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Extended Annual Review Report

Project Number: 41914-014 Equity Number: 7274 Loan Number: 2418 September 2016

Loan and Equity Investment Housing Development Finance Corporation Plc. (Maldives) This is an abbreviated version of the document which excludes commercially sensitive and confidential business information that is subject to exceptions to disclosure set forth in ADB's Public Communications Policy 2011

CURRENCY EQUIVALENTS Currency Unit – rufiyaa (Rf)

At Appraisal At Project Review

1 July 2016 $0.06489 Rf15.40

1 February 2008 Rf1.00 = $0.07813 $1.00 = Rf12.80

ABBREVIATIONS

ADB – Asian Development Bank BML – Bank of Maldives CAGR – compound annual growth rate DMF – design and monitoring framework ESMS – environmental and social management system GDP – gross domestic product HDFC – Housing Development Finance Corporation HDFC-I – HDFC Investments Limited of India IFC – International Finance Corporation IFI – international financial institution IPO – initial public offering LIBOR – London interbank offered rate NPL – nonperforming loan PFI – participating financial institution PSOD – Private Sector Operations Department TA – technical assistance TEAP – Tsunami Emergency Assistance Project XARR – extended annual review report

NOTE In this report, “$” refers to US dollars.

Vice-President D. Gupta, Private Sector and Cofinancing Operations Director General M. Barrow, Private Sector Operations Department (PSOD) Director C. Roberts, Private Sector Portfolio Management Division, PSOD Team leader Team members

I. Chua, Senior Investment Officer, PSOD A. Cheema, Investment Specialist, PSOD M. Gunawardhena, Investment Specialist, PSOD J. Gomez, Safeguards Officer, PSOD V. Ramasubramanian, Safeguards Specialist, PSOD

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgment as to the legal or other status of any territory or area.

CONTENTS

Page BASIC DATA i EXECUTIVE SUMMARY ii

I. THE PROJECT 1

A. Project Background 1 B. Key Project Features 2 C. Progress Highlights 2

II. EVALUATION 3

A. Project Rationale and Objectives 3 B. Development Results 4 C. ADB’s Additionality 8 D. ADB Investment Profitability 8 E. ADB Work Quality 9 F. Overall Assessment 10

III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS 11

A. Issues and Lessons 11 B. Recommended Follow-Up Actions 11

APPENDICES 1. Maldives Housing Market Overview 13 2. Design and Monitoring Framework 14 3. Estimation of Return on Invested Capital 16 4. Business Performance 17 5. Financial Statements 21 6. Results and Ratings for Project Contributions to Private Sector Development

and ADB Strategic Development Objectives – Financial Intermediaries 22

BASIC DATA

Loan and Equity Investment Housing Development Finance Corporation

(Loan No. 2418 and Equity Investment No. 7274 – Maldives)

Key Project Data

As per ADB Loan Documents ($ million)

Actual ($ million)

Total Project Cost: 12.00 9.75 Total Investment:

Loan: Committed 7.50 7.50 Disbursed 7.50 Outstanding NIL

Equity: Committed 4.50 4.50 Disbursed 2.25

Key Dates Actual

Concept Clearance Approval 17 April 2007 Board Approval 08 April 2008 First Disbursement (Equity) 09 February 2009 First Disbursement (Loan) 10 February 2009 Loan Agreement 23 July 2008 Shareholders Agreement 23 July 2008 Loan Effectiveness 23 July 2008

Financial and Economic Internal Rates of Return (%) Appraisal XARR

Financial Internal Rate of Return (project financial rate of return on equity)

21.2% ($) 19.2% ($) 22.7% (Rf)

Economic Return on Invested Capital (EROIC) … 13.8%

Project Administration and Monitoring Number of Missions

No. of Person-Days

Due Diligence Mission 3 11 Project Administration 1 2 XARR Mission 1 3 … = data not available, ADB = Asian Development Bank, XARR = extended annual review report

EXECUTIVE SUMMARY In February 2008, the Board of Directors of the Asian Development Bank (ADB) approved a $4.5 million equity investment and a $7.5 million senior secured loan to the Housing Development Finance Corporation (HDFC) in the Maldives. The Housing Development Finance Corporation (HDFC) was established in 2004 as a wholly owned government institution to provide long-term housing finance in the country. The government decided to privatize the company due to strong demand for housing finance and the inability of the government to source long-term funding for HDFC. Three international investors participated in HDFC’s privatization in 2009, leaving the government with 49% of HDFC’s capital. ADB and the International Finance Corporation (IFC) own 18% each, and India’s HDFC Investments Limited (unrelated to HDFC in the Maldives) owns 15%. ADB and IFC have each provided a loan of $7.5 million. The government’s employment of a public–private partnership model in the privatization of HDFC transferred the controlling interests in government and majority shares to international shareholders. At the time of this extended annual review, HDFC remained the only specialized housing finance company in the country and held 50.9% of the housing finance market share. HDFC is a household name in the country’s housing finance sector and helps deliver solutions for the growing housing needs of the population. It made a significant contribution to the housing market in helping the government create a legal framework that allowed freehold title to a single unit of housing. In this way it became possible that a standalone house or an apartment could be purchased through a mortgage facility. This was a paradigm shift in a market where houses were traditionally built on shared land allocated for the family many generations earlier. The transaction’s development results are rated satisfactory overall. The effect of the ADB loan and equity investment on private sector development and ADB strategic objectives is rated excellent. The privatization helped transform HDFC into a commercially viable, private sector-led company that could compete, grow, and develop effective ways to meet the mortgage financing needs of the people of the Maldives. The project contributed measurably to (i) meeting an urgent need for housing in the Maldives (ii) increasing the availability of mortgage lending and strengthening the financial sector, and (iii) generating jobs and additional revenue. The economic performance of the project is rated satisfactory. HDFC’s inclusive business model helped cultivate the products and services of small and medium-sized enterprises in the value chain as suppliers of construction materials and services. HDFC also helped deepen the financial sector through pioneering the issuance of domestic corporate bonds that were subscribed to by institutional and retail investors. Economic return on invested capital of the project was calculated at 1.3 times the weighted average cost of capital. Environmental, social, health, and safety performance is rated satisfactory. HDFC established policies for an environmental management system in accordance with ADB’s guiding principles. No involuntary resettlement occurred and no impacts on indigenous peoples were observed as a result of ADB’s investment in HDFC. Business success is rated satisfactory. During its 7 years of operation since privatization, HDFC has grown to become the dominant player in the housing finance market. Its active loan portfolio has reached Rf1 billion, but its nonperforming loan ratio was a sound 2% as of the end of 2015. With the introduction of Islamic banking products, repricing of interest rates, and extension of

housing loan tenors to 20 years, HDFC is poised to continue its success through 2016 and beyond. The return on invested capital for the project was calculated at 1.1 times the weighted average cost of capital. ADB’s additionality is rated satisfactory. ADB’s investment came at a time when the government needed long-term funding to sustain the operations of HDFC. ADB could have provided only a long-term loan, which would have satisfied HDFC’s immediate debt funding needs. However, a long-term loan coupled with an equity investment that helped in the privatization of HDFC proved to be a more sustainable solution and had a discernible impact on HDFC’s development. The infusion of additional equity and its expanded capitalization enabled HDFC to increase leverage during 2011–2016. It has not needed additional equity during this period. ADB’s investment has encouraged other international financial institutions and commercial banks to fund HDFC’s debt funding requirements since 2011. ADB investment profitability is rated satisfactory. The financial internal rate of return for ADB’s equity investment is calculated at 22.7%, equivalent to 1.3 times the cost of equity. ADB work quality is rated satisfactory. This is based on ADB’s (i) screening, appraisal, and structuring of the project; and (ii) its monitoring and supervision. In 2005, ADB contributed $600 million to the Asian Tsunami Fund, which provided a grant of $20 million and a loan of $1.8 million to finance tsunami relief in the Maldives. Although the housing sector was not a priority under this assistance, ADB believed that an investment in housing finance would complement the assistance. For this reason, ADB structured and proposed a loan and equity investment in HDFC to improve housing and atoll development and strengthen the country’s financial sector as well. The combination of the loan and equity structure proposed by ADB not only allowed HDFC to expand its lending activities but also helped it narrow its maturity gap and lower its debt–equity ratio from a high of 7:1 in 2007. The various aspects of loan administration were performed carefully by successfully balancing the management of risk and client service requirements. This extended annual review rates ADB’s investment in HDFC successful overall. HDFC has grown and made good progress despite challenging episodes of economic and political instability in the country. Its future and prospects for continued growth look very promising. It is thus important for HDFC’s board to find an immediate replacement of the outgoing CEO due to retire in September 2016. ADB has been a shareholder in HDFC for 7 years, and its investment in HDFC has met its development objectives. As an exit strategy, it would be in ADB’s interest to participate in HDFC’s initial public offering (IPO). However, the Maldives stock exchange lacks depth, efficiency, and liquidity, rendering an IPO unattractive to external investors. HDFC has deferred its IPO plans due to political uncertainty, and it is uncertain when it will list its shares. ADB is currently exploring possible investment exit alternatives to participating in an IPO, such as sale of its equity to a strategic investor whose interests are aligned with those of HDFC.

