Subdued 1Q for DFCC Bank amidst extremely volatile conditions

In the backdrop of an extremely challenging environment in the banking industry, DFCC Bank said it recorded a moderate performance in spite of significant disruption to the local economy, due to Sri Lanka’s ongoing energy, foreign exchange, and economic crises. 

These circumstances were exacerbated by global uncertainty and external challenges arising out of the military operations and standoffs between Russia and Ukraine, as a result of which global energy prices too have soared.

DFCC said a highly inflationary environment within Sri Lanka has further compounded these issues, resulting in a relatively subdued financial performance by the Bank. Along with this, rising impairment costs and provisioning for the same resulted in a negative impact on profitability for the quarter. However, this should ease as impairment mitigation measures take effect over the upcoming quarters.

On a more positive note, during the Q1, DFCC Bank partnered with USAID to support Sri Lanka’s MSME’s with a focus on women-led enterprises that will enable the bank to empower identified high growth sectors.

The following commentary relates to the unaudited Financial Statements for the period ended 31 March, presented in accordance with Sri Lanka Accounting Standard 34 (LKAS 34) on “Interim Financial Statements”.

Profitability

The DFCC Group comprises of DFCC Bank PLC (DFCC), and its subsidiaries – Lanka Industrial

Estates Limited (LINDEL), DFCC Consulting Ltd. (DCPL) and Synapsys Ltd. (SL), the joint venture company – Acuity Partners Ltd. (APL) and associate company – National Asset Management Ltd. (NAMAL).

The Group recorded a PBT of Rs. 326 million and a PAT of Rs. 527 million for the quarter ended 31 March, compared with Rs. 2,036 million and Rs. 1,583 million, respectively, in 2021.

The net interest income (NII) which is the core business of the Bank recorded a healthy growth of 76% and reached Rs. 4.7 billion at the end of Q1 2022.The increase in AWPLR by 328 bps over the past 12 months and the time lag in repricing the existing deposits contributed to an increase in interest margin from 2.66 % in December 2021 to 3.80% in March.

Total Operating Income

DFCC Bank posted a total operating income of Rs. 5,624 million for the quarter ended 31 March compared to Rs. 4,734 million in the comparative period, which is a 19% increase. In order to proactively address the current and potential future impacts of prevailing economic conditions, the Bank has made prudential impairment provision on the lending and investment portfolio with a 682% increase compared to the comparable period.

After accounting for the higher charge for impairment loss, the Bank reported a profit before tax (PBT) of Rs. 143 million and a profit after tax (PAT) of Rs. 367 million for the quarter ended 31 March. This compares with a PBT of Rs. 1,915 million and a PAT of Rs. 1,479 million in the comparable period.

Other Operating Income

Due to exchange rate depreciation, import restrictions and other unfavourable economic conditions, the momentum of the business was noticeably negatively affected. However, the concerted effort made has helped the Bank to maintain the non-funds income (NFI) almost at the same level to record Rs. 639 million for the quarter ended 31 March. Other operating income has increased mainly due to increases in dividend income during the quarter ended 31 March.

Impairment Charge on Loans and other losses

Impairment provisions for the quarter ended 31 March was Rs. 2,817 million compared to Rs. 356 million in the comparable period of last year. The impaired loan (stage 3) ratio increased from 3.03% in December 2021 to 3.13% in March. 

In order to address the current and potential future impacts of prevailing economic conditions on the lending portfolio, the Bank has made adequate impairment provisions, as at 31 March, by introducing changes to internal models to cover unseen risk factors in the present highly uncertain and volatile environment including additional provisions made for the Bank’s exposure to foreign currency denominated financial instruments issued by the Government of Sri Lanka. 

With these additional provisions made to cover the additional risk in the economic environment including currency depreciation, impairment charge has recorded an increase of 682% compared to the comparative period of the last year.

Operating Expenses

During the period ended 31 March, the Bank’s operating expenses increased from Rs. 2,031 to Rs. 2,420 million compared to the corresponding period in 2021 primarily due to increase in inflation. With the implementation of the core banking system during last year, the Bank created multiple channels for service delivery to customers through a strong digital drive, providing access to enhanced banking services during difficult times. This resulted in an increase in IT related expenses in order to support the infrastructure upgrades. 

