ECONOMYNEXT – Fitch Ratings said it was confirming an A-(lka) rating on Sri Lanka’s DFCC Bank Plc with a stable outlook, amid an improvement in operating environment, indicated by headline macroeconomic indicators.
Fitch said it expected the country’s stabilising economic conditions to support DFCC’s ability to generate and defend business volumes, “but the bank’s predominant exposure to the persisting domestic OE risks constrains its business profile.”
DFCC’s net loans in total assets inched up to 56.9% by end-1Q24 from 54.1% in 2023, reversing a contracting trend since 2021 (74.9%), reflecting early signs of lending resumption, the rating agency said.
The full statement is reproduced below:
Fitch Affirms DFCC Bank at ‘A-(lka)’; Outlook Stable
Fitch Ratings – Colombo – 22 Jul 2024: Fitch Ratings has affirmed Sri Lanka-based DFCC Bank PLC’s (DFCC) National Long-Term Rating at ‘A-(lka)’. The Outlook is Stable. Fitch has also affirmed DFCC’s senior and subordinated debt ratings of ‘A-(lka)’ and ‘BBB(lka)’, respectively.
KEY RATING DRIVERS
Intrinsic Profile Drives Rating: DFCC’s National Long-Term Rating reflects its own financial strength, which is highly influenced by exposure to the sovereign’s weak credit profile (Long-Term Foreign-Currency Issuer Default Rating (IDR): RD; Long-Term Local-Currency IDR: CCC-) and the ongoing sovereign debt restructuring, which had
been putting pressure on the bank’s credit profile. The rating also reflects DFCC’s modest domestic franchise as Sri Lanka’s eighth-largest commercial bank.
Stabilising OE: Sri Lankan banks’ operating environment (OE) continues to show signs of stabilisation, as evident in sustained improvements in reported headline macroeconomic indicators, supporting the recovery in banks’ operational flexibility.
Further improvement to the banks’ OE remains contingent on successful execution of the sovereign’s external debt-restructuring exercise alongside the restoration of the sovereign’s creditworthiness, given the strong link between sovereign financial health and banks’ operating conditions.
Lending Likely to Resume: Fitch expects Sri Lanka’s stabilising economic conditions to support DFCC’s ability to generate and defend business volumes, but the bank’s predominant exposure to the persisting domestic OE risks constrains its business profile.
DFCC’s net loans in total assets inched up to 56.9% by end-1Q24 from 54.1% in 2023, reversing a contracting trend since 2021 (74.9%), reflecting early signs of lending resumption.
Sovereign Risk Lingers: DFCC’s risk profile is linked closely to the sovereign credit and market risk, with just over a quarter of assets in rupee-denominated treasury securities at end-2023. We estimate DFCC’s exposure to defaulted foreign currency-sovereign instruments to be one of the lowest among peers. That said, this significant overall exposure makes the bank vulnerable to sovereign’s repayment capacity and liquidity position.
Asset-Quality Risks Prevail: We estimate DFCC’s impaired (stage 3) loans ratio at 1Q24 to have remained flat at 18%, the highest among the large-private banks (peer average: 12.9%). Fitch expects a modest improvement in the ratio over the near- to medium-term due to focused recoveries, improved borrower repayment capacity, and anticipated loan book expansion. The sovereign exposure continues to weigh on the bank’s asset quality.
Profitability to Normalise: DFCC’s operating profit/ risk weighted assets ratio improved to 6.8% in 1Q24 from 4.1% in 2023, above the large private banks’ peer average of 5.2%, supported by the zero-risk weighted high-yielding government security portfolio. The bank’s planned growth in loans – attracting significantly higher risk weights – and the declining yields in government securities should see this ratio normalising over the
medium term.
Thin Capital Buffers: DFCC’s bank-level common equity Tier 1 (CET 1) ratio at end1Q24 was 10.4% (group level 11.3%), the lowest among the large private banks (peer average: 14.2%). We estimate the ratio to have improved by approximately 79bp if 1Q24 profit were included. The bank’s CET 1 ratio is currently benefitting from the low risk weights attributable to government securities. In our view, the bank’s thin capital buffers, relative to peers, conditions its ability to expand the loan book – which attracts higher risk weighting.
Funding and Liquidity Risks Ease: We believe the favourable external sector flows and the bank’s focus on liquidity preservation have subsided stresses on funding and liquidity and reduced the risk of bank failure. That said, DFCC’s funding and liquidity profile, particularly in foreign currency, remains susceptible to sudden changes in creditor sentiment driven by adverse changes to the sovereign’s credit profile, similar to peers.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
The bank’s National Rating is sensitive to a change in the bank’s creditworthiness relative to other Sri Lankan issuers.
A deterioration in DFCC’s key credit metrics beyond our base-case expectations relative to peers would also lead to increased pressure on its rating, which is driven by its intrinsic financial strength.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
Positive rating action on the sovereign may lead to an upgrade. A sustained improvement in key credit metrics beyond our base-case expectations relative to peers, could also lead to an upgrade.
OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS SENIOR DEBT
DFCC’s outstanding senior unsecured debentures are rated at the same level as its National Long-Term Rating in accordance with Fitch’s criteria. This is because the issue ranks equally with the claims of the bank’s other senior unsecured creditors.
SUBORDINATED DEBT
DFCC’s Basel III-compliant Sri Lankan rupee-subordinated debt is rated two notches below the National Long-Term Rating anchor. This reflects Fitch’s baseline notching for loss severity for this type of debt and our expectations of poor recoveries. There is no additional notching for non-performance risks, as the notes do not incorporate goingconcern loss-absorption features.
OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES
The senior and subordinated debt ratings will move in tandem with the bank’s National Long-Term Rating.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
Additional information is available on www.fitchratings.com