Sri Lanka | Banks, Finance and Insurance EQUITY RESEARCH Initiation of coverage 29 June 2016
DFCC Bank PLC (DFCC.N0000)
ROE recovery key to re-rating We expect DFCC to improve its financial performance and deliver stronger Key statistics shareholder returns in the medium-to-long term, as it transforms into a full-fledged CSE/Bloomberg tickers DFCC.N0000/DFCC SL banking services provider following the merger with its commercial banking Share price (28 Jun 2016) LKR129 subsidiary, DFCC Vardhana Bank. The lower ROE compared% to peers, due to the No. of issued shares (m) 265 relatively higher need for capital given the riskier nature of its project financing Market cap (USDm) 231 business, meant that DFCC Bank consistently trailed its peers in terms of valuation Free float (%) 63% historically. We now see a compelling growth story with both the commercial 52-week range (H/L) LKR204/128 banking and project financing segments buttressing loan growth, and with better Avg. daily vol. (shares, 1yr) 32,040 access to low-cost funding securing its competitive edge over peers. Considering Avg. daily turnover the political, fiscal and economic uncertainties that could hamper DFCC’s growth (USD’000) 38 along with that of the banking sector, we forecast 16.2% gross loan CAGR leading to net interest margin (NIM) improvement to 5.0% through 2018E. Coupled with Source: CSE, Bloomberg Note: USD/LKR=142.1 (average for the year ended 28 Jun greater operating efficiency and lower credit costs, we forecast DFCC to reach 2016) 11.7% ROE in 2018E. Our P/B and P/E - based analyses yield a 12-month valuation range of LKR127-156. Share price movement Healthy 16.2% loan book CAGR, mix-shift towards low-cost funding indicate 110% stronger NIMs by 2018E: We expect to see double digit growth in the loan portfolio 100% driven by both project financing and commercial banking businesses combined. A rising CASA ratio as DFCC attracts more low-cost funding alongside a consolidating banking 90% network, combined with the advantage of access to long-term international credit lines it 80% already enjoys, form the basis of our forecasts of 95bps NIM expansion to 5.0% in 2018E. 70% Improving cost efficiency and credit quality drive better shareholder returns: We 60% estimate cost-to-income ratio (CIR) to recover to 39.6% in 2018E from the 55.0%* Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 reported in 2015, inflated by one-off merger related costs. Paving the way to this recovery, DFCC ASPI S&P SL 20
DFCC achieved a CIR of 39.0% in 1Q16, the best among peers. With stronger recovery processes in place, we forecast NPL improvement to 3.4% in 2018E from 3.7% in 2015, Source: CSE, Bloomberg and impairment charges at a conservative 0.7% of credit costs, in line with its three year Share price performance average. We forecast an EPS CAGR of 39.6% over 2016E-2018E, leading to ROE 3m 6m 12m recovery to 11.7%, up from 4.6% in 2015.* DFCC -7.9% -20.8% -35.5% Capitalized well above the regulatory minimum; needs to strengthen Tier II: DFCC’s Tier I ratio stood at 15.4% at end 2015. DFCC raised qualified debt in 2015 to overcome S&P SL 20 3.9% -7.5% -14.9% the weakness of insufficient Tier II capital. All Share Price Index 4.0% -7.6% -10.1% Cohesive and consistent economic policy crucial to establish investor confidence: Source: CSE, Bloomberg In 1Q16, GDP grew at a moderate 5.5% recovering from 4.8% recorded in 2015, while Summary financials IMF forecasts suggest 5.0% growth from 2016E onwards. Sri Lanka is currently undergoing tight fiscal reforms, with the aim of achieving economic and financial discipline LKRm while ensuring sustainable growth; evidence of effective implementation of such reforms (Year-end 31 Dec) 2015 2016E 2017E and consistent economic and fiscal policy is crucial to establishing investor confidence. Net interest income 6,385 9,873 12,368 Improvements in key indicators such as credit growth (up 27.7% YoY as of March 2016), Net revenue 8,570 12,593 15,502 and inflation below mid-single digit levels bode well, though interest rates rose to 10% from 7% in 2015. Low private sector credit-to-GDP ratio, low mortgage lending and Operating profit 3,064* 6,003 7,792 personal credit levels also suggest potential room for stable growth in the banking system. PBT 2,553* 5,102 6,566 Net income 1,592* 3,761 4,586 We establish a 12-month valuation range of LKR127-156: DFCC currently trades at a 0.8x 12-month forward P/BV multiple compared to peer average of 1.1x. We expect to Recurrent EPS 6.0* 14.2 17.3 see upward rerating with its improved financial performance and recovering ROE. Hence, ROE (%) 4.6%* 8.6% 10.1% we arrived at a 12-month valuation range of LKR127-156 for DFCC shares assigning a P/B (x) 1.0x 0.8x 0.7x 0.9x 12-month forward P/BV, further justified by applying a 12-month forward P/E of 8.6x. Source: DFCC, Copal Amba estimates We expect DFCC to deliver greater shareholder returns through average dividend yield Note: *9M ending Dec 31, includes one-off amalgamation of 4.5%, higher than its three year historical average of 2.8%. costs and 2015 ROE, EPS are annualized.