I. THE PROJECT A. Project Background 1. In February 2008, the Board of Directors of the Asian Development Bank (ADB) approved a $4.5 million equity investment and a $7.5 million senior secured loan to the Housing Development Finance Corporation (HDFC) in the Maldives.1 A tsunami in 2004 had damaged the country’s resort islands, stunted economic growth, and greatly affected the housing sector. By 2007, the increased demand for housing finance that had followed the disaster had exhausted the initial equity funding provided by the government when it established HDFC as a state-owned corporation in 2004. 2. To raise commercial loans and long-term funding internationally, HDFC needed to be privatized. ADB, the International Finance Corporation (IFC), and the HDFC Investments Limited of India (HDFC-I) participated in the privatization in 2009.2 The Maldives HDFC has been 49% owned by the government since privatization. The balance of 51% is shared by IFC and ADB—with 18% each—and HDFC-I, which has a 15% holding. Along with their equity investments, ADB and IFC provided loans. IFC granted HDFC technical assistance (TA) as well, and HDFC-I served as a technical and strategic partner. HDFC remains the only specialized housing finance institution in the Maldives and offers longer maturities and lower interest rates in mortgage lending than competing financial institutions.3 It plays a central role in an ambitious government plan to provide new housing, improve living conditions, and make the country more resistant to future natural disasters.

3. One-third of the Maldives’ 350,000 residents live in the capital city, Malé, where population density has put extreme stress on the social and physical infrastructure. The low-lying island country also faces particular threats from rising sea levels and rapid climate change. The government started to reclaim land in 1997 in an attempt to provide a sustainable solution to the constraints imposed by its low-lying, archipelagic topography and limited land area. In 2001, it established the Housing Development Corporation as a state-owned enterprise to undertake land reclamation to create a new, high-elevation island—Hulhumalé, to be located within the Hulhulé-Farukolhufushi Lagoon. 4. The government started the first phase of the land reclamation to create Hulhumalé in 1997, completing it in 2003. By the end of that year, phase 1 of the Hulhumalé development had a population of 35,000, a little more than half of the phase 1 target of 60,000. The second phase of reclamation began in 2015. The 240-hectare phase 2 development is aiming for a population of 100,000. Both phases combined would house almost half the population of Maldives. To avoid large vacancies, the government must attract large numbers of tenants from Malé to the new island. HDFC has a critical role to play in meeting this challenge. It must help fill the growing financing requirements for meeting the housing needs of the country’s population, this relocation effort, and the rapid housing development on Hulhumalé.

1 ADB. 2008. Report and Recommendations of the President to the Board of Directors: Proposed Loan and Equity

Investment — Housing Development Finance Corporation. Manila. 2 Housing Development Finance Corporation India is not related to HDFC Maldives.

3 Housing Development Finance Corporation management.

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B. Key Project Features 5. ADB’s financing consisted of both a senior secured loan and an equity investment The $7.5 million loan is secured by receivables from mortgage loans. It has a maturity of 7 years, including a 24-month grace period, and carries a floating interest priced at a credit spread over the 6-month London interbank offered rate (LIBOR). The loan was disbursed in two tranches: $4 million on 11 February 2009, and the balance on 11 August 2010. HDFC fully repaid its loan to ADB on 11 February 2016. 6. ADB initially approved an equity investment of up to $4.5 million, but only US$2.25 million was disbursed (in February 2009), equivalent to an 18% shareholding. The other half was cancelled in July 2013 because the shareholders did not see the need for additional capital. At the time, capital adequacy was already excessive at 76%, and the debt to equity ratio was low at 1.5:1.0.4 ADB ownership of 18% gives it the right to appoint one nominee director. 7. EDA Rural Systems was appointed under the IFC’s TA grant to HDFC to develop a responsible financial inclusion strategy for HDFC so that HDFC could manage its operations effectively on a larger scale. The TA involved an assessment of five areas of HDFC’s operations: (i) policies and guidelines, (ii) systems and procedures, (iii) sales and marketing, (iv) the operating and support department, and (v) staff training. HDFC provided the in-house training, and off-site training was conducted at HDFC-I’s training center in Mumbai. The TA project was completed in December 2011. C. Progress Highlights 8. The privatization of HDFC was one of the first public–private partnerships entered into by the government. HDFC has since grown and made good progress despite challenging episodes of economic and political instability in the country. As of 2015, HDFC held 50.9% of the market share for housing finance. Bank of Maldives (BML) held 31.8%, followed by Maldives Islamic Bank at 12.8%, with the remaining 4.5% shared between five other commercial banks.5 9. After privatization in 2009, HDFC has been able to attract debt funding from four international financial institutions (IFIs) and international commercial banks. These investors have included FMO of the Netherlands (2011), Hongkong and Shanghai Banking Corporation (2012), DEG of Germany (2014), and the Bank of Ceylon (2016). 10. In 2012, HDFC launched HDFC Amna, a product offering sharia-compliant Islamic home financing to its customers. This gave potential borrowers a wider variety of housing finance choices, both Islamic and conventional, and enabled HDFC to diversify its portfolio in a cost-effective manner. HDFC’s long-term plan is to spin off HDFC Amna as a separate company offering Islamic financing facilities. 11. In January 2013, HDFC became the first company in the Maldives to issue a local bond listed on the Maldives stock market.6 The bond had a tenor of 5 years and a total subscription of Rf51.9 million. In January 2014, HDFC issued the country’s first ever Islamic bond. The Rf22.5

4 Calculated as the ratio of total liabilities to total equity.

5 Appendix 1 provides an overview of the housing market in the Maldives.

6 Information obtained during due diligence mission and; Housing Development Finance Corporation. 2013. 2013

Annual Report. Male.

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million Islamic bond (Sukuk) issue was subscribed by 468 investors, is listed on the stock exchange, and has a tenor of 10 years.7 Both bonds have been rated AA by International Care Ratings of India. The issuance of long-term bonds in local currency is an important step in creating more funding for sustainable housing finance in the Maldives. However, market depth remains low.8 12. HDFC paid its first cash dividend in 2011 and has continued to pay annual dividends since then. In 2014, HDFC paid an additional 10% cash dividend on top of the usual 15% annual dividend to mark its 10th anniversary. As of July 2016, ADB had received Rf17.7 million in cash dividends. 13. In 2014, HDFC started an enterprise resource planning project that is still under way and under which HDFC will move onto an Oracle platform for finance, planning and lending. The project will allow HDFC to prepare its staff and technology infrastructure to meet the growing needs of the business.

II. EVALUATION A. Project Rationale and Objectives 14. HDFC was established by the government to help provide decent homes to all the country’s people, but a lack of available long-term finance was preventing the company from continuing to pursue this goal. Before privatization, HDFC’s main sources of funding came from bonds issued to local companies and from the Provident Fund held at the Ministry of Finance and Treasury. The loans from ADB and IFC and the privatization of HDFC brought stability to the company, provided comfort and confidence to other subsequent stakeholders, facilitated access to international funding, and strengthened governance practices. The intervention from the international shareholders thereby provided the impetus for HDFC’s sustainable growth and development. 15. HDFC’s transformation into a public–private partnership in 2009 opened up sources of sustainable funding to finance its business expansion. HDFC has provided mortgage finance not only for people in the country’s capital but also for residents of far-flung atolls under the country’s island outreach program. 16. Experienced nominee board directors from the international community were made available to HDFC by the international shareholders. These directors helped transform the company into a commercially viable, private-sector led company that competes with commercial banks and develops effective ways to help meet the mortgage financing needs of the country’s people. 17. The equity investments were accompanied by technical support. The IFC’s TA grant helped strengthen HDFC’s policies, procedures and internal controls; train HDFC staff in best practices; and prepare HDFC for expansion. IFC engaged EDA Rural Systems to identify weaknesses and provide the necessary recommendations to strengthen HDFC’s financial management and operating processes, including the process for environmental assessments.

7 Information obtained during due diligence mission and: Housing Development Finance Corporation. 2014. 2014

Annual Report. Male. 8 Interview with Housing Development Finance Corporation management, 26–28 April 2016; Housing Development

Finance Corporation. 2015. 2015 Annual Report. Male. pp. 27, 46.

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HDFC-I served as the strategic partner for HDFC and provided off-site training of HDFC staff at its training center in India. B. Development Results 18. The development impact is rated satisfactory.

1. Contribution to Private Sector Development and ADB Strategic Objectives

19. The effect of the ADB loan and equity investment on private sector development and ADB strategic objectives is rated excellent. The project contributed measurably to (i) meeting the urgent need for housing, (ii) increasing the availability of mortgage lending, and (iii) generating jobs and additional revenue. Support by ADB, along with other stakeholders, helped HDFC meet the key output and outcome targets specified in the project design and monitoring framework (DMF), which is shown in Appendix 2.

