August, 9, 2022
Amidst a turbulent economic environment, and significant disruption to the economy, as a result of Sri Lanka’s multiple crises of economy, energy and foreign exchange, DFCC Bank has continued to deliver value to all stakeholders. The Bank has recorded a moderate performance for the 1st half of the year, ended 30th June 2022, battling against a volatile business environment, further compounded by external challenges and domestic political uncertainty.
The country is in the midst of its worst financial crisis, after its foreign exchange reserves plummeted to record lows, with dollars running out to pay for essential imports including food, gas, medicine and fuel. As a result, Sri Lanka faces a significant shortage of power, energy, imported products (including essential food), gas etc. Moreover, a highly inflationary environment within Sri Lanka has further compounded these issues, resulting in relatively subdued financial performance by the Bank.
Along with this, rising impairment costs and provisioning for the same have resulted in a negative impact on profitability for the period. However, this should ease as impairment mitigation measures take effect over the upcoming quarters, and inflation is expected to ease. The impact of corrective policy measures taken by the Central Bank and the expected improvements in both domestic and global supply conditions, coupled with the recent tightening of monetary policy and more effective communication of the same, is envisaged to help alleviate public concern with regard to inflation in the period ahead as well.
The following commentary relates to the unaudited Financial Statements for the period ended 30 June 2022, presented in accordance with Sri Lanka Accounting Standard 34 (LKAS 34) on “Interim Financial Statements”.
The DFCC Group comprises of DFCC Bank PLC (DFCC), and its subsidiaries – Lanka Industrial Estates Limited (LINDEL), DFCC Consulting (Pvt) Limited (DCPL) and Synapsys Limited (SL), the joint venture company – Acuity Partners (Pvt) Limited (APL) and associate company – National Asset Management Limited (NAMAL).
In order to proactively address the current and potential future impacts of prevailing economic conditions, the Bank has made prudential provision on the lending and investment portfolio resulting in a 313% increase in the impairment provision compared to the comparable period.
After accounting for the higher charge for impairment loss, the Bank reported a profit before tax (PBT) of LKR 331 Mn and a profit after tax (PAT) of LKR 513 Mn for the period ended 30 June 2022. This compares with a PBT of LKR 2,753 Mn and a PAT of LKR 2,031 Mn in the comparable period.
The Group recorded a PBT of LKR 690 Mn and a PAT of LKR 824 Mn for the period ended 30 June 2022, compared with LKR 2,994 Mn and LKR 2,237 Mn, respectively, in June 2021.
Due to the prevailing financial crisis, as a monetary policy tightening measure, the government decided to increase interest rates to arrest the development of demand driven inflationary pressures in the economy and preempt the escalation of adverse inflationary expectations, to provide the required impetus to stabilize the exchange rate and also to correct anomalies observed in the market interest rate structure. Accordingly, the interest rates on deposit and lending products of the banks have adjusted upwards considerably. The net interest income (NII), which is the core business of the Bank, recorded an increase of 97% and reached LKR 11.1 Bn by the end of Q2 2022. The increase in AWPLR by 1480 bps over the past 12 months and the time lag in repricing the existing deposits contributed to an increase in the interest margin from 2.66 % in December 2021 to 4.45% in June 2022.
DFCC Bank posted a total operating income of LKR 12 Bn for the period ended 30 June 2022 compared to LKR 9 Bn in the comparative period, which is a 35% increase. 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 record a non-fund income (NFI) of LKR 1,183 Mn for the period ended 30 June 2022, which is only a 9% decrease compared to the comparable period.
The impaired loan (stage 3) ratio increased from 3.03% in December 2021 to 3.53% as at end June 2022. 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 during the quarter, 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, the impairment charge has recorded an increase of 313% compared to the comparative period and was LKR 6,808 Mn for the period ended 30 June 2022 compared to LKR 1,649 Mn in the comparable period of last year.
During the period ended 30 June 2022, the Bank’s operating expenses increased from LKR 4,095 Mn to LKR 4,831 Mn, compared to the corresponding period in 2021, primarily due to the increase in inflation. With the implementation of the core banking system during the last year, the Bank created multiple channels for service delivery to customers through a strong digital drive, providing access to enhanced banking services. 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 helped to facilitate effective cost controls, which resulted in operating expenses being curtailed and managed at these levels.
Changes in fair value of investments in equity securities and fixed income securities (treasury bills and bonds) and movement in hedging reserve are recorded through other comprehensive income. Total other comprehensive expense that was reclassified during the period to the income statement mainly includes the negative movement of LKR 13,594 Mn from hedging reserve which was due to the currency depreciation which impacted the hedged foreign currency borrowing (hedge item) and the swap arrangement (hedge instrument). As per the option given under the Statement of Alternative Treatment (SoAT) on Reclassification of Debt Portfolio issued by the Institute of Chartered Accountants of Sri Lanka (CA Sri Lanka), the Bank has reclassified the investment in long term debt instruments from fair value through other comprehensive income to amortized cost. A fair value loss of LKR 4,729 Mn was recorded on account of equity securities outstanding as at 30 June 2022.
As a result of rising interest rates, high inflation and currency depreciation, the Bank did not pursue an aggressive lending growth strategy. The gross loan portfolio of the Bank of LKR 416,619 Mn as of 30 June 2022 recorded an increase by LKR 31,660 Mn compared to 31 December 2021. The net increase reflected is mainly due the effect of the devaluation of rupee on the foreign currency lending portfolio in spite of steps being taken by the Bank to reduce the
foreign currency lending portfolio by over LKR 9 Bn during the period ended 30 June 2022.
Similarly, the deposit portfolio of the Bank also experienced an increase of LKR 23,663 Mn to record LKR 343,524 Mn as at 30 June 2022 compared to LKR 319,861Mn as at 31 December 2021. This resulted in a loan to deposit ratio of 114% as at 30 June 2022. The CASA ratio decreased to 29.20% as at 30 June 2022. DFCC Bank will continue 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.
As at 30 June 2022, the Bank has recorded Tier 1 and Total Capital Adequacy ratios of 10.84% and 14.14%, respectively. The Bank’s Net Stable Funding Ratio (NSFR) was 124.58% and Liquidity Coverage Ratio (LCR) – all currency was 133.37% as at 30 June 2022. All these regulatory ratios were maintained above the minimum regulatory requirement. During the quarter, with the objective of increasing Tier 1 capital in order to assist future asset growth, the Bank raised LKR 3.6 Bn by way of a Rights Issue of shares at an issue price of LKR 55/- per share.
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