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DFCC Bank PLC
Table of Contents
Set for growth as a single entity ...... 3 Dual growth engines to drive the gross loan CAGR at 16.2% 2016E-2018E ...... 3 Project finance business to fuel loan growth ...... 5 Commercial banking business gaining momentum ...... 7 Competitive pricing to back loan growth ...... 8 DFCC has better access to long-term funding ...... 9 Borrowings from international financing agencies a main source of long-term funding ...... 9 DFCC secured long-term funding through local and international bond and debenture issues ...... 11 Improving retail banking business facilitates low cost funding ...... 11 Continuous loan repayments ease the stress on funding even further ...... 11 CASA ratio to expand with an uptick in deposits ...... 12 Stronger NIMs and efficiency gains to drive ROE recovery ...... 13 Net interest income growth to drive NIM recovery ...... 13 Non-interest income to improve further in line with business growth ...... 14 DFCC has the best CIR in the industry ...... 15 NPL ratio to converge towards industry norms; prudent provisioning to absorb any future losses ...... 16 2018E forecasts - LKR21.80 EPS and ROE recovery to 11.7% ...... 17 DFCC is well capitalized; requires further improvement in Tier II capital ...... 18 We establish a 12-month valuation range of LKR127-156 for DFCC’s shares ...... 19 Share price performance ...... 22 Earnings release focus areas ...... 23 Appendix 1: Company overview...... 24 Appendix 2: Key financial data ...... 29
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DFCC Bank PLC Set for growth as a single entity
DFCC Bank has emerged successful and ready for growth after the turmoil of the past two years – following the abandoned merger talks with NDB and the successful takeover of DFCC Vardhana Bank. Operating as a single entity providing both project financing and commercial banking services sets the stage for DFCC to reach its full potential as a fully-fledged banking services provider, thus laying the foundation for it to effectively compete with larger peers. Prior to the merger, DFCC Bank, which carried out the development banking business, constituted 54.1% of the gross loan book, 43.4% of funding, 49.8% of net interest income and 64.1%1 of profit before tax (as of FY15) while the rest was mostly formed by its commercial banking arm, DVB. Going forward, DFCC and DVB will operate as a single entity providing both development and commercial banking services. We believe that this would bring substantial benefits to their operations through loan growth and efficiency gains leading to improved profitability over the medium-long term, (three to five years, in our estimation). DFCC bank and DVB operationally merged their corporate banking credit divisions in FY11 while functioning as two legal entities as a legal merger was not an available option for the two banks, given the local regulatory framework. Removal of these restrictions during the implementation of the fiscal consolidation program in 2015 enabled the amalgamation of the two entities. The amalgamation results in a stronger balance sheet, which enables DFCC to attract more credit lines and funding from both local and foreign sources, in our view. Further, as a commercial bank, DFCC should be able to attract more low cost funding via deposits, resulting in a positive impact on interest expenses and, in turn, on the NIM in the long-run. The merger will also allow DFCC to tap into a larger clientele as a full-fledged banking services provider. On the expense front, the merger would result in a slight increase in the cost-income ratio alongside the gradual transformation of its delivery points to full-fledged branches over 2016E-2018E. Furthermore, we expect personnel costs to increase with training involved in 2016E.At the same time, costs should see a decline through one license fee, integrated IT systems and integrated processes, partially off-setting the cost increases.
Dual growth engines to drive the gross loan CAGR at 16.2% 2016E- 2018E We project DFCC’s loan book to grow at a healthy 16.2% CAGR over 2016E-2018E to reach LKR261.8bn by 2018E, driven by growth in both the project finance portfolio and in commercial banking. We believe that the merger would have a favorable impact on loan book growth as it continues to leverage on both development banking and commercial banking clientele through cross-selling. To facilitate this, DFCC is in the process of expanding its distribution network. Standalone DFCC and DVB branches are now under one umbrella and DFCC is converting its service points to complete branches, in addition to opening up new branches. Credit to the private sector grew 27.7% YoY in 1Q16 against 20.0% growth in the DFCC loan book. We believe DFCC has positioned itself well to capture momentum in the private sector credit growth, similar to the past.
1 Excluding LKR829m capital gain on disposal of shares of NTB.
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DFCC Bank PLC Loan book to grow in line with the private sector credit growth
YoY growth 50% 40% 30% 20% 10% 0% -10% -20% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 2015*
Gross loan growth Private sector credit growth
Source: DFCC, CBSL Note: *YTD growth
Currently, DFCC’s gross loan book stands at LKR170.5bn (as of 1Q16). DFCC’s gross loan portfolio grew at a 17.7%2 CAGR over FY14-20153 to LKR166.7bn driven mainly by the growth in term loans. Term loans contributed 73.3% to the gross loan book growth over the same period. On average, term loans contributed 58.6% to total gross loans over FY14-2015. As of 2015, project loans constituted around 60.0% of term loans; overdrafts and trade finance for 14.6% and 11.2% respectively. Higher risk loans such as pawning represented less than 1.0% of the loan book. Leasing and HP loans shared 9.3% of the loan portfolio in 2015, but saw a 0.5% QoQ decline in 1Q16 due to rapidly increasing vehicle prices.
Term loans contributed average 73.3% to gross loan … and contributed 61.3% to gross loans in 2015 growth over FY14-2015
Contribution Other to growth% Asset backed loans 2% 100% 2% 80% Lease & HP 9% 60% 40% Trade finance 11% 20% Term loans 61% 0% -20% FY12 FY13 FY14 FY15 2015* Overdrafts 15% Term loans Overdrafts Trade finance Lease & HP Asset backed loans Other
Source: DFCC Source: DFCC Note: *YTD growth The high percentage of term loans on DFCC loan book reflects the nature of its development banking business. However, we expect DFCC to see better diversification in terms of types of loans, with the expansion in its commercial banking business. On a positive note, DFCC’s loan portfolio is well- diversified across multiple industries, with non-manufacturing sectors accounting for over 70.0%. This too would help stable and sustainable loan growth.
2 Higher historical gross loan CAGR of 17.7% is due to its lower base of LKR106.5bn in FY13. 3 CAGR over FY14-2015 for all balance sheet and income statement items, refers to CAGR over 01 April 2013 to 31 December 2015 period (2.75 years). This is due to the change in financial year end from March 31 to December 31 in 2015.
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DFCC Bank PLC
Loan book is well diversified across different sectors Market share maintained well above 3.0%
Others Market YoY 12% share % growth Consumer durables 5% 60% 3% Manufacturing Transport 24% 3.8% 4% 3.5% 3.6% 3.5% 3.5% 3% 3.2% 3.4% 3.3% 40% Fin. & business serv 3% 4% 20% Tourism 2% 5% 1% 0% Infrastructure 7% Trading 0% -20% 22% FY09 FY10 FY11 FY12 FY13 FY14 FY15 2015* Construction 9% Agriculture & fishing Market share (RHS) DFCC loan growth (LHS) Industry loan growth (LHS) 11%
Source: DFCC Source: DFCC, CBSL Note: *YTD growth In terms of the clientele, the group’s loan book is broadly equally split between Corporate and small and medium scale enterprise (SME) clients. This even split helps DFCC to manage the risks and rewards of the two businesses effectively, in our view. DFCC managed to maintain its market share4, in terms of gross loans, at over 3.0%. DFCC’s loan book recorded 17.3% YTD growth in 2015, during a period when the industry average was at 15.5%. We expect to see a similar growth trend going forward, aided equally by DFCC’s project financing and commercial banking businesses.
