DFCC Bank PLC

DFCC Bank PLC: Rating reaffirmed; outlook revised to Negative

InstrumentRated Amount (LKR Mn)Rating Action
Issuer RatingN/A[SL]AA-; Outlook revised to Negative from Stable

Rating action

ICRA Lanka Limited has reaffirmed the Issuer Rating of DFCC Bank PLC (“DFCC”/” the Bank”) at [SL]AA- (Pronounced SL double A minus), while revising the outlook to Negative from Stable.

Rationale

The outlook revision from Stable to Negative factors in the declining capital buffers of the Bank and the moderating asset quality levels. ICRA Lanka notes that the sharp growth in the lending book, increased the Bank’s risk weighted assets (RWAs)  by ~14% YoY in CY2021, thereby adversely impacting the capital ratios. Furthermore, the fair value losses in equity and fixed income securities due to the unfavourable treasury bond and bill yields have also depleted the Bank’s Networth. DFCC’s tier 1 capital adequacy ratio moderated to 9.31% as on December 31, 2021 from 10.82% as on December 31, 2020 against the regulatory requirement of 8.00%. DFCC has a modest capital buffer against regulatory minimum requirement in comparison to its peer Licensed Commercial Banks (LCBs). The Bank plans to raise about LKR 6 Bn (~1.6% of RWAs) via a rights issue in May 2022 to improve its capital buffers. Given the subdued performance of the equity market, the appetite for the subscription of rights issue remains a key sensitivity.

The rating outlook revision also factors in the deterioration in the bank’s asset quality with gross non-performing asset ratio (GNPA %) increasing to 5.60%  as on December 31, 2021 from 5.18% as on September 30, 2021 (5.56% as on December 31, 2020). The macro-economic challenges resulted in higher slippages in Q4CY2021, while the intensifying power outages and fuel shortage is likely to further stress the asset quality in Q1CY2022. However, ICRA Lanka takes comfort from the bank’s healthy provision coverage with Stage 3 impairment coverage ratio at 49.16% as on December 31, 2021. Further, the bank’s profitability indicators remained moderate with return on assets (ROA) at 0.68% which was lower than the LCB average of 1.23% in December 31, 2021.

The rating continues to consider its established track record as the pioneer development bank in the country. DFCC became a fully-fledged commercial bank in 2015. Stemming down from its development banking strength, DFCC’s portfolio is majorly concentrated in the corporate segment (49% of total portfolio) as on December 31, 2021. DFCC’s lending portfolio grew faster at 21% YoY compared to LCB sector average of 15% in CY2021. The rating also takes comfort from the rising share of the current and savings deposits to total deposits (CASA%) to 30.80% as on December 31, 2021 compared to 23.57% as on December 31, 2020. The improved low-cost funding base together with low systemic rates in CY2021, improved the Bank’s cost of funding to 5.74% in CY2021 (7.41% in CY2020).

The bank’s ability to improve its capital buffers through successful equity infusion, internal generation and the sustained maintenance of sufficient buffer over the regulatory requirement along with the improvement in the asset quality would remain key monitorable.

Outlook: Negative

The outlook revision from Stable to Negative factors in the declining capital buffers of the Bank and the moderating asset quality levels. The outlook may be revised to “Stable”, if DFCC is able to augment its capital profile and improve its asset quality indicators. The rating could be downgraded in case of further depletion of the capital buffers and deterioration in the asset quality. 

Key rating drivers

Credit strengths

Established track record for long-term financing with a strong focus on corporate lending- Established in 1955, DFCC Bank is the first development bank in Sri Lanka and is also one of the pioneering development banks in the Asian region. The Bank’s corporate book grew by over 30% YoY in the CY2021 and accounted to 49% of the gross portfolio of the Bank as on December 31, 2021. The SME segment which accounted to 32% of the portfolio as on December 31, 2020 moderated to 25% of the gross portfolio by December 31, 2021. Contrary to the SME segment, the retail segment witnessed growth in CY2021 to reach LKR 87 Bn portfolio and accounted for 23% of the portfolio as on December 31, 2021 (20% as on December 31, 2020). State-owned exposures moderated to 4% of the total portfolio as on December 31, 2021 from 5% as on December 31, 2020. DFCC’s concentration levels continue to remain high due to exposures towards some large and established corporates in the country, to whom DFCC has provided long-term financing since inception. As on December 31, 2021, the top 20 largest group exposures accounted for 44% of the Bank’s total gross portfolio.

Funding profile; Healthy CASA ratios while the gearing levels too increased in CY2021; Being a corporate centric bank, DFCC is less reliant on public deposits in comparison to its peer LCB’s. As on December 31, 2021, the total deposits to total funding stood at 76% (LCB sector average of 84%). However, this has somewhat increased from 70% two years ago. The low deposit dependence of DFCC in public deposits is due to Bank’s access to long term funding lines from multilateral and Development Finance Institutions. The Current and Savings accounts to total deposits (CASA%) have significantly improved in CY2021 to 30.80% as on December 31, 2021 from 23.57% as on December 31, 2020. ICRA Lanka takes note of the depletion of the Bank’s Networth (fair value losses from equity and fixed income securities) and the increase in the deposit base which has led to an increased gearing level of 8.73 times as on December 2021 (8.25 times as on December 31, 2020), but was largely in line with LCB sector average of 9.75 times.