20. Meeting urgent need for housing in the Maldives. The average number of person per household in the Maldives in 2007 was 12. This was estimated to be equivalent to a backlog of 10,000 housing units. By 2012, this average had improved to only 8 people, which meant that about 2 families were sharing each accommodation. The government had targeted a rate of 4 members per household by 2015, requiring an estimated 12,000–15,000 additional housing units. To decongest the capital, Malé, and to provide the country’s people with better living conditions under which each family can own an apartment, the government embarked upon the Hulhumalé reclamation project (paras. 3, 4). Since 2009, HDFC has played an integral role in helping bridge the housing deficit by providing 1,065 new loans to individuals and families in the Maldives (Table 1).

Table 1: New Housing Loan Origination, 2009–2015

Indicator 2009 2010 2011 2012 2013 2014 2015 Total

New housing loan origination (loan count) 68 101 325 176 126 126 143 1,065

Source: Housing Development Finance Corporation management.

21. One of the major contributions of HDFC to the housing market was to help the government establish a legal structure for title registration and sale of apartments in Hulhumalé to promote homeownership. Previously, the government had provided people with provisions or rights to the use of land and this right was passed on to succeeding generations through inheritance of land-usage rights. Now, a citizen of the Maldives can have a freehold title to a single unit of housing, and can use the asset as collateral to secure loans for businesses or for a second home. This arrangement has encouraged major local and international construction companies to enter the housing development industry. 9 22. Increasing availability of mortgage lending and strengthening of the financial sector. HDFC provided housing finance lending to low-income people, who comprise more than 40% of the population. It helped low-income applicants qualify for home loans by allowing them to pool the extended family’s income rather than determining eligibility based on one individual’s income alone. This family-based structure allows a single housing loan to be shared by the related family members who have legal rights to inherit shared ownership of the property. This

9 Housing Development Finance Corporation. 2014. 2014 Annual Report. Male. p 65.

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usually involves four or more active co-borrowers whose incomes provide the capacity to make the repayments on a single housing loan.10 23. Another HDFC product makes home loans more affordable by allowing the borrower to pay only half of the 20% required equity down payment at the time of application and to pay the 10% balance while the housing is under construction. About 5% of applications received by HDFC sought these terms. Along with HDFC’s outreach program to provide mortgages to residents of the country’s outer atolls, this product has helped many low-income families obtain housing loans.11 24. HDFC launched the outreach program in 2010 on 12 islands with the critical mass needed to sustain a viable mortgage portfolio. It provided mortgage loans to 295 families from the outer atolls in 2015, lifting this program’s share of HDFC’s overall loan portfolio to 10%. HDFC also has a social housing program that it operates off the balance sheet and that is guaranteed by the government. During 2004-2015, 473 families outside of Malé region received housing loans under this program. 25. In 2015, HDFC increased the maximum tenor of its housing loans from 15 to 20 years, thereby making mortgages and monthly installments more affordable. In addition, it operates a flexible installment plan that can reduce monthly repayments to the levels that would be provided under loans with a 25-year term in return for a final lump sum payment after 20 years. HDFC is the only institution in the Maldives that provides fixed-term 20-year loans. The others, including BML, offer a maximum tenor of only 15 years. HDFC also offers lower mortgage rates than competitor commercial banks, with repayments directly deducted from a borrower’s salary. In April 2015, HDFC rewarded its existing customers for their loyalty with a rate cut of 0.25%. 26. HDFC has also introduced a credit protection mechanism by arranging for mortgage insurance that strengthens the eligibility of potential borrowers. The insurance, arranged through a partnership between HDFC and the state-owned Allied Insurance, covers properties under HDFC mortgages during and after construction. 27. HDFC has increased the availability of housing loans to both middle-income and low-income home buyers. More importantly, HDFC lowered the average cost of borrowing by 50bps for all new housing applications that are approved starting 1 April 2015 to 11% (under salary benefit scheme )fixed for the term of the loan, thus increasing affordability. 28. Generating jobs and additional revenue. One HDFC product provides enterprising borrowers with loans to help them use one-third of the space in their dwellings to generate additional monthly family income through rentals to commercial businesses or to operate trading or other home businesses and cottage industries.12 This has helped develop new small and medium-sizes enterprises in the country. 29. The increase in housing construction activities brought about by the expansion of the housing credit available in Malé, Hulhumalé, and outer atolls has had a positive multiplier effect on the economy by creating new jobs and helping construction companies and materials and services suppliers expand.

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Interview with Housing Development Finance Corporation management, 26–28 April 2016. 11

Interview with Housing Development Finance Corporation management, 26-28 April 2016. 12

Housing Development Finance Corporation PLC. 2011. 2011 Annual Report. Male. Page 12. - The product accounted for 48.3% of HDFC’s loan portfolio in 2013 and 49.9% in 2014.

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2. Economic Performance 30. The economic performance of the project is rated satisfactory. The government’s housing and commercial property development in Hulhumalé is a positive for the economy, since it is creating more jobs. It is also providing an effective antidote to the risks of rising sea levels due to climate change. HDFC’s inclusive business model includes products and services that involve cottage industries in the value chain, e.g., suppliers of carpentry work and building materials such as compressed cement blocks.13 The growth of construction in Hulhumalé and in other parts of the Maldives that has occurred due to the greater availability of housing funding has benefited construction service companies and material providers and contributed to the country’s gross domestic product. 31. HDFC made a significant contribution to the housing development market in helping create a legal framework that allowed freehold title to a single unit of housing. In this way, it became possible that a standalone house or an apartment could be purchased through a mortgage facility. This was a paradigm shift in a market where houses traditionally were built on shared land allocated for the family many generations earlier.14 32. HDFC’s bond issues were subscribed to not only by the government and corporate investors, but also by the individual retail investors (para. 11). This has helped financial sector development, broadened involvement in the financial system, and mobilized local funding sources. 33. The reevaluated economic return on invested capital is 13.8%, 1.3 times the 11% weighted average cost of capital (Appendix 3), thus resulting in a satisfactory rating for economic performance.

3. Environmental, Social, Health, and Safety Performance

34. The project is rated satisfactory for its performance on ADB environmental, social, health, and safety policies and objectives and adherence to the standards applicable at approval. ADB’s loan and equity investment in HDFC was classified as category FI for the environment. It is category FI, treated as C, according to ADB’s Policy on Indigenous Peoples (1998) and under ADB’s Environment Policy (2002). No involuntary resettlement occurred or impacts on indigenous peoples were observed as a result of the loan and equity investment. 35. As required under ADB’s Environment Policy and covered by a loan agreement covenant, HDFC established and complied with an environmental management system (EMS) that set out screening and assessment procedures and built capacity to implement them in line with the guiding principles agreed with ADB. 36. Under its EMS, HDFC has implemented a rapid environmental and social assessment checklist to help in its decision-making. HDFC complies with international environmental impact guidelines when it provides housing finance. Review of HDFC’s national approvals and site visits by ADB staff confirmed that the subprojects financed by HDFC have complied with national regulations and the requirements of ADB’s Environment Policy.

13

Housing Development Finance Corporation PLC. 2012. 2012 Annual Report. Male. 14

Housing Development Finance Corporation PLC. 2011. 2011 Annual Report. Male. Page 12.

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37. HDFC has developed a compliance and evaluation checklist that is used by its EMS officers when they review application documents and evaluate whether all the approvals needed from government and regulatory agencies such as the Ministry of Housing and Infrastructure and the Environmental Protection Agency have been obtained for proposed projects. This includes a review and evaluation of permits and clearances for land use and zoning, building, demolition, dewatering, and sanitation. HDFC ensures strict adherence to planning and building codes through technical inspections at every step of the construction process. HDFC conducts site visits at each major stage of house construction. Corrective actions are recommended and monitored whenever gaps are identified. Loan drawdown is structured based on construction milestones. HDFC does not fund any housing development project that has not been cleared either by the two city councils or the 11 provincial councils involved. The corporation’s senior management is made aware of the findings of technical inspections. ADB monitored and supervised HDFC’s environment safeguards implementation through the annual environmental and social performance monitoring reports submitted by HDFC. HDFC has received no environmental grievances related to its operations during the course of ADB’s investment. 38. The TA provided by IFC included help to implement social safeguards. The TA consultant, EDA Rural Systems, formulated an integrated social performance management approach and trained HDFC staff to implement it in its services. The approach included requirements for respectful collection practices and high ethical standards in the treatment of customers, as well as a comprehensive complaints handling process. The process enables HDFC to make use of client feedback to serve customers better and design and deliver its products more effectively. 39. HDFC was unable to send an officer to ADB-sponsored environmental and social safeguard training, although this was required during project approval and included in the loan agreement as a staffing and capacity building step in EMS operationalization. However, HDFC management supported implementation of the EMS policy, formed an environment management committee, and hired an EMS officer with sufficient experience to properly oversee and implement HDFC’s EMS. HDFC’s execution of the EMS has been satisfactory and has required only minimal ADB supervision.