Project finance business to fuel loan growth The project financing portfolio grew 12.8% CAGR over FY14-2015 while the gross loan portfolio grew 17.7% CAGR over the same period. DFCC’s project financing business facilitates both corporates and SMEs through term loans, finance leases, investment securities and guarantees. Currently, the total project financing portfolio stands at LKR90bn5 and accounts for 54.0% of DFCC’s total gross loans (as of 2015).
Project finance loans growth tracks gross loan growth …and on average, accounted for 60% of gross loans
YoY LKRbn % growth 100 80% 67% 65% 65% 54% 50% 63% 61% 59% 80 55% 40% 60% 30% 60 20% 40% 10% 40 0% 20% 20 -10% -20% 0 0% FY10 FY11 FY12 FY13 FY14 FY15 2015* FY09 FY10 FY11 FY12 FY13 FY14 FY15 2015 Project financing portfolio (LHS) Gross loan growth Project financing portfolio growth Share of gross loans (RHS)
Source: DFCC Source: DFCC, Copal Amba estimates for FY15 and 2015 Note: *YTD growth
4 Banking industry comprised of both licensed commercial banks (LCBs) and licensed specialized banks (LSBs). 5 Copal Amba estimates using available information.
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DFCC Bank PLC Post-conflict, Sri Lanka witnessed stronger GDP growth facilitating industry and services sectors to improve their businesses through an investor friendly operating environment. This led to a steady growth in the project financing business particularly in SMEs, which in turn, has the ability to create more job opportunities, reduce poverty and to support achieving higher and sustainable economic growth. According to the Ministry of Industry and Commerce, the SME sector gradually increased the contribution to GDP from 40.0% in 2013 to 52.0% in 2014 accounting for more than 75.0% of local enterprises and providing 45.0% of employment opportunities. Timely and adequate funding is a key requirement for SMEs in order to grow their businesses. The government of Sri Lanka with the assistance of international borrowing agencies continuously encourage local financial institutions to provide required funding for SMEs. The government has outlined the National Policy Framework for SME Development with the aim to support the establishment of globally competitive and sustainable SMEs. In the 2016 Budget, the government proposed to implement a Credit Guarantee Scheme for micro, small and medium scale enterprises (MSMEs) in 2016 with LKR500m as the initial capital under which 75.0% of defaulted principal amount will be guaranteed. During 2015, the ADB provided an USD100m credit line for the SME sector through participating financial institutions. With the required infrastructure in place and with the continuous government backing, we expect the SME sector to see notable growth in the medium- to-long term. We believe that DFCC’s development banking business has the ability derive benefits from the improving SME sector through its competitive edge over its peers in two main ways. . Access to long-term funding We believe that DFCC is better positioned to access to long-term funding relative to its peers. Most commercial banks and small and medium scale development banks have limited access to long-term credit lines preventing them from aggressively competing in the project financing market. Furthermore, such small and medium scale development banks do not possess the necessary expertise and infrastructure to facilitate obtaining or disbursing long-term funding. DFCC therefore has a strong competitive edge in this segment, particularly due to its strong balance sheet, further strengthened through the merger with DVB. . Expertise in project financing DFCC possesses expertise and experience in project financing, built over nearly 40 years. It makes significant investment in human capital starting from the point of recruiting with a systematic procedure to up-skilling employees by providing timely training opportunities. Further, the merger with DVB has provided DFCC a staff trained in commercial banking, which means less investment in project finance training over new recruits would be required. We believe that DFCC could effectively capitalize on their expertise on development banking to improve the project financing portfolio.
Effect of lagged disbursements set to kick in DFCC had undrawn approved project loans of LKR49bn6 by December 2015. The time lag between loan approval and actual disbursement is relatively long, which is an inherent characteristic of project financing. Hence, current loan approvals are an indication of the loan book growth in the subsequent year. Thus, the 38.9% YoY improvement in project loan approvals in 2015 indicates the room for substantial loan growth in 2016E. Over FY14-2015, project loan approvals recorded growth at a 31.0% CAGR whilst the project financing portfolio and gross loans grew at a 12.8% and 17.7% CAGR respectively.
6 Copal Amba estimates
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DFCC Bank PLC
Approved loan growth translates into gross loan growth with a lag
YoY growth 120% 90% 60% 30% 0% -30% -60% FY10 FY11 FY12 FY13 FY14 FY15 2015*
Gross loans growth Approved loans growth
Source: DFCC, Copal Amba estimates for FY15 and 2015 Note: *YTD growth
Commercial banking business gaining momentum DFCC offers commercial banking services to corporates, SMEs and individuals. We expect the commercial banking business to give further support to the loan book growth. Since FY04, with the introduction of commercial banking business, the bank has improved its presence in consumer lending as well. This is evident by the gradual decrease of the share of project financing loans to total loans (Figure 7) and the simultaneous increase in commercial banking loans’ contribution to growth.
Commercial banking business’s contribution to gross loan growth has significantly improved except in FY15
Contribution to growth % 100% 11% 20% 80% 34% 43% 56% 60% 81% 73%
40% 89% 80% 66% 57% 20% 44% 19% 27% 0% FY10 FY11 FY12 FY13 FY14 FY15 2015 Project financing Commercial banking
Source: DFCC, Copal Amba estimates for FY15 and 2015
Pre-merger, DVB’s loan book grew at a 24.0% CAGR 2012-2014, comfortably outpacing sector growth at 14%, albeit on a lower loan book base. Its loan book mainly consisted of lending to corporates and SMEs for commercial purposes.
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DFCC Bank PLC We expect personal financial services (PFS) to become a key growth sector going forward due to its strategic importance to DFCC. DFCC commenced operations in PFS during FY11 providing a complete solution for individual borrowers and it is marketed under a separate brand. PFS consists of both lending and deposit products. As of 2015, the PFS portfolio stood at LKR14.0bn (up 37.0% YoY).
