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June 18 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has revised India-based infrastructure finance company, IDFC Limited's (IDFC), Outlook to Stable from Negative. Its Long-Term Issuer Default Rating (IDR) has been affirmed at 'BBB-'.
KEY RATING DRIVERS
The rating action follows the revision of the Outlook on India's Long-Term IDRs to Stable from Negative (see 'Fitch Revises India's Outlook to Stable; Affirms Ratings at 'BBB-'' dated 12 June 2013 at www.fitchratings.com).
IDFC's standalone credit strength - which is the main factor underpinning the IDR - reflects its sound and stable financial profile. Healthy capitalisation levels, a strong earnings profile and robust asset quality are its key drivers. Nonetheless, the rating is constrained by IDFC's wholesale funding profile and high concentration risk which it seeks to mitigate by conservatively managing its liquidity and the use of effective risk management practices.
IDFC reported a decline in its gross non-performing loan (NPL) ratio to 0.15% in the financial year to March 2013 (FY12: 0.3%) with a specific provision cover of 66% (FY12: 52%). Management's guidance of rising NPLs - from their current low levels - is in line with Fitch's expectations. However, IDFC's expectation to restrict the gross NPL ratio within 1% is ambitious given the harsh environment which is expected to continue over the next 18 to 24 months.
Fitch believes that overall stressed assets, including restructured loans, are likely to increase at IDFC but should be much below the banking system's average of 9.6% (as at end-December 2012), as nearly 80% of its exposure is to operating assets. Moreover, contingency reserves at around 9.4x of gross NPL (at FY13) provide additional buffer in the event of stress.
IDFC reported modestly higher Tier 1 and total capital ratios at 19.8% (FY12: 18.5%) and 22.1% (FY12: 20.8%) respectively, at FY13. Core equity constitutes around 97% of the capital base (Fitch estimates) which provides a strong loss absorption capacity. The capital buffer, though significant, is necessary for IDFC's concentration risks. IDFC has set a minimum Tier 1 floor above the regulatory requirement although Fitch does not expect it to decline significantly from its current levels.
IDFC's share of long-term funding constituted nearly 92% of the total funding mix in FY13. This adds stability to IDFC's wholesale funding profile and improves the match between its liabilities and assets, which are long-term in nature. IDFC's modest growth expectations for the immediate term should also provide some support to liquidity and capital. While Fitch takes into account that strong linkages with the Indian government will aid IDFC's refinancing capability, extraordinary sovereign support is not factored into the current rating.
IDFC's firm, albeit declining, profitability acts as the first line of defense in a stress scenario with a pre-provisioning operating profit-to-total assets buffer of 4.4% as at FY13 (FY12: 4.6%). Net interest income accounts for about 75% of the total operating income while pressure on its net interest margins (FY13: 3.97%; FY10: 4.16%) reflects its wholesale funding profile. However, other sources of income (fees, treasury) contribute the remaining 25% and help mitigate volatile funding costs. Profitability at the net level (FY13 return on average assets: 2.7%; FY12: 2.9%) is supported by low costs and stable provisions (at around 50bps-60bps of total assets).
RATING SENSITIVITIES - IDRs
IDFC's niche focus on infrastructure has, thus far, been mitigated by conservative capital levels and robust asset quality, which Fitch expects IDFC to maintain in line with its business profile and rating. Therefore, any sustained disruption or reversal of the above strengths will be a potential downgrade trigger on the IDR. An upgrade to the sovereign rating may not necessarily lead to an upgrade of IDFC's IDR unless it is also supported by its standalone credit strength.
At the same time, IDFC's ambition to expand - given its intention to apply for a banking license may push it beyond its core competencies and into new businesses and unfamiliar risks. While this could potentially add diversification benefits, it may also result in lower capital buffer over time which could put the IDR under pressure.