Fitch affirms DFCC Bank at ‘AA’; Outlook Stable

Fitch Ratings Lanka has affirmed DFCC Bank’s (DFCC) National Long-Term Rating at ‘AA(lka)’ with a Stable Outlook. The agency has also affirmed DFCC’s senior debentures at ‘AA(lka)’ and subordinated debentures at ‘AA-(lka)’.

DFCC CEO Nihal Fonseka

The ratings continue to reflect DFCC’s strong capitalisation relative to its risk profile. Consolidated Tier 1 capital adequacy ratio (CAR) of 21.0% at end-March 2012 (FYE12) is significantly higher than that of rating peers, and is reinforced by the bank’s ongoing profitability and capital retention. CAR was boosted to 26.8% at FYE11 from large capital gains during the year before normalising to its historical average by FYE12.

The ratings also factor in DFCC’s high exposure to medium- to long-term project finance (70% and 44% of bank and group advances, respectively, at FYE12), which is more vulnerable to economic downturns and is dependent on long-term funding. Fitch however notes that group concentration to project finance has been decreasing due to growth at DFCC’s subsidiary - DFCC Vardhana Bank PLC (DVB; ‘AA-(lka)’/Stable). DVB is a licensed commercial bank, whose contribution to consolidated advances was 37% at FYE12 (FYE11: 31%) and is likely to increase further.

In line with its strategy to consolidate its banking business, DFCC has almost fully integrated its banking operations with DVB and re-branded the group’s banking business as DFCC Banking Business. The two entities share common corporate, business and branch banking divisions, and their customers have a single interface for all products.  A rating downgrade could result from a sustained weakening in capitalisation due to high credit growth or weak profitability. The ratings may also come under pressure from a shift in the group’s risk profile as DVB grows to account for a larger share of group assets. Considering the inherent risks in DFCC’s business model as it stands currently, and its already high ratings on the national scale, Fitch sees limited scope for an upgrade.

Fitch expects DFCC’s high loan growth to moderate in line with a regulatory direction issued in February 2012 limiting credit growth to 18% (23% if the remainder is financed externally). DFCC’s consolidated loan growth of 46.8% (standalone: 33.8%) in FY12 was higher than that of the bank sector (2011: 32%). While DFCC has sustained its capitalisation amid rapid growth, such high levels of growth in the prevailing economic environment of rising market interest rates and external sector pressures could pose risks to asset quality. Nevertheless, Fitch derives comfort from DFCC’s high provision coverage and considerable capital buffer available to absorb potential loan losses. Un-provided NPLs accounted for just 4.7% of equity at FYE12. Asset quality was sustained up to FY12 with a continued decrease in gross non-performing loans since FY10, supported by an improved economic environment, tighter credit controls and an increasing exposure to lower risk corporate clients. Consolidated gross NPL ratio was 4.5% at FYE12, down from 6.8% at FYE11 (FYE10: 10.3%).

DFCC is a licensed specialised bank and Sri Lanka’s only development finance institution. DFCC is listed on the Colombo Stock Exchange and is majority-held by private investors. However, the State also has a significant holding in the bank with an effective interest of 33.4% at FYE12 (FYE11: 32.1%).