Since inception, PFS portfolio recorded significant growth
LKRbn YoY growth 16 0.6 14 0.5 12 10 0.4 8 6 0.3 4 0.2 2 0 0.1 2010 2011 2012 2013 2014 2015 PFS portfolio (LHS) PFS portfolio growth (RHS)
Source: DFCC, DVB
Competitive pricing to back loan growth DFCC grew its loan book substantially over FY14-2015 (at a 17.7% CAGR), with the support of competitive pricing. Its pricing strategy varies according to each client group, allowing DFCC to generate more business opportunities.
Competitive pricing assures a sustainable loan book growth
Division Strategy Rationale Corporate Banking Low margins and high volume To reduce cost-per-delivery Business Banking Medium margin and medium volume To stay within risk-return thresholds Branch Banking Medium to high margins with aggressive pricing To acquire new relationships and continued focus on SMEs
Source: DFCC
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DFCC Bank PLC DFCC has better access to long-term funding
More than 60.0% of DFCC’s funding sources are long-term. DFCC has four main sources of long- term funding, a decisive factor in development banking. . Borrowings from international financing agencies (credit lines) . Bonds and debentures . Deposits . Loan repayments
Most of DFCC’s funding sources are long-term; 40.0% of interest bearing funding payable after one year (as of 2015)
LKRbn 90 40% 80 70 60 50 21% 19% 40 30 13% 20 7% 10 0 >3 months 3-12 months 1-3 years 3-5 years >5 years
Source: DFCC
Borrowings from international financing agencies a main source of long-term funding DFCC historically obtained funds required for its long-term project lending mostly through international development financial agencies. However, its dependency on international credit lines is declining, along with a simultaneous increase in time deposits, which we view positively. In 2015, funds obtained through international credit lines accounted only for 13.3% of total interest bearing liabilities.
DFCC’s dependency on international credit lines is decreasing
% 100% 19% 23% 27% 28% 27% 26% 26% 19% 25% 28% 80% 4% 11% 12% 6% 7% 11% 11% 10% 12% 11% 60% 33% 23% 31% 30% 31% 47% 50% 41% 46% 45% 40% 8% 7% 7% 7% 5% 3% 2% 20% 42% 12% 13% 14% 38% 34% 37% 38% 30% 32% 19% 15% 13% 0% FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 2015 International credit lines Debentures Time deposits Other deposits Other borrowings
Source: DFCC
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DFCC Bank PLC While the fund sourcing is a decisive factor, fund utilization is also a crucial factor in development banking. The funds obtained from these international agencies are repayable in 10-15 years’ time on average while DFCC grants project loans to their customers to average six years’ tenure. Therefore, DFCC is able to reuse these international long-term credit lines 2.0-2.5x before repaying. As a result, we believe that DFCC enjoys an advantage over its peers, particularly commercial banks, whose main funding source is term deposits with average five years’ tenure.
DFCC has successfully negotiated with international borrowing agencies to fund their long-term lending over the years
Period Credit line Borrowing agency Amount Fund utilization Purpose FY97 Energy Services Delivery International Development USD19.7m (credit) Completed Energy services Project Association (IDA) Global Environment Fund (GEF) USD3.8m (grant) FY97 Renewable Energy for Rural International Development USD115m (credit) Completed in FY12 Energy services Economic Development Association (IDA) (RERED) Project Global Environment Fund (GEF) USD8m (grant) EIB Global Loan 1 EIB EUR40m Completed SMEs and health and climate change mitigation projects FY08 EIB Global Loan 2 EIB EUR50m Completed SMEs and health and climate change mitigation projects FY08 Post Tsunami Line of Credit - European Investment Bank (EIB) EUR60m Completed in FY10 Private sector companies Contract A affected by the 2004 Tsunami FY09 DFCC V Credit Line for SME Kreditanstalt fur Wiederaufbau EUR5m Completed in FY12 SMEs in the North and the East (KfW) FY11 na Nederlandse USD15m na na Financierings–Maatschappij Voor Ontwikkelingslanden N.V (FMO) FY12 na Asian Development Bank (ADB) USD15m USD7.5m is utilized in Housing FY14 USD7.5m was availed in 2015 FY12 na German development financing USD30m na na institution (DEG) FY13 12-month offshore na USD45m na na commercial syndicated loan FY14 SME & Green Energy Global European Investment Bank (EIB) EUR90m LKR5.7bn utilized in 70% for SMEs and 30% Loan 2015 for green energy initiatives
Source: DFCC
Despite the risk of losing certain funding lines due to improved economic conditions, as the country moves towards middle income status, international credit lines are still available (eg. to fund green/renewable energy projects.
EIB SME & Green Energy Global Loan credit line In March 2014, the government of Sri Lanka and EIB appointed DFCC to administer a EUR90m credit line from EIB. DFCC is one of the three participating banks of the credit line along with the Commercial Bank of Ceylon PLC (COMB) and the Regional Development Bank. The credit line is deployed in the SME sector as well as in green energy initiatives (renewable energy and energy efficient projects). 70.0% of funds has been allocated to the SME sector and the balance 30.0% is allocated to green energy initiatives. The credit line is obtained at a low fixed interest rate for a longer repayment period making the credit line more attractive. By end of 2015, DFCC disbursed LKR5.68bn out of this credit line while all three participants disbursed LKR6.74bn (EUR42.46m) or 47.2%. By November 2015, the entire EUR90m
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DFCC Bank PLC (LKR14.65bn) credit line was allocated between 167 customers through their participating banks and the remainder of the loan will be disbursed during 2016E.
DFCC secured long-term funding through local and international bond and debenture issues DFCC was able to raise a significant amount of funding through debenture issues, in additions to international credit lines. DFCC offered its first international bond issue worth of USD100m in FY14.
