DFCC records Rs. 2.37 b PAT for nine months

Group performance

The DFCC Group recorded a consolidated profit after tax of Rs. 2,374 m for nine months ended 31 December 2012 compared with Rs. 2,204 m in the corresponding period of the previous year (comparable period).

The financial year of subsidiaries DFCC Vardhana Bank Plc (DVB) and Synapsys Ltd., joint venture Acuity Partners Ltd. and associate company National Asset Management Limited, ends on 31 December and therefore the results of these entities are consolidated with the bank with a time lag of three months.

The banking business of the DFCC Group is undertaken by DFCC Bank (DFCC), a licensed specialised bank and 99% owned subsidiary DFCC Vardhana Bank (DVB), a licensed commercial bank. Both banks function as one economic entity and as such to the consolidated performance of the two banks referred to as DFCC Banking Business (DBB) is analysed later in this review. A consolidated Income statement for DBB derived from the interim financial statements has been released to the Colombo Stock Exchange as supplementary financial information.

Apart from the DBB which contributed Rs. 2,215 m to profit after tax (based on partial consolidation in the supplementary income statement of DBB) and is analysed below in greater detail, the investment banking joint venture, Acuity Partners (APL) contributed Rs. 105 m in the current period, 16% lower than Rs. 125 m in the comparable period.

The current period however includes a deemed disposal gain of Rs. 83 m (50% of the total recorded by APL) arising from a transaction by its subsidiary Lanka Ventures PLC accounted in the income statement as per the previous Sri Lanka Accounting Standards.

However, at the end of the current financial year, consequent to re-presentation of the full year financial statements under the new accounting standards, this deemed disposal gain would be accounted as other comprehensive income in the equity and not in the income statement as currently presented.

The investment banking business was adversely impacted by the economic environment that prevailed although there were signs of uplift toward the end of the current period. The contribution from APL’s core activities was significantly lower than in the previous period. The contribution from all other subsidiaries and associate company collectively was Rs. 103 m in the current period (Rs. 79 m in the comparable period).

Banking business

Net interest income as well as loans and advances recorded growth although DVB due to its lower base was constrained by the credit ceiling imposed on the banking sector by the Central Bank.

DBB funded the credit expansion largely through customer deposit mobilisation with deposits growing to Rs. 60.4 billion in the current period. However, the high interest rate regime that prevailed had an adverse impact on the Net Interest Margin (NIM). On a composite basis, NIM of DBB was 4.6% in the current period compared with 4.9% in the comparable period.

The last quarter of the current period saw a reversal of the declining trend with NIM of DBB increasing to 4.6% for the nine month period compared with 4.4% at the half year stage on an annualised basis.

Other income of DBB was Rs. 1,014 m in the current period, 14% lower when compared to the comparable period. This reduction was mainly due to the fact that a second interim dividend from Commercial Bank Of Ceylon PLC paid in the comparable period in Dec 2011, being declared after 31 December 2012. As a result Rs. 104.6 m was not accounted in the income statement in the current period. Also, gains from sale of non affiliated shares was only Rs. 76 m in the current period compared to Rs. 254 m in the comparable period since market conditions were not conducive for disposing mature investments.

DBB continued with a funding strategy of selling foreign currencies, mainly US Dollars and generating Sri Lankan Rupees for lending activities with a better net interest income compared to the margin on foreign currency denominated loans. The market risk relating to these transactions was partially hedged through swaps. The swap cost was charged to foreign exchange income and it exceeded the foreign exchange profit from trading and translation gains thus recording an overall loss.

The gross non-performing loan ratio of DBB increased to 4.8% as at 31 December 2012 compared with 4.3%, on 31 March 2012. The gross non performing loans of DBB increased by Rs. 1,064 m during nine months ended 31 December 2012. However, there was a reduction of Rs. 141 m non-performing loans during the quarter ended December 2012. Recognising that in a relatively high interest rate regime temporary problems of debt servicing do arise, DBB through pro-active measures and active monitoring strived to contain the incidence of default events.

