Fitch affirms DFCC Vardhana at ‘AA-’/Stable

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

The ratings reflect Fitch’s expectation that support would be forthcoming from DVB’s parent, DFCC Bank (DFCC; ‘AA(lka)’/Stable), if required.

DVB is 99.12% owned by DFCC, and is strategically important to the parent in expanding the group’s product offering. The two banks were operationally merged in 2011 with regulatory approval, and DVB accounted for 39% of group assets and 76% of deposit funding by the quarter ended 31 March 2012 (Q112).

DVB’s loan growth of 75% (albeit on a small base) was higher than that of the banking sector of 32% in 2011. The growth was supported by DVB’s increased outreach and marketing efforts against a backdrop of a conducive credit environment and stemmed from all segments, as the bank increased its corporate and retail segment exposures. Lending is likely to ease in 2012, but remain close to the 23% credit ceiling imposed by the regulator. The bank’s high deposit growth of 43% (2010: 7%) was unable to keep pace with the rapid loan growth in 2011, resulting in its loans/deposits ratio soaring to 99% by end-2011 (end-2010: 81%). However, the ratio improved to 86% by end-June 2012 due to the bank’s greater deposit mobilisation efforts and slower loan growth. Fitch expects the ratio improve further during 2012 with likely high deposit growth.

Fitch notes that DVB has maintained its capitalisation at comfortable levels despite the high loan growth during the year. Tier 1 capital adequacy ratio stood at 12.2% at Q112 (end-2011: 13.7%), helped by a capital injection in Q311, and while further capital dilution is likely with growth, this will be limited by the regulatory credit ceiling.

DVB’s non-performing loans (NPLs) are likely to increase in 2012 with increased pressures on its trade finance segment (26% of advances) and higher market interest rates. However, Fitch takes comfort from DVB’s conservative provisioning policy and larger capital buffer available to absorb potential loan losses. Un-provided NPLs accounted for 15.7% of equity at end-Q112 (2011: 12.7%) and were less than that of the sector.

The bank’s revised strategy to increase corporate exposures, coupled with continued upward pressure on deposit rates, has squeezed its historically higher net interest margins (NIMs) to levels more in line with the sector. NIMs declined to 5.3% in 2011 (2010: 6.3%) and partly offset the positive impact of a higher fee and commission income and lower provisioning costs on return on assets (ROA: 1.4% in 2011, 0.9% in 2010). With a lower proportion of demand and savings deposits, DVB’s funding costs have been higher than peers.

The one-notch difference between the ratings of DVB and DFCC reflects Fitch’s view on the timeliness of support available from its parent. A higher propensity for DFCC to support its subsidiary, as evidenced by an improvement in the parent’s credit profile, or a complete merger of DVB with DFCC could result in DVB’s rating being equalised with that of DFCC.

Conversely, a weakening in DVB’s strategic importance to DFCC, a significant reduction in DFCC’s shareholding in DVB or a weakening in DFCC’s credit profile or propensity to support DVB could result in a downgrade of DVB’s ratings.

DVB is a licensed commercial bank majority owned by DFCC, which is a licensed specialised bank and Sri Lanka’s only development finance institution.