4. Business Success 40. After its capital restructuring in 2009, HDFC’s assets grew at a compound annual growth rate (CAGR) of 22.3% to Rf1.2 billion in 2015 from Rf300 million in 2008. HDFC’s overall profitability, capitalization, and prospects for sustainability and growth have been based on strategies that aim to capitalize on the company’s strengths and market opportunities while managing risks and its available resources. 41. HDFC’s loan book expanded rapidly following the establishment of a legal structure for title registration on the new island of Hulhumalé in March 2010. To process the housing application backlog, aggressive lending put pressure on HDFC’s liquidity. The funds available were fully lent out, which breached liquidity covenants in 2012. HDFC immediately cured this breach by tapping additional international lenders (para. 9) and issuing corporate and Islamic bonds (para. 11). This was a signal of investor confidence. Throughout the growth period, HDFC’s capacity to absorb losses was significantly above the regulatory limit. 42. Appendices 4 and 5 contain a more detailed analysis of HDFC’s financial performance during 2008–2015 based on its capital adequacy, asset quality, management, earnings, and liquidity. The financial highlights for the period include the following:

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(i) The CAGR of gross loans was 27.7%. Nonperforming loans were at a very low average level of 1.7%, compared with 20.0% for the country’s overall banking industry. (ii) The CAGR of total capital was 26.9% due to strong internal capital generation on top of the capital infusion by the IFIs (para. 9). (iii) Net income showed a CAGR of 25.2%, which resulted in the declaration of Rf98.8 million in dividends during 2011–2015.

43. The project yielded a real return on invested capital of 11.8% (Appendix 3). This exceeded the weighted average cost of capital of 11% and thus the project is rated satisfactory for business success. Moreover, HDFC’s equity generated a return of 19.2% in US dollar terms for investors (para. 46), further reinforcing the rating for business success. C. ADB’s Additionality

44. ADB’s additionality is rated satisfactory. ADB’s investment was made at a time when the government needed long-term funding to sustain the operations of HDFC. HDFC could not obtain this financing due to lack of long-term domestic funding and its inability to borrow internationally without sovereign guarantees. ADB could have provided only a long-term loan, which would have satisfied HDFC’s immediate debt funding needs. However, a long-term loan coupled with an equity investment that helped in the privatization of HDFC proved to be a more sustainable solution and had a discernible impact on HDFC’s development. The equity infusion increased HDFC’s capitalization to the point that HDFC was able to raise leverage during 2011–2016 without the need for additional equity. Its debt–equity ratio remains very low at 1.7:1.0 (footnote 4), allowing HDFC to raise more debt to expand its loan portfolio in the near and medium terms without the need for existing shareholders to provide more capital. 45. ADB’s equity investment alongside those of IFC and HDFC-I diluted the government’s share to 49%. The loans and the additional capitalization had a catalytic effect that enabled HDFC to increase leverage and raise commercial loans on its own without the need for government support or guarantees. To keep pace with its growing loan book and liquidity needs, HDFC was able to attract debt funding from four other IFIs aside from ADB and IFC (para. 9). HDFC was also able to obtain a loan from the Bank of Maldives in 2013, and it successfully pioneered local-currency corporate bond issuance in the Maldives (para. 11). D. ADB Investment Profitability

46. ADB investment profitability is rated satisfactory. ADB’s loan to HDFC was benchmarked against IFC’s loan to HDFC disbursed in the same year. ADB’s loan carried broadly similar terms and seniority as IFC’s. The IFC and ADB loans were both secured by receivables from mortgage loans. The IFC loan was fully repaid in January 2016, and ADB’s was fully repaid in February 2016. 47. ADB’s equity investment of $2.25 million generated a financial internal rate of return of 22.7% in local currency terms and 19.2% in US dollar terms (Table 2). The terminal value is based on the assumption that equity will grow at 10% per annum in 2016 as projected by HDFC

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and a price–book ratio multiple of 1.0.15 Based on the estimated cost of equity in local currency terms of 18.06%,16 the financial internal rate of return yielded a multiple of 1.3.

Table 2: ADB Equity Cash Flow and Return Calculation Amount (million) Item FIRR 2009 2010 2011 2012 2013 2014 2015 2016

Cash flows (USD) 19.2% (2.3) - 0.1 0.2 0.2 0.2 0.5 5.9 Cash flows (Rf) 22.7% (28.8) - 2.0 2.9 2.9 2.9 7.2 90.1

FIRR = financial internal rate of return. Sources: Housing Development Finance Corporation audited financial statements, 2008–2015; Asian Development Bank estimates.

E. ADB Work Quality 48. ADB’s work quality is rated satisfactory based on (i) its screening, appraisal, and structuring of the project; and (ii) its monitoring and supervision.

1. Screening, Appraisal, and Structuring of the Project

49. Prior to this project, ADB’s Private Sector Operations Department (PSOD) had very limited experience in the Maldives and was looking for opportunities to support development of the country’s financial sector. After a tsunami struck the country in 2004, ADB contributed $600 million to establish the Asian Tsunami Fund to respond to the needs of affected developing member countries. The Asian Tsunami Fund provided a grant of $20 million and a loan of $1.8 million to finance the ADB’s Tsunami Emergency Assistance Project (TEAP) in the Maldives in 2005. 17 The TEAP aimed to help achieve sustainable economic growth by minimizing the devastating impact of the tsunami in the transport, power, sanitation, agriculture, and fisheries sectors. 50. Although the housing sector was not a priority under the TEAP, PSOD believed that an investment in housing finance would complement the TEAP’s efforts and fit its objective of providing post-tsunami support for infrastructure sectors. For this reason, PSOD structured and proposed a loan and equity investment in HDFC to improve housing and atoll development and strengthen the country’s financial sector as well. 51. Both aspects of ADB interventions enabled HDFC to expand its lending activities. The loan helped narrow the maturity gap, while the equity investment helped lower HDFC’s debt–equity ratio from a high of 7:1 in 2007. Equity investors from ADB, IFC and HDFC-I provided HDFC with a mix of nominee directors who had the skills and expertise to share international best practices and provide the proper guidance that would ensure the success of HDFC’s operation as it expanded.

52. ADB’s work quality is rated excellent.

15

In 2015, ADB and the International Finance Corporation received an expression of interest to buy-out their stakes in Housing Development Finance Corporation at an indicative rate of a 1.0 price–book multiple.

16 ADB. 2014. Internal memorandum on cost of equity—Office of Risk Management. Manila.

17 ADB. 2005. Report and Recommendation of the President to the Board of Directors on a Proposed Grant and Loan to the Republic of the Maldives for the Tsunami Emergency Assistance Project. Manila

10

2. Monitoring and Supervision

53. ADB’s monitoring and supervision for HDFC is rated satisfactory. ADB monitored compliance with the reporting and financial covenants in the facility agreement. It conducted fact–finding missions and prepared periodic monitoring reports. PSOD staff undertook a review mission in October 2013 that provided the project team with a realistic overview of housing demand and supply in the Maldives. The mission allowed PSOD to better understand HDFC’s operations and governance practices and better appreciate HDFC’s business model. It helped ADB improve (and increase) the company’s equity valuation, which had been estimated at below investment cost prior to the mission. The mission helped open and maintain communication lines that improved ADB’s collaboration with HDFC. 54. The project administration team assisted HDFC when it required consents, waivers, and amendments of certain provisions in the facility agreements. PSOD and HDFC staff worked together in assessing the issues involved in these requests, taking into account the potential credit risk impact vis-à-vis ADB’s support for continuing business development and sustainability.

55. As an equity shareholder in HDFC, ADB appointed an external consultant to HDFC’s board. An ADB employee was appointed as the alternate nominee director. The board of directors of HDFC meets at least every 3 months, and the director provides updates to the PSOD project officer whenever needed. 56. HDFC was given annual invitations to attend the ADB-sponsored financial asset and liability and risk management forum from its inception in 2008 until it ended in 2014.18 The forum was provided as TA to ADB’s nonsovereign financial institution clients, to help them adopt international banking and financial institution standards and best practices for critical operations. F. Overall Assessment 57. Overall, the project is rated successful (Table 3).

18

Housing Development Finance Corporation attended all the forums except the one in 2009.

11

Table 3: Evaluation of Loan and Equity Investment to Housing Development Finance Corporation

Item Unsatisfactory Less than

Satisfactory Satisfactory Excellent

Development Results √

(i) Contribution to private sector development and ADB strategic development objectives

√

(ii) Economic performance √ (iii) Environmental, social, health, and safety

performance √

(iv) Business success √ ADB Additionality √ ADB Investment Profitability √ ADB Work Quality √ (i) Screening, appraisal, and structuring √ (ii) Monitoring and supervision √

Unsuccessful Partly

Successful Successful Highly

Successful

Overall Rating √

ADB = Asian Development Bank. Source: ADB.