The ratio of operating expenses to operating income of the DBB was 41% in the current period approximately the same as in the comparable period. The 15% increase in operating expenses in the current period was compensated by additional income.

In common with banking industry, the personnel cost is a significant proportion of the operating expenses. The personnel cost in the current period inclusive of retirement benefits was Rs. 1,036 m being a 26% increase over Rs. 825 m in the comparable period.

DBB increased its head count from 1,228 employees at the beginning of the current period to 1,268 on 31 December 2012, a modest increase of 3%. Salary and benefits in DBB were revised following a survey to bring these in line with market. Some high level skills needed for business expansion and succession planning in personal financial services, marketing, risk management, treasury and senior management were acquired through external recruitment.

DBB has embarked on a comprehensive review of its organisation structure to optimise the deployment of its human resources through further synergies to be reaped through centralisation, shared services between DFCC and DVB and expected attrition. DBB recorded a 10% increase in operating profit before taxes which to Rs. 3,146 m. Profit after tax (both VAT on financial services and income tax) was Rs. 2,215 m, an increase of 9% over the Rs. 2,031 m recorded in the comparable period.

The current period included an adjustment for a one off, non recurrent financial services value added tax over provision for the prior year amounting to Rs. 184 m. Without this, DBB’s profit after tax for the current period was Rs. 2,031 m, approximately the same as in the comparable period.

Investments

The quoted equity investment securities of DFCC are carried at a cost of Rs. 4,992 m as at 31 December 2012. The aggregate market value of the investments on 31 December 2012 amounted to Rs. 14,702 m with an unrealised gain of Rs. 9,710 m. The unrealised gain reported on 30 September 2012 was Rs. 11,396 m.

As commented in the previous commentary on half year results, given vagaries of the domestic and global stock markets the unrealised gain can fluctuate significantly. For instance as at 30 January 2013, the date interim financial statements for nine months ended 31 December 2012 was authorised for issue, the unrealised gain was Rs. 10,009 m.

The interim non-audited financial statements are not based on the new accounting standards and therefore the unrealised gain is currently not recognised in the financial statements. However, under the new accounting standards all listed shares currently classified as investment securities would be reclassified as available for sale and marked to market and the unrealised gains recognised in the equity of DBB.

Transition to new accounting standards

This is the last occasion on which financial statements are presented under previous accounting standards. The final quarter interim financial statements and the Annual Financial Statements for the year ending 31 March 2013 will be prepared under the IFRS based new accounting standards.

As indicated in the notes to the interim financial statements, based on current unaudited estimates, the impact on the equity of DFCC of transition to the new accounting standards will not be adverse.

Prudential indicators

The capital adequacy and liquidity ratios continued to be well above the stipulated regulatory minimum. Specific provision cover for the DBB was 72% and un-provided NPLs as a proportion of equity was under 8%.

Future developments

Access to diversified sources of long term funds at a reasonable cost is important for DFCC to prudently leverage its franchise in the project lending space in post war Sri Lanka. For DVB, increasing the current and savings account component of its customer deposits and the higher yielding personal financial assets are priorities. The environment in 2012 was not conducive to achieving either of these but looking forward the DBB is better placed to realise these objectives.

The Road Map 2013 announced by the Central Bank indicated that inflation, interest rates and exchange rate will be managed in a manner that will encourage investment and economic growth. The credit ceiling that applied in 2012 is not applicable in 2013 which will permit DVB to target the growth of personal financial assets more aggressively. The announcement made in the Budget proposals for 2013 that the Government will facilitate DFCC Bank to raise up to US$ 250 m in long term funds from international capital markets is also a favourable development.

The foreign exchange risk cover and tax free interest income from deployment of funds raised that were proposed in the budget will stand the bank in good stead to enhance its development financing mandate. The bank is actively pursuing this opportunity.