interest rates on its existing
housing loans with effect from 1 October 2012 - by up to 200bps or up to a
ceiling rate of 18% - which the bank expects will stem the deterioration in
profits in the near-term.
HDFC successfully amended its Act of Incorporation in November 2011, in order to
be able to disburse short-term lending products such as gold-backed loans,
Islamic finance, and leasing. Furthermore the bank expects to introduce
variable-rate housing loans starting in 2013 which will be re-priced annually in
line with market rates. However, gaining a critical mass in these products is
likely to take 24 months or more, and the successful implementation of these
strategies will be key in determining the level of HDFC's long-term
HDFC's credit risk management has been satisfactory, considering the low income
nature of its borrowers. Credit quality is supported by the low default risk of
housing loans relative to other consumer loans. Loans in arrears of over 18
months have remained broadly below 1.8% of total advances between 2009 and 2012.
HDFC's rating may be downgraded further if its linkages with the state weakens,
including a dilution of the state's majority ownership of the bank. Fitch does
not expect rating upside for HDFC over the medium-term, given that a successful
reduction in the bank's exposure to interest-rate risk will likely take longer
HDFC is a licensed specialised bank created by an Act of Parliament. At
end-September 2012 HDFC's asset base stood at LKR20.4bn, while it had a network
of 21 branches and 11 service centers.