III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS

A. Issues and Lessons 58. The demand for housing in the Maldives is expected to continue to exceed supply as the population grows and as long as the quality and overcrowding of living accommodations still need to be improved. This makes it critical that HDFC succeeds in sustaining its business of providing the country’s residents with the funding they need to buy and own their own homes. IFC’s TA played a critical role in preparing HDFC and its staff to meet the service level required to operate efficiently during its expansion stage. 59. The project illustrated the importance of hiring experienced and effective managers to steer a company toward success. Despite a limited customer base and lack of market depth in the Maldives, HDFC was able to expand its business, remain profitable, and provide valuable services to the community due to strong managers. B. Recommended Follow-Up Actions

60. ADB has been a shareholder in HDFC for 7 years, and its investment in HDFC has met its development objectives. As an exit strategy, it would be in ADB’s interest to participate in HDFC’s initial public offering (IPO). However, the Maldives stock exchange lacks depth, efficiency, and liquidity, rendering an IPO unattractive to external investors. HDFC has deferred its IPO plans due to the political uncertainty, and it is uncertain when it will list its shares. ADB is currently exploring possible investment exit alternatives to participating in an IPO, such as sale of its equity to a strategic investor whose interests are aligned with those of HDFC. 61. Because the retirement of the current Managing Director is approaching, shareholders and HDFC’s board of directors should find an immediate replacement who is at least as qualified.19 A succession plan should be developed to allow continuity in the execution of the

19

The retirement of Anildilruk Priyanka Baddevithana is scheduled for September 2016.

12

business plan and strategy. Such a plan will also keep current and potential management and staff motivated to work long term for the company.

Appendix 1 13

MALDIVES HOUSING MARKET OVERVIEW 1. The Maldives is home to 350,000 people living on 189 islands dispersed over 90,000 square kilometers. Based on the government’s 2004 census, 40% of the country’s 68,249 households are in and around Malé. The remaining 60% are dispersed in the 187 administrative islands. Constraints on buildable land have made Malé one of the most densely populated capital cities in the world. Households in the Malé area have an average of about eight members, compared with six in households in the country’s outer atolls. Reaching a desirable persons-per-unit average of four in Malé would require an estimated 12,000–15,000 new housing units. The Maldives’ government is working to address this housing backlog through strategies involving the Housing Development Corporation. 2. The Housing Development Corporation is a state-owned enterprise established to facilitate national housing construction. It spearheaded the reclamation and development of Hulhumalé, a new, high-elevation island located within the Hulhulé-Farukolhufushi Lagoon. Phase 1 of the Hulhumalé reclamation, consisting of 188 hectares, began in 1997 and was completed in 2003. As of end 2015, there were an estimated 35,000 people living in phase 1, more than half of the 60,000 target for 2020. The second phase of the reclamation of Hulhumalé, consisting of 240 hectares, started in 2015. Phase 2 will be a mixed use development which will include commercial, residential and light industrial properties and targets a population of 100,000. A bridge is currently being constructed to connect Malé to Hulhumalé. 3. Due to the high demand for housing, Global Projects Development Company of the United Kingdom began reclamation work on a coral reef close to Malé in 2010, aiming to establish a new city. However, the government changed the zoning for the property in 2015 from residential to industrial and handed the project over to a newly established government entity, Gulhi Falhu Investment Company.

4. Housing has been the government’s top priority. As a result, it established Housing Development Finance Corporation (HDFC) in 2004 to provide housing finance to match the expansion of housing infrastructure in Malé and Hulhumalé. HDFC remains the only specialized housing finance institution in the country. As of 2015, HDFC held 50.9% of the market share for housing finance. Bank of Maldives (BML) held 31.8%, followed by Maldives Islamic Bank at 12.8%, with the remaining 4.5% shared between five other commercial banks. However, BML changed its marketing strategy in 2013 by making housing finance its top line product. BML has been in the housing mortgage market since its inception in 1982 and has expanded its housing mortgage loans. In 2015, these loans represented about 10% of its total loan portfolio. HDFC’s other competitors are the Maldives Islamic Bank, State Bank of India, and Bank of Ceylon. 5. HDFC’s listed debt instruments consist of a Rf52 million conventional bond (2013) and a Rf22.5 million Sukuk (2014) listed on the Maldives stock exchange.1 Although the country has a low national savings rate, the retail public subscribed 15% of the Islamic bond issue. The balance went to the state-run national pension fund and two local insurance companies.

1 The Maldives Stock exchange has very limited secondary market trading activities and only six listed companies.

14 Appendix 2

DESIGN AND MONITORING FRAMEWORK Design Summary Performance

Targets/Indicators Assumptions and Risks Assessment

Impact Residents of Malé and Hulhumalé have greater access to housing in the Maldives Unlock “dead capital” or capital that cannot be accessed through the creation of a formal mortgage financing market

Increased formal housing for families in Malé and Hulhumalé Mortgage finance as percentage of gross domestic product increased

Increased access to mortgage finance from banks leading to more individuals receiving mortgage loans and stimulating the supply of housing in the economy

Stable or increased economic development in the Maldives

Housing loans granted during 2008–2015 totaled Rf1.4 billion and went to 2,873 borrowers. More than half of the loans were used to construct multistory residential buildings, which accommodate more families than single-story houses. Housing supply has increased with the completion of Hulhumalé phase 1. There are now 35,000 people living in phase 1 units. Phase 2 is ongoing and expected to house 100,000 people. Banking credit given to the construction sector (proxy for mortgage finance) as a percentage of GDP grew from 3.0% in 2013 to 4.6% in 2015.

1

Outcome HDFC provides increased access to long-term mortgage loans to individuals in the Maldives

HDFC’s number of mortgage loan borrowers increased (20% in next 24 months) HDFC’s credit quality is high; NPLs make up less than 4% of its total portfolio HDFC’s capital adequacy ratio remains above prudential norms

Demand for mortgage loans from individuals continues

Local currency loans are demanded. The supply of property is adequate. HDFC does not breach domestic prudential norms.

The number of mortgage loan borrowers grew at a CAGR of 22% from 733 in 2008 to 2,873 in 2015.

1 A surge in

demand occurred in 2011 after the establishment of legal titling framework in Hulhumalé reclamation. All loans are disbursed

1 Source: Housing Development Finance Corporation. One loan may have multiple borrowers of record (para. 21,

main body).

Appendix 2 15

No adverse economic developments occur in the Maldives

No adverse regulatory changes affect the financial sector. No adverse regulatory changes affect the legal and regulatory framework governing the property subsector.

in local currency. Borrowings are comprised of 45.4% foreign currency and 54.6% local currency. All foreign currency borrowings are hedged. Gross NPLs over the 2008–2015 period were 1.7% of gross loans (on average). At 2.2%, the highest NPL ratio was in 2015. CAR remained well above the regulatory limit of 10%. CAR started at 153.4% in 2008 and gradually declined to 79.7% in 2015 as the portfolio expanded.

Output ADB provides a long-term US dollar loan to HDFC. ADB invests $2.25 million in HDFC (up to $4.5 million)

As of May 2008, HDFC has $7.5 million in the form of a loan from ADB. As of May 2008, ADB has purchased shares from HDFC equivalent to $2.25 million. Mortgage loan requests received by HDFC increase by 20% per annum from current levels.

Prevailing market conditions are stable. All regulatory approvals are in place for ADB.

The loan was fully repaid in February 2016. ADB made a $2.25 million equity investment in HDFC in February 2009, equivalent to 18% ownership. The number of mortgage loan borrowers grew at a CAGR of 22% from 733 in 2008 to 2,873 in 2015.

1 Maldives Monetary Authority. Annual Report 2015. 2015. Male.

ADB = Asian Development Bank, CAGR = compound annual growth rate, CAR = capital adequacy ratio, HDFC = Housing Development Finance Corporation, NPL = nonperforming loan.

16 Appendix 3

ESTIMATION OF RETURN ON INVESTED CAPITAL

Table A3.1: Weighted Average Cost of Capital

Item 2015

(Rf million)

Capital Weight

Cost of capital WACC

Debt (excluding ST Wakala) 533 54% 4.93% 2.7% Shareholders’ equity 455 46% 18.06% 8.3%

Total 988 11.0%

WACC = Weighted average cost of capital. Note: A loan from Bank of Ceylon in 2016, with a tenor of 6 years and a 1-year grace is priced at the 6-month Treasury rate (Maldives) plus 2.3% with a floor of 5.5% and ceiling of 9.5%. Given the current 6-month Treasury rate of 3.5% as of 30 June 2016, the cost of borrowing is calculated at 5.8%. The final cost of debt is net of 15% corporate income tax. Sources: Housing Development Finance Corporation audited financial statements, 2008–2015; ADB. 2014. Internal memorandum on cost of equity—Office of Risk Management. Manila.