Improved earnings profile; DFCC Bank reported an operating profit of LKR 5,544 Mn [1](+26% YoY) in CY2021 on a total asset base of LKR 485,505 Mn as on December 31, 2021. The Bank’s net interest margin (NIM%) improved to 2.66% in CY2021 from 2.53% in CY2020, mainly benefitting from the improved cost of funding due to high CASA share and low systemic rates. DFCC’s fee-based income/ATA increased to 0.55% in CY2021 from 0.47% in CY2020. ICRA Lanka envisages fee income to further improve with the implementation of the core banking system in Q4CY2021. Other income/ATA increased to 0.67% in CY2021 as compared to 0.46% in CY2020, which is mainly attributable to dividend income and gains on sale of fixed income securities. DFCC Bank is the largest shareholder of Commercial Bank of Ceylon PLC; largest private LCB in the country and earns a significant dividend income from the same (~14% of the PBT in CY2021). The operational expenses increased by over LKR 1,000 Mn due to steps taken to curb the pandemic within banking premises while the impairment charges too increased by over LKR 1,000 Mn due to effects on the borrowers from the challenging macro environment. Overall, DFCC’s profitability improved with ROA of 0.68% in CY2021 from 0.55% in CY2020; yet remains below the annualised LCB sector average of 1.23%.

Credit Challenges:

Asset quality indicators remains weak; unlikely to improve in the near term; ; The GNPA% of DFCC increased to 5.60% as on December 31, 2021 from 5.18% as on September 30, 2021. Although, the LCB sector average stood at around 4.5%, it was mainly driven by the healthy asset quality indicators of the Domestically Systematic Important Banks (DSIBs); the other similar-sized LCBs to DFCC reported similar GNPA% to that of DFCC. ICRA Lanka draws comfort from DFCC’s Stage 3 impairment ratio of 49.16% as on December 31, 2021. Furthermore, the net non-performing asset ratio marginally improved to 2.25% as on December 31, 2021 (2.32% as on December 31, 2020). ICRA Lanka expects that the current macro-challenges and the intensifying power outages and fuel shortage is likely to further stress the asset quality in the near term.

Low capitalisation buffers; rights issue (~1.6% of RWA) announced; Owing to the net fair value losses reported in the equity and fixed income securities and the fast growth in the lending portfolio (14% YoY growth in RWAs in CY2021) has put pressure on the capitalisation profile of the Bank. This resulted in the contraction of the capital buffers of Bank. As on December 31, 2021, DFCC’s tier 1 capital ratio stood at 9.31% against a regulatory requirement of 8.00%. The last capital infusion of LKR 2.8 Bn was in CY2019 via a rights issue. Further, the Bank announced a rights issue of around LKR 6.0 Bn (~1.6% of RWAs) by May 2022 which is expected to improve the capital buffers, although the subdued performance of the equity market is likely to affect the appetite for the subscription of rights. ICRA Lanka notes that the fair value impact from the sovereign debt restructuring is likely to be lower than that of some of the large commercial banks, as the exposure towards international sovereign bonds (ISB) by DFCC as on December 31, 2021 is only 1% of its asset base.

Analytical approach: For arriving at the ratings, ICRA has applied its rating methodologies as indicated below.

Links to applicable criteria:   ICRA Lanka’s Credit Rating Methodology for Banks

About the Bank:

DFCC Bank was set up in 1955 as Sri Lanka’s first Development Finance Institution on the recommendation of the World Bank and is one of the oldest development banks in Asia. In October 2015, DFCC Bank and its 99% owned subsidiary, DFCC Vardhana Bank amalgamated to become a commercial bank. DFCC Bank is now a Licensed Commercial Bank offering a range of development banking and commercial banking products and services.

The Bank is involved in commercial lending activities such as project financing, and trade finance, and SME finance, while also providing the full range of retail banking products, such as housing loans, personal loans, leases, and credit cards.

During the calendar year ended December 2021, DFCC Bank reported a profit after tax of LKR 3,222 Mn on a total asset base of LKR 486 Bn, vis-à-vis a profit after tax of LKR 2,388 Mn on a total asset base of LKR 465 Bn during the previous fiscal.

Key financial indicators
LKR MnCY2018*CY2019*CY2020*CY2021*
Net Interest Income12,41512,66211,00712,653
Profit after Tax/ (Loss)2,7682,0742,3883,222
Net worth43,84647,48049,35748,986
Loans and Advances (Net)249,734272,818301,909365,901
Total Assets374,908404,897465,077485,505
Return on Equity6.04%4.54%4.93%6.55%
Return on Assets (On PAT)0.78%0.53%0.55%0.68%
Gross NPA3.28%4.85%5.65%5.60%
Net NPA1.20%2.07%2.32% 2.25%
Capital Adequacy Ratio (Tier 1)10.77%11.34%10.82%9.31%
Gearing (times)7.417.398.258.73
*Audited Financials    
Rating history for last three years:

Analysts
Sachini Costa
+94-774781595
sachini.costa@lalinda

Niraj Jalan
+91-33-71501146
naraj.jalan@icraindia.com

[1] Operating profit before taxes on financial services


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