Jul 24, 2018 (LBO) - Fitch Ratings has maintained Housing Development Finance Corporation Bank of Sri Lanka's (HDFC Bank) National Long-Term Rating of 'BBB-(lka)' on Rating Watch Negative (RWN), a statement said. "The RWN, first placed in August 2017, has been maintained pending a capital infusion from the Sri Lankan state (B+/Stable) to help HDFC Bank meet the LKR 5 billion minimum regulatory capital requirement," it said. "We expect the state, the bank's major shareholder, to extend its support but the timing of the capital infusion depends on regulatory clearance." The agency has also maintained the RWN on the 'BBB-(lka)' rating of HDFC Bank's senior secured and senior unsecured debentures. The full statement follows: Fitch Ratings-Colombo-24 July 2018: Fitch Ratings has maintained Housing Development Finance Corporation Bank of Sri Lanka's (HDFC Bank) National Long-Term Rating of 'BBB-(lka)' on Rating Watch Negative (RWN). The agency has also maintained the RWN on the 'BBB-(lka)' rating of HDFC Bank's senior secured and senior unsecured debentures. KEY RATING DRIVERS The RWN, first placed in August 2017, has been maintained pending a capital infusion from the Sri Lankan state (B+/Stable) to help HDFC Bank meet the LKR5 billion minimum regulatory capital requirement. We expect the state, the bank's major shareholder, to extend its support but the timing of the capital infusion depends on regulatory clearance. The minimum capital requirement has been in force since 2016. Fitch downgraded HDFC Bank on 29 January 2018 after the state failed to provide the capital to the bank in a timely manner. HDFC Bank's rating reflects Fitch's expectation that the bank will receive extraordinary support from the sovereign, if required. Our assessment captures the state's 51% effective holding, which includes the National Housing Development Authority's direct ownership of 49%; the bank's quasi-policy role in supporting housing-development initiatives; as well as HDFC Bank's low systemic importance. The bank's weak standalone profile is characterised by its above-industry exposure to low- and middle-income customers, mainly through housing loans, who tend to be more susceptible to economic cycles. The share of housing loans has declined over the years but it has remained high, at 82% at end-March 2018. The bank continued to have a high reported non-performing loan (NPL) ratio, which stood at 19.7% at end-March 2018. This was mainly due to defaults from housing finance backed by the Employees' Provident Fund (EPF), which contributed slightly more than half of the bank's total housing NPLs at end-March 2018. Nevertheless, the Central Bank of Sri Lanka annually reimburses HDFC Bank for EPF-backed loans in arrears for more than three months. The bank's NPL ratio remained high even without the EPF-backed housing loans at 8.9% at end-March 2018 (9.0% at end-2017), which reflects the concentration of its credit risk in the low- and middleincome housing-finance market. We see HDFC Bank's capitalisation as weak despite the bank's Fitch Core Capital (FCC) ratio of 16.8% at end-March 2018 because of the bank's substantial unreserved NPLs. Fitch expects HDFC Bank's asset and liability mismatches to persist due to its longer-tenor loan book and short-tenor deposit base, exerting pressure on the bank's liquidity. The bank's dependence on high-cost term deposits also weighs on its net interest margins and profitability. SENIOR DEBT RATINGS The bank's senior 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 notes as we consider recovery prospects to be average and comparable with that of unsecured notes in a developing legal system. RATING SENSITIVITIES NATIONAL RATINGS AND SENIOR DEBT Fitch may downgrade the bank's rating if there is a change in our expectation of state support for the bank. This may occur due to a weakening of the bank's linkages with the state, evident from a dilution of the state's majority-ownership of the bank, or a revision in Fitch's view of the bank's policy role. HDFC Bank's rating could be downgraded by several notches if the sovereign's ability to support is significantly impaired or if Fitch concludes that the bank can no longer rely on sovereign support. 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 Rating.