Table A3.2: Project Business Success

Amount (Rf million) Item 2009 2010 2011 2012 2013 2014 2015 2016

Equity investment, net of advances for share capital

(81)

Borrowings (excluding ST Wakala) (46) (46) (118) (31) (139) (100) 3 Net cost & benefits 18 24 41 49 51 55 61 Terminal value 501

1

Net Cash Flow (108) (22) (76) 18 (88) (46) 63 501 ROIC 12.1%

Inflation rate 4.5% 6.1% 11.3% 10.9% 2.3% 2.1% 1.0% 1.2% Discount factor 1.00 1.06 1.24 1.36 1.10 1.11 1.06 1.09

Inflation-Adjusted Net Cash Flow (108) (21) (62) 13 (80) (41) 60 461 ROIC Adjusted for Inflation 11.8% (greater than 11% WACC, Satisfactory) ROIC = Return on invested capital. Sources: Housing Development Finance Corporation audited financial statements, 2008–2015; Asian Development Bank estimates.

Table A3.3: Contribution to Economic Development

Amount (Rf million) Indicator 2009 2010 2011 2012 2013 2014 2015 2016

Net cash flow (108) (22) (76) 18 (88) (46) 63 501 Add: Taxes paid - - 3 9 9 10 11 -

Economic net cash flow (nominal) (108) (22) (73) 27 (79) (36) 74 501 EROIC (nominal) 14.3%

Inflation rate discount factor 1.00 1.06 1.24 1.36 1.10 1.11 1.06 1.09

Economic net cash flow (real) (108) (21) (59) 20 (72) (32) 70 461 EROIC (real) 13.8% (greater than 11% WACC by 1.3x, Satisfactory)

EROIC = Economic return on invested capital. Sources: Housing Development Finance Corporation audited financial statements, 2008–2015; Asian Development Bank estimates.

1 In 2015, ADB and the International Finance Corporation received an expression of interest to buy their stakes in

Housing Development Finance Corporation at an indicative rate of a 1.0 price–book multiple. The terminal value is based on an assumption by the Housing Development Finance Company’s management that shareholders’ equity will grow at a rate of 10% in 2016.

Appendix 4 17

BUSINESS PERFORMANCE

A. Financial Highlights

Table A4.1: Financial Highlights, 2008–2015

Amount (Rf million) CAGR 2008-2015 Indicator 2008 2009 2010 2011 2012 2013 2014 2015

Balance sheet

Gross loans 156 176 292 578 770 854 954 1,101 32.2% Total assets 302 418 488 665 798 974 1,103 1,237 22.3% Total deposits 6 15 20 29 36 40 40 59 38.8% Total liabilities 137 153 199 337 437 578 669 782 28.3% Shareholders' equity 165 266 289 328 361 396 435 455 15.6%

Income statement

Net interest income 16 25 30 44 63 67 74 77 25.1% Total operating income 17 29 34 66 73 76 83 90 26.9% Net income 10 19 24 49 49 51 55 61 29.3%

CAGR = compound annual growth rate. Source: Housing Development Finance Corporation audited financial statements, 2008–2015.

B. Business Analysis

1. Capitalization The capitalization of the Housing Development Finance Corporation (HDFC) is rated excellent. Capital adequacy indicators in 2008–2015 remained well above the regulatory 12% and the Asian Development Bank (ADB) loan covenant 10% limits. Because HDFC was a government institution before being privatized in 2009, the ratio of equity to assets was 54.6% in 2008, a very conservative and expensive capital structure. Shareholder equity was Rf165 million in 2008 and grew to Rf455 million in 2015, a 280% increase. The debt–equity ratio in 2015 was a low 1.7:1.0. 1 This gives HDFC the capacity to build its borrowings for business growth and expansion. 1. The total capital adequacy ratio peaked at 195.5% in 2009 but declined gradually to 79.7% in 2015 as HDFC grew its portfolio. Tier 1 share capital and internally generated capital make up 87% of total equity. Since HDFC began paying dividends in 2011, ADB has received Rf17.7 million in dividends. The Maldives still follows the capital requirements under Basel 1 and has plans to move up to those under Basel 2 or 3 in the future.

Table A4.2 Capital Adequacy Indicators, 2008–2015 Indicator 2008 2009 2010 2011 2012 2013 2014 2015

Tier 1 Capital to RWA 153.4% 195.5% 192.2% 102.6% 90.2% 75.3% 77.0% 70.7% Total CAR 153.4% 195.5% 192.2% 102.6% 90.2% 86.7% 87.3% 79.7%

CAR = capital adequacy ratio, RWA= risk-weighted assets. Sources: Housing Development Finance Corporation audited financial statements, 2008–2015; Asian Development Bank estimates.

2. Asset Quality

2. The quality of HDFC assets is rated excellent. Its portfolio is divided into residential mortgage loans in Malé (68.7%), Hulhumalé (22.6%), and other atolls (8.7%). HDFC’s strict

1 Calculated as the ratio of total liabilities to total equity.

18 Appendix 4

credit underwriting policies allow mortgages only to borrowers who have sustainable income sources from employment, business or rental income.

Table A4.3 Portfolio growth by product type, 2008–2015 Amount (Rf million)

CAGR Loan Type 2008 2009 2010 2011 2012 2013 2014 2015

Conventional housing 151 170 250 542 724 806 908 976 30.6% Islamic housing 18 28 35 120 60.7% Commercial 5 6 42 36 28 19 10 4 (2.3%)

Total 156 176 292 578 770 854 954 1,101 32.2%

Annual growth (&) 12.8% 66.2% 97.9% 33.2% 10.9% 11.7% 15.4%

( ) = negative. Source: Housing Development Finance Corporation reports.

3. HDFC’s loan portfolio grew by 66.2% in 2010 and 97.9% in 2011 (Table A4.3). This was after establishment of legal property titles in Hulhumalé in March 2010. HDFC’s attempt to service the housing application backlog in 2011 caused its liquidity ratio to drop to 2% in 2012. It increased to 19% in 2013 after HDFC found additional funding.2 4. Gross loans increased by a compound annual growth rate (CAGR) of 32.2% in 2008–2015, but HDFC managed to keep its ratio of nonperforming loans to gross loans at an average of 1.7% through a prudent underwriting policy. This is within the 2% forecast in the base case scenario at project inception. It is within the ADB loan covenant ratio limit and much lower than the Maldives banking industry’s average of 20% as of 2015. Starting in 2013, HDFC revised its provisioning policy in accordance with its external auditor’s advice to free up funding for lending growth. As a result, provisions for loan loss reserves in 2015 declined to 58.3%, significantly down from a peak of 202.6% in 2010. The loan portfolio remains highly collateralized with buildings and land provided by borrowers as security and a maximum loan–value ratio of 80%.

Table A4.4 Asset quality indicators, 2008–2015

Indicator 2008 2009 2010 2011 2012 2013 2014 2015

Gross NPLs as a % of gross loans

2.0% 1.8% 1.3% 1.4% 1.4% 2.0% 1.7% 2.2%

Total LLR as a % of NPLs

56.1% 163.2% 202.6% 127.0% 103.7% 66.6% 75.1% 58.3%

NPL = nonperforming loan, LLR = loan loss reserves. Note: Gross NPLs were computed based on the definition provided in the facility agreements. Sources: Housing Development Finance Corporation audited financial statements, 2008–2015; Asian Development Bank estimates.

5. In 2012, HDFC introduced Islamic finance products through HDFC Amna, a sharia-compliant financing facility under HDFC’s existing license. HDFC’s Islamic lending grew tremendously during 2015 and increased its share in the overall portfolio to 10.9% from 3.7% in 2014.

3. Management

6. HDFC’s management is rated satisfactory. The Managing Director, Dr. Anil Dilruk Priyanka Baddevithana, has 35 years of mortgage industry experience. Prior to his position at HDFC, he was deputy director for 6 years at HDFC Bank of Sri Lanka (unrelated to HDFC in the Maldives). In 2014, after having served two appointments of 3 years each as the managing

2 Refers to Liquid Assets to Deposits and Money Market Funding.

Appendix 4 19

director of HDFC, his tenure was extended until September 2016. HDFC is also supported by a strong board with two representatives from the Government of Maldives and one representative for each of the institutional shareholders—International Finance Corporation, HDFC India, and ADB. HDFC India, backed by more than 30 years of mortgage industry experience, is the company’s technical partner.

4. Earnings

7. Profitability is rated excellent. HDFC’s profitability has continued on an upward trend, with a reported net income of Rf60.5 million in 2015, up from Rf10.5 million in 2008. Profitability grew at a CAGR of 29.3% during 2008–2015. 8. HDFC’s net interest margin (NIM), although narrowed as a result of rate cuts, is still adequate to cover operating expenses. The NIM peaked at 8.7% in 2012 after aggressive loan expansion before gradually declining to 6.8% in 2015. The decline was in line with an HDFC decision to reward its loyal customers with a 0.25%–0.50% rate cut on existing loans and new loans. 9. Despite the narrower NIM, return on equity was 13.6% in 2015, and return on assets was 5.2% (Table A4.5). That is because the cost–income ratio improved from 21.6% in 2014 to 18.8% in 2015.