DFCC’s local and international debenture issues
Year Bond Amount Maturity Coupon rate FY06 Local LKR40m 5 years 6M net T-bill + 2.000% Local LKR170m 5 years 6M gross T-bill + 1.000% Local LKR200m 5 years 13.750% Local LKR500m 5 years 6M gross T-bill + 1.000% Local LKR590m 10 years 14.000% Local LKR1bn 5 years 15.54% FY08 Local LKR200m 5 years 6M gross T-bill + 1.000% Local LKR500m 5 years 6M gross T-bill + 1.000% FY12 Local LKR833m 5 years 11.500% Local LKR167m 5 years 6M gross T-bill + 1.500% FY13 Local LKR36.4m 2 years 16.000% Local LKR506m 3 years 16.500% FY14 International USD100m 5 years 9.625% FY15 Local LKR5bn 3 years 8.360% 2015 Local LKR3bn 5 years 9.100% Local LKR2bn 5 years 9.400% 2016 Local LKR5.3bn 3 years 10.625%
Source: DFCC
Improving retail banking business facilitates low cost funding DFCC’s growing deposit base has helped them to limit the dependency on borrowings from international financing agencies. Being a commercial bank, DFCC now has the ability to raise low cost funding through attracting more savings and demand deposits. As of 2015, DFCC had total deposits of LKR110.6bn, (from LKR45.7bn in FY12) out of which 80.7% were term deposits. As a result of the improved deposit base, the contribution from multilateral and bilateral lenders to DFCC’s total interest bearing liabilities decreased to 13.3% in 2015 from 30.2% in FY12. In the meantime, the proportion of customer deposits has grown to 55.9% in 2015 from 50.7% in FY12.
Continuous loan repayments ease the stress on funding even further Flow of funds in the form of loan repayments is DFCC’s next source of funding. On average, repayments amounts to more than 50.0% of the total disbursements during the year. Therefore, DFCC has the ability to reuse these loan repayments for long-term lending, allowing to recycle the funds. In addition to the aforementioned, two other sources of funding available for DFCC, in our opinion.
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DFCC Bank PLC . DFCC has the ability to tap in to its investments equity market, primarily its 15.0% investment in COMB valued at LKR15.5bn (June 2016). . DFCC’s leverage of 4.2x as at 2015, measured as Risk Weighted Assets (RWA) over shareholders’ equity, is the lowest in the sector which averaged 6.8x during the same period. This low leverage situation allows room for DFCC to comfortably raise further debt if necessary.
CASA ratio to expand with an uptick in deposits We project DFCC’s deposit base to improve at an 18.2% CAGR over 2016E-2018E as a result of the growing retail banking business. As a licensed commercial bank, DFCC now has the opportunity to attract more savings and current accounts. However, the increasing interest rate regime could limit the CASA improvement. As a result, we expect CASA ratio to witness a 2.3ppts expansion through 2018E to 21.4% from 19.0% in 2015. This should translate into lower funding costs over our explicit forecast period.
Higher CASA to result in lower cost of funds through 2018E
CASA ratio Cost of funds 30% 14.0% 25% 12.0% 10.0% 20% 8.0% 15% 6.0% 10% 4.0% 5% 2.0% 0% 0.0% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 2015* 2016E 2017E 2018E
CASA ratio (LHS) Cost of funds (RHS)
Source: DFCC, Copal Amba estimates Note: *2015 cost of funds is annualized.
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DFCC Bank PLC Stronger NIMs and efficiency gains to drive ROE recovery
DFCC was able to achieve loan book growth at a 17.7% CAGR over FY14-2015 resulting in net interest income growth at a 7.4% CAGR7 over the same period. The NIM witnessed a drop of 147bps to 4.2% mainly owing to the late repricing of the majority of borrowings at a low interest rate regime. We expect DFCC to utilize their expertise in development banking while improving its commercial banking business to grow the loan portfolio at a 16.2% CAGR over 2016E-2018E. We expect to see improved CASA translating into better NIM alongside recovering interest rates and project NIM enhancement of 95bps to 5.0% over 2016E-2018E. DFCC should, in our view, be able to improve cost efficiencies through 2018E. We expect EPS growth at a 39.6% CAGR8 over 2016E-2018E, which, in turn, should push the ROE up to 11.7% in 2018E.
Net interest income growth through improving gross loan book assisted by recovering interest rates
YoY growth NIM 50% 7% 40% 30% 6% 20% 5% 10%
0% 4% -10% -20% 3% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 2015* 2016E 2017E 2018E
Gross loan growth (LHS) Net interest income growth (LHS) NIM (RHS)
Source: DFCC, Copal Amba estimates Note: *2015 gross loan growth is YTD, net interest income growth and NIM is annualized.
Net interest income growth to drive NIM recovery We expect DFCC’s net interest income to grow at CAGR of 22.8% over 2016E-2018E9 compared to a historical 7.4% over FY14-201510. This growth will primarily be underpinned by a 16.2% CAGR in DFCC’s gross loans. We forecast DFCC’s NIM to improve to 5.0% over the forecast period from 4.1% in 2015, owing to the recovery of interest rate regime. In 1Q16, DFCC’s NIM declined 55bps YoY to reach 3.2%, recording a new low for the company. This was primarily as a result of a lagged impact of the reduction in lending interest rates to single digit levels during 2015 from double digit levels seen previously, and the time lag in repricing in the long- term borrowings. Unlike in most other commercial banks, DFCC’s funding sources are predominantly long-term, hence its NIM drop in 1Q16 was greater than the industry, which averaged 25bps YoY. We believe that the interest rates in the country have bottomed out. CBSL is no longer in stringent control of interest rates and market decides interest rates through free movements of money demand and supply. Interest rates are now on an upward trajectory. DFCC, similar to other local financial institutions, has historically benefitted in rising interest rate environments. However, we remain conservative in our estimates and forecast DFCC’s NIM to average 4.0-5.0% over 2016E-2018E.