However, the numerous process automation and workflow management systems introduced during the quarter under review helped to facilitate effective cost controls, which resulted in operating expenses being curtailed and managed at these levels.

Other Comprehensive Income

Investments in equity securities and treasury bills and bonds (fixed income securities) are classified as financial assets and their change in fair value is recorded through other comprehensive income.

Accordingly, a fair value loss of Rs. 2,702 million and a net fair value loss of Rs. 1,760 million were recorded on account of equity and fixed income securities outstanding as at 31 March, respectively. 

Further, the movement in hedging reserve resulted in a net loss of 5,885 million mainly due to the currency depreciation which impacted the hedged foreign currency borrowing (hedge item) and the swap arrangement (hedge instrument).

Business Growth

As a result of rising interest rates, high inflation and currency depreciation, the Bank did not pursue an aggressive growth strategy. The loan portfolio of the Bank of Rs. 392,640 million as of 31 March recorded an increase by Rs. 26,740 million compared to 31 December 2021 mainly due to the revaluation of the foreign currency lending portfolio due to currency depreciation. 

Similarly, the deposit portfolio of the Bank also experienced an increase of Rs. 28,674 million to record Rs. 348,535 million as at 31 March compared to Rs. 319,861 million as at 31 December 2021. This resulted in a loan to deposit ratio of 113% as at 31 March. The CASA ratio improved to 33.59% as at 31 March. Funding cost of the Bank was also contained by using medium to long-term concessionary credit lines. 

When these concessionary term borrowings are considered, the CASA ratio further improves to 37.73% as at 31 March. DFCC Bank continued its approach to tap local and foreign currency related long to medium- term borrowing opportunities to facilitate lending to deserving segments of the market whilst maintaining a high-quality portfolio.

Equity and Compliance with Capital requirements

As of 31 March, the Bank has recorded Tier 1 and total capital adequacy ratios of 8.97% and 12.25%, respectively. The Bank’s Net Stable Funding Ratio (NSFR) was 121.65% and Liquidity Coverage Ratio (LCR) – all currency was 147.34% as at 31 March. All these regulatory ratios were maintained above the minimum requirement.

With the objective of assisting the future asset growth of the Bank as a full-service retail bank, the Bank submitted a resolution to its shareholders for a Rights Issue and received the shareholder approval at the Extraordinary General Meeting held on 30 March to issue 109,247,953 new ordinary shares by way of a Rights Issue at a consideration of Rs. 55 per each ordinary share. 

The ordinary shares under the proposed Rights Issue were to be issued in the proportion of 12 Ordinary Shares for every 37 shares held by the holders of the issued ordinary shares of the Bank. The successful completion of the Rights issue will greatly contribute to an increase in DFCC’s Tier 1 capital.

DFCC Bank CEO Thimal Perera said: “As a result of immense domestic economic challenges, coupled with significant challenges in the external environment too, the Bank had to weather a wave of consecutive challenges during the quarter. Despite healthy growth in operating income, the bottom line has suffered significantly as a result of provisioning to cope with rising impairment. 

“However, the financial state and stability of the enterprise remains solid and robust, while profitability has suffered as a result of higher impairment, triggered by the present economic crisis domestically, volatile economic conditions globally and various micro environmental factors.”

In spite of the present challenges, we have worked hard to successfully forge ahead with establishing a landmark partnership with USAID. The funds and assistance we will obtain through this partnership will allow us to focus on lending to high-growth businesses in select sectors that have been outlined, most of which are relatively insulated from the present challenges.

While the current macroeconomic conditions remain challenging, given the significant increase in interest rates, challenges with regard to foreign exchange availability and difficulties in remitting foreign currency, DFCC Bank remains committed to supporting our customers, aiding them in navigating the current operating environment through our focus on customer centricity and digitisation, while adapting to the present needs. 

As progress is made in terms of negotiating with financial bodies, such as the IMF, and Sri Lanka’s creditors, we believe stability will be restored in the short to medium term.

“Backed by our robust business strategy, which has been amended to take into account the prevailing volatile conditions, the Bank has taken steps to ensure resilient performance during the remainder of the year. We believe we will be successful in this endeavour, and we look forward to delivering sustainable growth in the future,” Perera added.