Fitch downgrades Sri Lanka’s HDFC Bank to BBB-(lka), maintains on RWN

Fitch Ratings has downgraded Housing Development Finance Corporation Bank of Sri Lanka's (HDFC Bank) National Long-Term Rating to 'BBB-(lka)' from 'BBB(lka)'. HDFC Bank's senior secured and senior unsecured debentures have also been downgraded to 'BBB-(lka)' from 'BBB(lka)'. The ratings are maintained on Rating Watch Negative (RWN). The one-notch downgrade reflects Fitch's assessment of the weakening of support from the Sri Lanka sovereign (B+/Stable) to HDFC Bank. This is after the state failed to provide capital to the bank in timely manner for it to meet the minimum LKR5 billion regulatory capital requirement by 1 January 2018. However, Fitch believes that it is still likely that the authorities would provide adequate support to meet the shortfall within an extended deadline. The RWN reflects the risk that the state, as major shareholder, would not raise the bank's capital to meet the minimum capital requirement, in which case Fitch will downgrade the rating to reflect the bank's weaker intrinsic strength. KEY RATING DRIVERS HDFC's rating reflects Fitch's expectation that the bank would receive extraordinary support from the sovereign, if required. Our assessment captures the National Housing Development Authority's direct 49% stake in the bank, which brings the state's holdings in the bank to 51% effectively; the bank's quasi-policy role in supporting housing-development initiatives; as well as HDFC Bank's low systemic importance. Fitch's assessment of the bank's standalone profile is weak compared with better-rated peers. HDFC Bank's reported NPL ratios (18.5% at end-3Q17) are above the industry average and its capital buffers (Fitch Core Capital ratio of 14.2% at end-3Q17) are thin and declining. The bank is also more exposed than peers to low- and middle-income customers, mainly through housing loans (87% of total loans at end-3Q17), which are susceptible to economic and interest rate cycles. The bank's outstanding debentures are rated in line with its National Long-Term Rating and rank equally with the claims of other senior unsecured creditors. Fitch has not provided any rating uplift for the collateralisation on the senior secured debentures as their recovery prospects are considered to be average and comparable with those of the unsecured notes in a developing legal system. RATING SENSITIVITIES Fitch will downgrade the bank's rating if the sovereign does not raise HDFC Bank's capital as this would indicate that sovereign support cannot be relied upon. Should this occur, Fitch is likely to downgrade the bank to the 'BB' category on the National Rating scale; the extent of the downgrade would depend on whether the bank's intrinsic strength continues to weaken. Furthermore, Fitch may also downgrade HDFC Bank's ratings if there is a change in our expectation of state support due to a weakening of the bank's linkages with the state, through a dilution of the state's majority ownership or a revision of Fitch's view of the bank's policy role. HDFC Bank's rating could be affirmed and removed from RWN if the state were to provide the additional capital required in the next six months. The ratings of the senior secured and senior unsecured debentures will move in tandem with HDFC Bank's National Long-Term Ratings.