7 2015 figure is annualized. 8 2015 figures contain significant one-off amalgamation costs, which was not disclosed by DFCC. 9 2015 base figure is annualized. 10 2015 figure is annualized
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DFCC Bank PLC Funding mix shift, late repricing at recovering interest rate regime push NIM expansion
% YoY growth 16% 40%
12% 20% 8% 0% 4%
0% -20% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 2015* 2016E 2017E 2018E
Interest income rate (LHS) Cost of funds (LHS) NIM (LHS) Net interest income growth (RHS)
Source: DFCC, Copal Amba estimates Note: *2015 figures are annualized
The shift in the funding mix will have a significant impact on the funding costs of DFCC. The majority of DFCC’s multilateral and bilateral borrowings are received at the Average Weighted Deposit Rate (AWDR). As discussed earlier, historically these foreign based funds formed a considerable share of the company’s interest bearing borrowings and DFCC did not enjoy the CASA advantage to the same extent as its peers. Over FY07-FY11 period, customer deposits accounted for 30-40% of total interest bearing liabilities compared to other LCB average of 75-80%. However, we expect a gradual shift in DFCC’s borrowing mix towards customer deposits as a result of the improving retail banking business. DFCC’s borrowings mix has changed gradually as customer deposits, which are usually lower cost funds, account for 55.9% (2015) at present. Accordingly, DFCC’s average cost of funds fell to 6.7% in 2015 from 7-12% over FY07-FY11 period. In line with DFCC’s growth in customer deposits in a recovering interest rate environment, we forecast the average cost of funds at around 6.7% over 2016E-2018E.
Non-interest income to improve further in line with business growth We expect DFCC’s non-interest income to grow at a CAGR of 5.0% over 2016E-2018E11 compared to its historical CAGR of 13.7% over FY14-201512. DFCC’s non-interest income has traditionally accounted for 20.0-30.0% of total banking income and principally includes net fee and commission income as well as gains from investments. As a percentage of average total assets, it yielded 1.3% in 2015 compared to 1.2% in FY14. Fee income is generated largely through trade finance and commercial banking services. It also includes consultancy fees earned from overseas assignments. DFCC has been able to grow its net fee and commission at a CAGR of 31.8% over FY14-201513 in line with gross loan growth. In our view, DFCC should be able to leverage its development banking customer base to grow its non- interest income/ fee business and we expect improving business volumes to support fee income growth. Hence, we forecast conservative growth in net fee and commission income over 2016E-2018E, at a 7.5% CAGR, in line with our gross loans forecast.
11 2015 base figure is annualized. 12 2015 figure is annualized. 13 2015 figure is annualized.
14 A capital market development initiative by the Colombo Stock Exchange in association with Copal Amba
DFCC Bank PLC Non-interest income to improve further with business volume growth
LKRbn Yield 4 3.0%
3 2.0% 2 1.0% 1
0 0.0% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 2015* 2016E 2017E 2018E
Non-interest income (LHS) Yield on total assets (RHS)
Source: DFCC, Copal Amba estimates Note: *2015 non-interest income is for nine months and 2015 yield on total assets is annualized.
DFCC has the best CIR in the industry In 1Q16, DFCC recorded the lowest CIR of 39.0% compared to its peers due to lower staff expenses. DFCC was able to maintain a lower CIR compared to the industry over the years except for 2015, mainly due to the one-off costs related to the amalgamation. DFCC reported 55.0% CIR in 2015, the highest reported in history. Since FY12, CIR recorded a gradual incline mainly as a result of expansion in operations, in terms of employees, branches and technology. However, we expect to see CIR return to 39.6% over 2016E-2018E due to enhanced efficiency alongside top line improvement.
DFCC’s CIR is the lowest in the industry in 1Q16 Timely investment in human capital has yielded better results
CIR LKRm/emplo yee/month 60% 1.0 55% 0.8 50% 0.6 45% 0.4 40% 0.2 35% 0.0 30%
Average revenue Average staff cost Average operating profit DFCC Industry
Source: DFCC, CBSL, Copal Amba estimates Source: DFCC, Copal Amba estimates Note: *Non-interest expenses includes one-off amalgamation costs Note: *Staff cost and operating profit include the impact of one-off amalgamation costs
As is common in the banking industry, staff cost is a significant proportion of DFCC’s operating expenses. On average, staff costs accounts for more than 50.0% of non-interest expenses of DFCC. On average, an employee generated around LKR0.5m revenue over FY14-2015 while the average
15 A capital market development initiative by the Colombo Stock Exchange in association with Copal Amba
DFCC Bank PLC costs (personnel expenses) per employee came in at around LKR0.1m14. We forecast staff costs to grow at an 8.5% CAGR over 2016E-2018E15.
NPL ratio to converge towards industry norms; prudent provisioning to absorb any future losses We expect DFCC’s NPL ratio to average 3.5% over 2016E-2018E compared to its historical three year average of 4.2%. DFCC’s NPL ratio is relatively higher than the industry. However, we expect the NPL ratio to converge towards the industry average as a result of improving asset quality. DFCC’s above industry NPL ratio stems from its exposure to SMEs. Approximately half of DFCC’s gross loans are lent to SMEs. The corporate development banking business is essentially a low margin operation but with good asset quality. For example, in FY15, the NPL ratio of corporate project loans stood at 0.08% (0.4% in FY14) and this helped the business offset the relatively high NPL ratios of the SME business (4.5% in FY15 and 5.5% in FY14). The total development banking portfolio’s NPL ratio stood at a low 2.01% in FY15.
NPL ratio to converge towards the industry average Impairment cover to rise with improving asset quality
NPL ratio Impairment Impaired cover ratio 10% 90% 8.0% 8% 85% 6.0% 6% 80%
4% 75% 4.0% 70% 2% 2.0% 65% 0% 60% 0.0% FY12 FY13 FY14 FY15 2015* 2016E 2017E 2018E Impairment cover (LHS) Impaired ratio (RHS) DFCC LCB Industry
Source: DFCC, CBSL, Copal Amba estimates Source: DFCC, Copal Amba estimates Note: NPL ratios for LCBs and industry is kept constant.