Table A4.5: Profitability and Efficiency Indicators, 2008–2015 Indicator 2008 2009 2010 2011 2012 2013 2014 2015

Net interest margin 6.0% 7.2% 6.8% 7.7% 8.7% 7.7% 7.3% 6.8% Non-interest income as a % of operating income

6.4% 13.0% 10.6% 33.9% 13.9% 12.4% 11.0% 15.0%

Provisions as a % of pre-provision income

13.8% 14.9% 9.9% 4.2% 3.4% 0.4% 0.8% 2.5%

Pre-provision income as a % of average total assets

2.3% 6.2% 5.8% 9.5% 8.2% 6.8% 6.3% 6.3%

Cost–income ratio 27.1% 23.4% 23.2% 16.6% 17.5% 20.9% 21.6% 18.8% Return on assets 4.0% 5.3% 5.2% 8.6% 6.7% 5.8% 5.3% 5.2% Return on equity 10.9% 8.9% 8.5% 16.0% 14.2% 13.5% 13.2% 13.6%

Sources: Housing Development Finance Corporation audited financial statements, 2008–2015; Asian Development Bank estimates. .

5. Liquidity

10. HDFC’s liquidity is rated satisfactory. Liquidity tightened due to the aggressive expansion of the loan book starting in 2010 as HDFC tried to process the loan application backlog following the resolution of titling issue in Hulhumalé. This depleted its cash position and its liquid asset–short-term liabilities ratio declined to 4.52% in 2012 (Table A1.6). However, HDFC was immediately able to raise funding from international financial institutions to fill the gap. In the first quarter of 2013, HDFC issued the country’s first listed bond. In 2014, HDFC launched the country’s first Sukuk to diversify its funding mix further. In addition, management undertook to maintain Rf20 million in local treasury bills at all times for liquidity.

20 Appendix 4

Table A4.6: Liquidity Indicators, 2008–2015

Indicator 2008 2009 2010 2011 2012 2013 2014 2015

Liquid assets to deposits and money market funding

228.5% 207.1% 101.6% 18.3% 2.0% 19.0% 20.7% 18.8%

Liquid assets to short term liabilities

228.5% 1671.4% 399.2% 65.7% 4.5% 53.7% 44.4% 76.3%

Sources: Housing Development Finance Corporation audited financial statements, 2008–2015; Asian Development Bank estimates.

Table A4.7 Funding Sources, 2008–2015 Amount (Rf million) CAGR

2008-2015 Indicator 2008 2009 2010 2011 2012 2013 2014 2015

Deposits 6 15 20 29 36 40 40 59 38.8% Borrowings 57 103 148 266 317 467 567 609 40.3% Others 74 35 31 42 84 71 62 113 6.3% Total funding 137 153 199 337 437 578 669 782 28.3%

Sources: Housing Development Finance Corporation audited financial statements, 2008–2015; Asian Development Bank estimates.

11. HDFC was not heavily affected by a sharp devaluation of the local currency (20% against the US dollar) that followed the Maldives’ move from a pegged foreign currency exchange rate regime to a managed peg system in April 2011.3 HDFC has effectively hedged its US dollar loans from ADB, the International Finance Corporation and all the other foreign currency lenders through cross-currency swaps with the State Trading Organization for the entire tenor of the loans. HDFC also used similar hedging strategy against hard currency loans from the other financial institutions.

3 The exchange rate system was changed by the Maldives Monetary Authority to support fiscal reform efforts and

help ease the pressure on the country’s currency.

Appendix 5 21

FINANCIAL STATEMENTS

Table A5.1: Statement of Financial Position, 2008–2015


Net customer loans 155 171 285 568 759 842 941 1,087 32.1% Other earning assets 145 238 197 86 30 93 141 103 (4.8%) Fixed assets, net 2 2 2 2 2 2 2 1 (4.2%) Other non-earning assets

1 8 5 8 7 37 19 47 73.1%

Total assets 303 418 488 665 798 974 1,103 1,237 22.3%

Total deposits and money market funding

6 15 20 29 36 40 40 59 38.8%

Other liabilities 74 35 54 95 207 211 306 219 16.7% Long-term borrowings 57 103 125 213 195 328 324 504 36.5% Total liabilities 137 153 199 337 437 578 669 782 28.2%

Common stock 1 159 159 159 159 159 159 159 106.4% Advances for share capital

129 51 51 51 51 51 51 51 (12.3%)

Retained earnings 16 35 59 98 132 168 207 228 46.1% Reserves 20 20 19 18 17 17 17 17 (2.5%) Total equity 166 266 289 328 361 396 435 455 15.5%

( ) = negative, CAGR = compound annual growth rate. Source: Housing Development Finance Corporation audited financial statements, 2008–2015.

Table A5.2: Income Statement, 2008–2015


Interest income 20 30 36 53 81 99 114 114 28.3% Interest expense (4) (5) (6) (10) (18) (33) (40) (37) 37.6% Net interest income 16 25 30 44 63 67 74 77 25.1%

Net fee and commission income

- 2 3 7 9 8 8 7 -

Other operating income

1 1 0 7 1 1 1 7 31.6%

Total operating income

17 29 34 58 73 76 83 90 26.9%

Less: operating expense

(5) (7) (8) (11) (13) (16) (18) (17) 19.1%

Pre-provision income 12 22 26 47 60 60 65 73 29.5%

Loss provisions (2) (3) (3) (2) (2) (0) (1) (2) (1.0%) Pretax income 10 18 24 45 58 60 65 71 32.4%

Taxes - - - (3) (9) (9) (10) (11) - Net income 10 18 24 41 49 51 55 61 29.3%

( ) = negative, CAGR = compound annual growth rate. Source: Housing Development Finance Corporation audited financial statements, 2008–2015.

Appendix 6

22

RESULTS AND RATINGS FOR PROJECT CONTRIBUTIONS TO PRIVATE SECTOR DEVELOPMENT AND ADB STRATEGIC DEVELOPMENT OBJECTIVES—FINANCIAL INTERMEDIARIES

(for Housing Finance)

Results Area Actual achievements Rating Justification Potential future achievements

Risk

1. Financial institution and Sub borrower PSD effects

1.1 Improved skills:

(i) Improved mortgage lending skills in the participant financial institution(s). (ii) Contribution via the participating financial institution(s) to improved sub borrower skills in operation of their businesses, e.g., via appropriate loan conditions, advisory services by the bank(s).

Despite an aggressive lending in 2010–2012, HDFC’s NPL remained low at 2.2% as of the end of 2015 due to HDFC’s prudent underwriting skills. The TA provided by IFC and HDFC-I enhanced staff knowledge and skills in underwriting and credit analysis. Under the management of the current CEO, HDFC formalized internal processes and control by improving systems and procedures and initiated the upgrading of MIS.

Excellent

HDFC established operational guidelines such as a loan evaluation and credit manual, project assessment guidelines, disbursement procedures, a recovery manual, and an HR manual. HDFC is currently upgrading its IT system on to an Oracle platform to improve operational efficiency. Staff were sent off-shore for training whenever necessary.

HDFC is faced with a high average employee turnover rate of 28% per annum. The highly skilled employees of HDFC can easily move to private or public sector companies that can offer higher compensation. HDFC thus loses its employees after they are trained. HDFC should look for other ways to motivate and retain its employees.

Low

1.2 Improved standards:

Improved standards and practices with regard to corporate governance and transparency, stakeholder relations, or ESHS in participating financial institutions or sub-borrowers.

The corporate governance policy of HDFC is patterned according to the Capital Market Development Authority corporate governance code. HDFC’s corporate governance policy is focused on integrity, transparency, and equality. HDFC set up a shariah amna department to ensure proper shariah governance mechanism is applied. A shariah committee was established to advise the Board of Directors on shariah-related matters. HDFC’s ESMS is compliant with ADB’s ESMS requirement.

Satisfactory HDFC adopted an environmental and social screening and assessment system to identify impacts and issues to aid its decision making. Loan drawdowns are structured based on construction milestones, a system under which the release of funds depends on clearance by local officials.

Continued careful implementation of ESMS by HDFC will further enhance compliance with environment and social risk management standards.

Low

1.3 Innovation: Innovative

ways of offering effective banking services for the mortgage finance market

HDFC offered several new products in the Maldives, such as loan-linked savings, long-tenor loans, extended family income pooling for loan application, a product for

Excellent HDFC’s market dominance and growing familiarity with the mortgage finance market’s needs and enhanced

The bank can utilize advancements in information technology to enhance products and services,

Medium

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(including new products, services, and technologies)

entrepreneur borrowers, and Islamic finance. In addition, HDFC introduced a credit protection mechanism by making mortgage insurance available, SMS payment reminders, and a customer loyalty rewards program.

capacity enabled them to expand mortgage lending. Some of HDFC’s innovative products are being replicated by the Bank of Maldives.

particularly in terms of the collection of monthly payments in the outer atolls.

1.4 Catalytic element:

Mobilizing or inducing more local or foreign market financing or foreign direct investment for the supported financial institution or sub-borrowers.

