HNB Finance’s Fitch National Long-Term Rating affirmed at ‘BBB+(lka)

Fitch Ratings has affirmed HNB Finance PLC’s (HNBF) National Long-Term Rating at ‘BBB+(lka)’. The Outlook is Stable. 
The agency has also affirmed the National Long-Term Rating on HNBF’s subordinated debentures at ‘BBB-(lka)’.
HNBF’s rating is driven by the expectation that its parent, Hatton National Bank PLC (HNB, A(lka)/Stable), would provide extraordinary support to HNBF, if required. 

HNB’s ability to support HNBF is reflected in its credit profile, which is underpinned by its standalone strength, Fitch Ratings said. 
“Our support assessment also takes into consideration HNB’s majority 51 percent shareholding, its oversight of HNBF’s strategic direction through board representation and the common HNB brand, which elevates reputational risk for the parent, should the subsidiary default,” the rating agency said in a statement.

HNBF is rated two notches below its parent to reflect the view that HNBF is of limited importance to the HNB group, accounting for only 3.6 percent of the group’s gross loans. 
Vehicle financing and microfinancing dominate HNBF’s loan book, comprising 65 percent of gross loans in the financial year ended March 2023 (end-FY23). These are not core products for HNB (9 percent of HNB’s loans); HNBF serves customer segments that are beyond the bank’s typical risk tolerance. There is also significant management independence and limited operational integration between HNBF and HNB.

Fitch also assesses HNBF’s standalone credit profile to be weaker than its support-driven rating because of its weak financial profile, small franchise with a 3 percent market share of sector assets at end-3QFY24, limited history of successful operation and evolving business model. Fitch expects HNBF’s business model to transition from traditional unsecured microfinancing (FY23: 35 percent of loans) towards increased vehicle financing (FY23: 30 percent), supported by the reduction in market rates and the resumption in economic activity.
Fitch expects HNBF to meet the regulatory minimum capital ratios in the near term. However, its aggressive loan growth plan could re-exert pressure on its capital ratios and leverage in the absence of an equity infusion and/or significant improvement to internal capital generation. 

The company’s Tier 1 capital ratio (excluding profits for the period) stood at 7.2 percent at end-3QFY24, below the regulatory minimum of 8.5 percent. HNBF’s leverage of 8.3x at end-3QFY24 was one of the highest among Fitch-rated Sri Lankan finance and leasing companies.

HNBF’s asset-quality metrics remain under pressure with its gross stage three loans ratio rising to 24 percent at end-3QFY24, from 16 percent at end-FY23, dominated by unsecured microfinance loans for which recoveries remain a challenge. The planned loan growth could lead to a decline in the stage three loans ratio but asset-quality challenges could increase as new lending seasons.

HNBF’s pre-tax profit/average assets ratio was 1.8 percent in 9MFY24, relative to pre-tax losses in FY23. The improvement in profitability stemmed from lower cost of funding alongside the dip in market rates, high-yield products including microfinance and gold loans (46 percent of loans at end-FY23) and significantly lower credit costs relative to FY23. Fitch expects profitability to improve further in the near to medium term as HNBF resumes lending activities and funding costs continue to decline.