DFCC has a well-diversified loan book as shown in figure 4, with exposure to growing industries such as manufacturing, financial services, trade and construction. Its exposure to the pawning business is less than 1.0% compared to the LCB average of 2.8%. Under SLFRS, DFCC’s impaired loans ratio improved to 5.1% in 2015 from 6.1% in FY15, while impairment cover increased to 72.1% from 69.4% during the same period. During FY15, around LKR1bn was written off as unrecoverable debt resulting in lower provisioning. However, we expect the impairment cover to improve with adequate provisioning and the declining impaired loans ratio. DFCC has made adequate provisioning for loan impairment over FY08-2015. Cost of risk16 was maintained at 0.5-1.0% levels in general except in FY09 and FY15. In FY15, nearly LKR1bn of collective impairment charge was reversed and written back to the income statement while in FY14, LKR1.2bn of impairment was charged to the income statement due to a change in DFCC’s impairment evaluation process. We project DFCC to maintain impairment charges at an average 0.7% of gross loans.
14 Average cost has been calculated excluding staff costs in 2015, which has a one-off impact through amalgamation. 15 2015 base figure is annualized. 16 Impairment charge as a % of gross loans.
16 A capital market development initiative by the Colombo Stock Exchange in association with Copal Amba
DFCC Bank PLC Improved asset quality to bring down cost of risk
LKRbn Cost of risk 1.8 1.4% 1.6 1.2% 1.4 1.0% 1.2 1.0 0.8% 0.8 0.6% 0.6 0.4% 0.4 0.2 0.2% 0.0 0.0% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 2015* 2016E 2017E 2018E
Impairment charge (LHS) Cost of risk (RHS)
Source: DFCC, Copal Amba estimates Note: *2015 impairment charge is annualized.
2018E forecasts - LKR21.80 EPS and ROE recovery to 11.7% We project DFCC to achieve 16.2% gross loan growth translating into 5.0% NIM through 2018E. Coupled with lower credit costs and improving CIR, we expect DFCC to achieve an EPS CAGR of 39.6% over 2016E-2018E17. In 2015, DFCC’s EPS came in at LKR6.01, down 39.9% YoY18, as a result of one-off amalgamation costs. DFCC has historically achieved an average ROE of 10.0% over FY08-FY15, largely due to DVB’s profitability. In 2015 DFCC’s ROE saw a steep decline to 4.6%19, owing to amalgamation costs. We forecast DFCC to improve ROE to 11.7% in 2018E with improving operating results. We expect the higher returns generated from commercial banking to be a significant contributor to this profitability. In 1Q16, DFCC showed early signs of recovery, reporting 9.0% ROE.
DVB has contributed most to the group’s ROE in recent years
% 16%
12%
8%
4%
0% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15
DVB DFCC standalone Group
Source: DFCC
17 2015 base figure is annualized. 18 2015 figure is annualized. 19 2015 net profit is annualized.
17 A capital market development initiative by the Colombo Stock Exchange in association with Copal Amba
DFCC Bank PLC DFCC is well capitalized; requires further improvement in Tier II capital
DFCC has maintained capital ratios well above the minimum regulatory requirement over the years, though the capital adequacy ratios have gradually come down as a result of steeper growth in risk weighted assets. DFCC’s Tier I ratio stood at 15.4% in 2015 and total CAR ratio stood at 15.3%. DFCC’s total CAR ratio is less than the Tier I ratio due to weak Tier II capital. At present, DFCC does not have sufficient amount of qualifying general provisioning or qualifying debt. In 2015, DFCC increased Tier II capital levels through raising debt. We expect that DFCC should be able to mitigate this issue through future debt issuances, and to improve their capital adequacy ratios mainly through profitability growth.
DFCC capital levels are well above the regulatory thresholds
% 30% 25% 20% 15% 10% 5% 0% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 2015 2016E 2017E 2018E
Tier I ratio CAR ratio Minimum Tier 1 ratio Minimum CAR ratio
Source: DFCC, Copal Amba estimates
In March 2015, CBSL set guidelines to LCBs on liquidity coverage ratios (LCR)20, which are required to be fully implemented by December 2018, and were due to commence from April 2015. Accordingly, LCBs need to improve their LCR from minimum 60.0-100.0% over this period. Further, CBSL expects to impose regulations on Basel III and leverage ratio with an intention to strengthen the capital buffers of LCBs.
20 LCR = Stock of high quality liquid assets (HQLA)/ Total net cash outflows over the next 30 calendar days
18 A capital market development initiative by the Colombo Stock Exchange in association with Copal Amba
DFCC Bank PLC We establish a 12-month valuation range of LKR127-156 for DFCC’s shares
We arrive at a 12-month valuation range of LKR127-156 for DFCC’s shares, given our outlook on its financial performance and recovering ROE. The current share price of DFCC stands at LKR129, closer to its 52-week lowest share price. We have established the target price using historical P/BV multiple based valuation while validating it further through historical P/E multiple based valuation. In addition, we cross-checked our valuation against the domestic peer group.
Our valuation range analysis suggests LKR127-156 per share (current share price: LKR129)
129
Historical P/BV 127 156
Historical P/E 127 155
52-week range 128 204
120 145 170 195 220
Source: DFCC, Bloomberg, Copal Amba estimates
P/BV analysis yields a 12-month valuation range of LKR127-156 per share We use a historical P/BV multiple based method as our primary valuation methodology. At peak levels, DFCC traded at 1.4x 12-month forward P/BV in October 2014, along with the uptick in loan and earnings growth in the banking sector. Trading multiples tanked after peak valuations owing to the decline in gold prices coupled with the decline in capital markets, coming down to trough levels of 0.8x in July 2012. DFCC shares are now trading again at its lowest valuation levels of 0.8x 12-month forward P/BV.
DFCC has traded at between 0.8x-1.4x on a P/BV basis for the last 4 years
LKR/share 300
250
200
150
100
50 Jun-12 Oct-12 Feb-13 Jun-13 Oct-13 Feb-14 Jun-14 Oct-14 Feb-15 Jun-15 Oct-15 Feb-16 Jun-16 0.8x 0.9x 1.1x 1.2x 1.4x Share price
Source: DFCC, Bloomberg, Copal Amba estimates
19 A capital market development initiative by the Colombo Stock Exchange in association with Copal Amba
DFCC Bank PLC DFCC is currently trading at a 0.8x 12-month forward P/BV multiple, at a 29.7% discount to its 2-year average of 1.1x. Given the favorable mid-to-long term outlook for DFCC and its capacity to improve financial performance and, in turn, provide stronger shareholder returns, we expect the stock to re- rate upwards within the next 12-months. We conservatively consider a 0.9x P/BV multiple for our base case valuation, well below the 2-year average multiple of 1.1x, which yields a 12-month target price of LKR141 for DFCC. Our bull case considers earlier than expected improvements in loan growth, faster recovery of interest rates and faster funding mix shift towards low cost deposits; in which case we expect the stock to rerate at a higher 1.0x P/BV multiple yielding a share price target of LKR156. Further, as our bear case, we consider the price impact of the stock continuing to trade at a 0.8x P/BV multiple, based on slow GDP growth and credit growth, unclear policy measures, lower business volumes and higher loan losses. Our sensitivity analysis provides a valuation range of LKR127-156 per share.