HDFC continuously worked to diversify funding sources. It made a pioneering contribution to the development of capital markets in the Maldives by listing both a conventional and an Islamic bond on the Maldives stock exchange. In addition to the loans obtained from ADB and IFC, 3 other IFIs have provided new funding to HDFC to support its loan expansion.

Excellent The presence of ADB (as a shareholder and a lender) and of the other IFIs as lenders indirectly assisted HDFC in mobilizing additional funding both in local and hard currency. The bond issuance showed that HDFC can source funding on its own, i.e., without the need for any government guarantee or support.

As financial strength and country risk factors stabilize and improve, HDFC may gain more opportunities to diversify funding sources, including offering shares in the stock market.

Low

1.5. Improved business performance. Expanded

mortgage lending with good portfolio and sub-borrower performance. Expansion of market share.

Mortgage lending expanded particularly in the Greater Malé area following the development and completion of Hulhumalé phase 1. HDFC’s loan portfolio grew from Rf156 million in 2008 to Rf1,101 million in 2015, equivalent to a CAGR of 32.2%.

Excellent Following the privatization, HDFC was steadily able to gain 50.9% of the market share in housing finance by 2015. Prior to privatization, the market was dominated by BML.

With improved capacity and diversified funding sources, HDFC should invest in infrastructure that will allow it to expand operations efficiently.

Low

2. PSD effects beyond financial intermediaries and sub-borrowers

2.1 Private sector expansion and institutional impact:

2.1.1 Contribution to an increased private sector share and role in the economy. 2.1.2 Contribution to expanded mortgage lending in the financial system. 2.1.3 Improved access to formal credit and banking services in the economy.

The ADB loan and equity investment provided HDFC with long-term funding it needed to sustain its business and the expansion of its mortgage loan portfolio. HDFC’s access to long-term funding sources domestically and internationally allowed it to offer the longest mortgage finance in the market spanning up to 20 years. HDFC also has the lowest mortgage rate in the market at 11% per annum, making mortgage funding more affordable for borrowers.

Satisfactory The project contributed to increased competition in the mortgage lending market, thus giving the mortgage borrowers more options and improved access to credit. This will likely have a positive long-term impact on private sector investment, growth, and employment in the Maldives.

Housing borrower access to formal credit and banking services in the economy is expected to increase further in the future with additional funding, new products and services, and enhanced underwriting and risk management capacity of banks.

Low

2.2 Competition: Enhanced

competition among local banks HDFC’s success appears to have given an impetus for other commercial banks to

Satisfactory New products and services introduced in the mortgage

Competition between local banks is expected to grow

Low

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or other types of financial institutions (including new product and service offerings, local-currency products) and/or contribution to increased competition in key sub-borrower markets.

launch aggressive home loan marketing and advertising campaigns in the housing mortgage market, particularly since the beginning of 2013.

market by local banks benefited mortgage borrowers by giving them wider options and more competitive terms.

further given increased awareness by banks of the high demand for mortgages. Cost efficiencies in product offerings may be achieved by banks in the future, which may have a favourable impact on pricing and income margins.

2.3 Demonstration effects:

Replication of new ways of offering effective banking services to the mortgage finance segment by other banks or institutions.

HDFC market practices and product offerings are being replicated by other players. BML, which had previously reduced its exposure to housing loans, increased its marketing to promote housing finance products in 2013 due to the booming housing market.

Satisfactory BML has replicated most of the products and services of HDFC, including HDFC concessional rate cuts to borrowers.

Given the high demand for housing in the Maldives, it will be beneficial for HDFC to send staff to attend seminars or training outside of the region to learn about new products and services that can be adopted by HDFC.

Low

2.4 Linkages: Contribution to

local savings and deposit mobilization via networks of participant bank(s); contribution to notable upstream or downstream link effects to sub-borrowers’ businesses in their industries or the economy.

The Maldives has the lowest saving index in the world, yet 15% of the HDFC’s Islamic bond issue amount was subscribed by retail buyers, indicating public confidence in investing savings in HDFC. HDFC’s program to allow borrowers to pay half of the 20% required equity down payment at application and the 10% balance during the housing construction phase is a good way to help borrowers learn how to save. About 5% of applications received by HDFC fall into this category. This product attracts borrowers to HDFC from low-income families and those residing in outer islands.

Satisfactory HDFC’s expanded branch network and use of internet and mobile banking have helped enhance its outreach to and accessibility from the outer atolls.

HDFC can strengthen market offerings to capture other cash management, savings, and investment requirements of mortgage borrowers.

Low

2.5 Catalytic element:

Contribution to mobilization of other local or international financing for financial institutions for mortgage borrowers, and by positive demonstration to market

Upon completion of their housing units, mortgage borrowers can use these assets as collateral to secure loans for businesses or for a second home.

Satisfactory ADB lending to HDFC and its encouragement of HDFC’s expansion of mortgage lending demonstrates ADB’s commitment to this market and belief in its viability.

Additional funding from local and foreign institutions continues to come in to support the growth and development of housing and the housing market, as well as of the local banking sector.

Low

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providers of debt and risk capital to borrowers.

2.6 Affected laws, frameworks, regulation:

Contribution to (i) improved laws, regulation, and inspection affecting mortgage financing; or (ii) a more enabling environment for mortgage financing via lobby activity, policy dialogue, or otherwise.

HDFC contributed to the establishment of a legal structure for title registration and sale of apartments in Hulhumalé. HDFC is also a constant contributor of knowledge and a promoter of constructive public dialogue at events organized by the Maldives Monteray Authority, the Housing Ministry, Islamic Affairs Ministry, the Ministry of Finance and Treasury, and the Capital Market Development Authority.

Satisfactory Prior to this law, citizens were granted rights only to use government land for housing. After the law was passed, citizens in Hulhumalé can have a freehold title to a single unit of housing.

Extending this law or creating a similar law for Malé could stimulate the mortgage market further, since current homeowners could be incentivised to undertake home improvement projects if title to the land passed to them.

Low

3. Contributions to other ADB strategic objectives

3.1 Inclusion: Increased

availability or reduced cost of financial services for the poor and other disadvantaged groups. Indirect inclusion benefits generated by subprojects/borrowers through forward/backward linkages to poor, female, or rural entrepreneurs; the provision of services or products for the poor, women, and rural populations; and employment of such groups.

HDFC’s inclusive business model developed a range of products and services that involve local cottage industries in the value chain as suppliers of carpentry work and such building materials such as compressed cement blocks. This reduces the cost of construction by avoiding the need to import materials and labor. Through the outreach program to extend home loans to outer islands, mortgage financing became accessible to people living in outer atolls. The Maldives benefited from a reduction in the average population density from about 12 people per household in 2007 to 8 people per household in 2012.

Excellent Support for mortgage market development through the ADB project will benefit low-income families and borrowers in other atolls, who were specifically targeted by the project.

Future IFI funding for onlending to qualified subborrowers as well as government financing initiatives targeted at other atolls and disadvantaged sectors will drive further financial inclusion.

Low

3.2 Job creation: Creation of

additional sustainable jobs or self-employment. Distinguish between jobs created within supported FI, sub-borrowers and beyond.

Growth in operations was supported by additional staff hired by HDFC to support its expanded operation and branches to be opened in the outer atolls. The boom in construction and home improvement industries created additional requirement for construction manpower

Excellent Funding support to HDFC helped create jobs at different levels.

Additional funding from IFIs and improvement in market conditions can provide new and greater demand for loans to fund business activities, encouraging job creation.

Low

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and engineers. The benefits extended to suppliers of construction materials and services, which contributed to economic growth. The introduction of the Million Plus product enabled entrepreneurial borrowers to establish small home-based businesses that have augmented their regular income and provided jobs for others.

3.3. Environmental sustainability: Contribution to

reductions in GHG emissions other environmental improvements through relevant lending policies and practices, and, targeting / allocations for borrowers with environmentally beneficial investments.

HDFC established an EMS that set out screening and assessment procedures as well as built capacity to implement them following the guiding principles agreed with ADB.

Satisfactory The project contributed to increased awareness of ESMS risks by HDFC and therefore by their borrowers.

ESMS training programs funded by IFIs and implementation of ESMS policies by HDFC as part of funding disbursement can create greater awareness and skills among banks and sub-borrowers.

Low

3.4. Regional integration:

Project contributions to regional cooperation and integration by facilitating trade or cross-border financial transactions.

Real estate developers from the People’s Republic of China came in to fill the gap for local construction companies for the development of Hulhumalé. In addition to housing, these firms are also involved in key infrastructure projects such as roads and bridges.

Satisfactory Housing units in Hulhumalé delivered by these foreign developers significantly augmented the number previously delivered by local construction companies.

The Maldives may want to invite other developers from neighboring India and Sri Lanka to increase competition and meet the current large deficit in housing units for its citizens.

Low

3.5 Any other project development outputs and outcomes

4. Overall Rating Satisfactory

ADB = Asian Development Bank, BML = Bank of Maldives, CAGR = ESMS = environmental and social management system, HDFC = Housing Development Finance Corporation, IFC = International Finance Corporation, NPL = nonperforming loan.