Fitch Affirms DFCC Bank at ‘A+(lka)’; Outlook Stable
Fitch Ratings has affirmed Sri Lankabased DFCC Bank PLC’s National LongTerm Rating at ‘A+(lka)’. The Outlook is Stable. At the same time, Fitch has affirmed the bank’s Sri Lankan rupee senior unsecured debt at ‘A+(lka)’. The ratings on DFCC’s Basel II- and Basel III-compliant Sri Lankan rupee subordinated debt have been affirmed at ‘A-(lka)’.
Key Rating Drivers
DFCC’s National Long-Term Rating is driven by its intrinsic financial strength. It reflects DFCC’s modest franchise among domestic commercial banks and thinning capital buffers relative to similarly rated peers.
The operating environment in Sri Lanka continues to be challenging. Sri Lanka’s real GDP contracted by 3.6% in 2020 as key economic sectors were severely disrupted by the coronavirus pandemic and the lockdowns to control the spread. We expect economic growth to rebound by 3.8% in 2021 and 3.9% in 2022 but this will depend largely on the containment of new Covid-19 cases in the country. The outlook on the operating environment assessment is maintained at negative to reflect the potential for further risks stemming from the sovereign credit profile or pressure on domestic operating conditions beyond our expectations independent of changes in the sovereign rating.
Sustained fast loan growth of 4.2% in 1Q21 and 11.2% in 2020 relative to the private-sector peer bank average of 2.1% and 5.7%, respectively, could continue to weigh on DFCC’s common equity Tier 1 (CET1) ratio in the medium term, in the absence of an equity infusion and sufficient internal capital generation to replenish its capital buffers. We expect the bank to bolster its capitalisation, although raising capital could be more difficult in the prevailing operating conditions. The bank’s tangible common equity/ tangible asset ratio of 11.1% at end1Q21 was higher than the peer average of 9.6%, reflecting the realisable gain on its stake in Commercial Bank of Ceylon PLC (CB, AA-(lka)/Stable), which is not factored into the CET1 ratio.
We believe the stake provides greater access to capital for DFCC, but the realisable gain could remain low in the medium term due to the weak performance of the Sri Lankan stock market. We expect DFCC’s asset-quality metrics to remain under pressure in the near term as relief measures are gradually phased out, although the deterioration in its impaired, or Stage 3, loan ratio could be masked by planned high loan growth.
The upgrade of a loan to a government institution (1.6% of gross loans) to Stage 2 from Stage 3 in 2020 almost offset new accretions to Stage 3 loans, thereby containing the growth in Stage 3 loans in 2020. This, combined with loan growth, led to DFCC’s impaired-loan ratio improving to 7.7% by end-2020 from 8.4% at end2019. DFCC’s operating profit/riskweighted assets increased to 2.9% by end-1Q21 from 1.5% in 2020 as the bank’s net interest margin widened due to lower rates for deposits. We expect DFCC’s earnings and profitability to improve in 2021 on the faster growth of the loan book to high-yielding segments despite potentially elevated credit costs.
DFCC’s profitability is also supported by the considerable dividend income from its stake in CB, which accounted for around 23% of group profit in 2020. We expect DFCC’s loan-to-deposit ratio to remain high in the medium term relative to that of larger private banks despite a gradual decline as the bank continues its aggressive deposit mobilisation strategy. DFCC is funded mainly by deposits, but its share of wholesale funding is higher than that of larger peers to support its sizeable project lending portfolio (30% of gross loans at end-2020). Foreign-currency wholesale funding accounted for at least 5% of DFCC’s funding at end2020 (2019: 7%) and we believe the deteriorating sovereign credit profile could weigh on its access to the funding. Foreign-currency deposits accounted for another 12% of total funding at end-1Q21 (2020: 11%).