Fitch affirms HNB at ‘AA-’

Fitch Ratings has affirmed Hatton National Bank PLC’s (HNB) National Long-term rating at ‘AA-(lka)’. The Outlook is Stable. The agency also affirmed HNB’s outstanding subordinated redeemable debentures of Rs. 6 b at ‘A+(lka)’.

Rating Action Rationale: HNB’s ratings reflect its strong domestic franchise in lending and deposit mobilisation as the fourth-largest bank in Sri Lanka, as well as its satisfactory capitalisation and stable operating performance. However, HNB exhibits weaker asset quality than higher-rated peers, partly owing to higher and more volatile non-performing loan (NPL) ratios and lower provisions coverage, which constrain its ratings.

HNB’s subordinated redeemable debentures are rated one notch lower than its National Long-Term Rating, to reflect their gone-concern loss-absorption qualities in the event of liquidation, and is in line with Fitch’s criteria for rating such securities.



Key Rating Drivers: HNB had a 9% share of loans and deposits each at end-2012. HNB has the fourth-largest foreign-currency deposit base, which provides the bank with a competitive edge. Current and savings accounts remain strong as a share of total deposits, albeit reduced to 39% in 2012 in line with the sector as market interest rates rose, from around 6.2% (average weighted deposit rate) since April 2011.

HNB was one of two banks among rated domestic peers to have raised fresh shareholder funds during buoyant domestic equity markets. At the same time, HNB’s higher exposure to the retail and SME segments than peers may necessitate a higher capital buffer to compensate for the additional risk, all else remaining equal.

HNB’s Tier 1 capital adequacy ratio (CAR) was 14.1% at end-2012 and is strong in a domestic context. This ratio falls to 11.85% if HNB were to set aside the full regulatory capital requirement against its gold-backed lending (pawning) portfolio (currently zero capital allocation based on domestic regulations). The adjusted figure would be modest compared with systemically important banks in the region.

HNB’s NPL concentrations are high, stemming in particular from loans to three tourism projects in Maldives, which were disbursed in 2008-09. Although the bank is optimistic, Fitch notes that recovery of these exposures could remain challenging in the near term, and will continue to put pressure on HNB’s asset quality.

The bank’s greater focus on the SME/retail sector in 2012, as a part of their long term strategy, can improve profitability if managed prudently, but also increases business risk insofar as these segments are more susceptible to economic downturns than corporates.

Pawning advances accounted for 16% of HNB’s loans in 2012 (2011: 14%). At end-2012, the average loan-to-value (LTV) ratio on the pawning book stood at 70%, but increased to 82% as at end-March 2013 due to falling gold prices. HNB has since cut pawning growth to reduce risk, with monthly portfolio growth slowing to 0.4% in April 2013 (January 2013: 1.7%). Comparatively the bank’s overall loans grew 1.5% in the first three months of 2013.

Rating sensitivities: A notable increase in HNB’s risk appetite, or a weakening of underwriting standards, which results in higher volatility in financial performance and asset quality could lead to a downgrade. In particular, a weakening of asset quality accompanied by a faster-than-expected dip in capitalisation and provisions for non-performing loans could also lead to downward rating pressure.

HNB has a higher business risk profile than higher-rated peers’, stemming from its higher exposure to retail and SME loans. Consequently the bank’s asset quality swings have been more pronounced. This, combined with weak economic conditions at present, leads the agency to believe that a rating upgrade is less likely in the medium-term.