P/E analysis produces a 12-month valuation range of LKR127-155 per share We have considered P/E multiples based valuation to support our opinion on DFCC share prices. The DFCC share traded at a range of 8.5x-18.5x 12-month forward P/E multiples over the past four years. Currently, it’s trading at a 7.8x 12-month forward P/E multiple.
DFCC has traded at between 8.5x and 18.5x on a P/E basis over the last four years
LKR/share 300
250
200
150
100
50 Jun-12 Oct-12 Feb-13 Jun-13 Oct-13 Feb-14 Jun-14 Oct-14 Feb-15 Jun-15 Oct-15 Feb-16 Jun-16
8.5x 11.0x 13.5x 16.0x 18.5x Share price
Source: DFCC, Bloomberg, Copal Amba estimates Note: P/E multiple bands around December 2015 has bottomed out due to lower EPS resulted through one-off amalgamation costs
We used a 1 year average P/E multiple of 10.6x as our base case as the 2 year average P/E multiple is distorted by the lower EPS recorded in 2015 as a result of one-off amalgamation costs. On a more conservative note, we expect DFCC share to trade at an 8.6x 12-month forward P/E resulting in a 12-month target price of LKR141 per share. With our bear case assumption of 7.7x and bull case assumption of 9.5x, the share should trade at a valuation range of LKR127-155.
Lower ROE explains discounted multiples DFCC has historically traded at a discount to its peer multiples mainly due to its lower-than-peer ROE. Over FY11-2015, DFCC has traded at an average 1.0x P/BV compared to its peer average 1.3x P/BV. We expect to see ROE recovery at DFCC with which the discount should narrow and d trade at a higher multiple.
20 A capital market development initiative by the Colombo Stock Exchange in association with Copal Amba
DFCC Bank PLC DFCC has historically traded at a discount to its peers
Company P/BV P/E FY15 2015 2016E 2017E 2018E FY15 2015 2016E 2017E 2018E DFCC 1.1x 1.0x 0.8x 0.7x 0.7x 15.2x 28.1x 9.1x 7.4x 5.9x 2014 2015 2016E 2017E 2018E 2014 2015 2016E 2017E 2018E COMB 2.1x 1.7x 1.5x 1.3x 1.2x 13.1x 10.4x 8.8x 8.0x 7.9x HNB 1.2x 1.1x 1.1x 1.0x 0.9x 8.0x 8.1x 7.3x 6.3x 6.0x SAMP 1.2x 1.1x 0.9x 0.8x 0.7x 7.7x 6.5x 5.5x 4.9x 4.3x NDB 1.5x 1.1x 0.9x 0.8x 0.8x 9.9x 9.0x 7.0x 6.0x 5.4x SEYB 1.3x 1.3x 1.1x 1.0x 0.9x 10.3x 8.5x 7.8x 6.8x 6.8x NTB 1.6x 1.3x 1.0x 0.9x na 8.8x 7.6x 6.3x 5.5x na PABC 1.6x 1.4x 1.3x na na 18.4x 7.7x 8.3x 7.4x na
Source: DFCC, Bloomberg, Copal Amba estimates
…which explained by the lower ROE and ROA
Company ROE ROA FY15 2015 2016E 2017E 2018E FY15 2015 2016E 2017E 2018E DFCC 8.0% 4.6% 8.6% 10.1% 11.7% 1.8% 0.9% 1.4% 1.5% 1.7% 2014 2015 2016E 2017E 2018E 2014 2015 2016E 2017E 2018E COMB 16.9% 16.7% 17.6% 17.4% 15.4% 1.6% 1.4% 1.4% 1.4% 1.3% HNB 15.7% 14.7% 15.3% 15.9% 15.1% 1.8% 1.6% 1.6% 1.6% 1.4% SAMP 15.9% 18.0% 18.0% 17.8% 17.6% 1.3% 1.4% 1.3% 1.3% 1.3% NDB 15.8% 12.6% 12.9% 14.7% 15.3% 1.7% 1.2% 1.2% 1.3% na SEYB 13.3% 15.0% 14.7% 15.4% 14.6% 1.4% 1.4% 1.4% 1.4% 1.3% NTB 19.6% 19.8% 18.0% 17.4% 17.2% 1.6% 1.7% 1.6% 1.7% 1.7% PABC 9.5% 19.8% 21.5% na na 0.6% 1.1% 1.2% na na
Source: DFCC, Bloomberg, Copal Amba estimates
21 A capital market development initiative by the Colombo Stock Exchange in association with Copal Amba
DFCC Bank PLC Share price performance
DFCC shares closed at LKR128.80 on 28 June 2016 recording a steep decline of 35.5% YoY, compared to 14.9% YoY decline in S&P SL20 index and 10.1% YoY decline in the All Share Price Index (ASPI). However, in terms of the share performance over the last three years, DFCC was able to outperform the market by a wider margin.
DFCC has outperformed the market over the last three years
% 180%
160%
140%
120%
100%
80% Jun-13 Oct-13 Feb-14 Jun-14 Oct-14 Feb-15 Jun-15 Oct-15 Feb-16 Jun-16 DFCC ASPI S&P SL 20
Source: CSE, Bloomberg
DFCC vs. key indices over last three years
3m 6m 1 year 2 years 3 years DFCC -7.9% -20.8% -35.5% -19.0% -6.3% S&P SL 20 3.9% -7.5% -14.9% -5.7% -3.3% ASPI 4.0% -7.6% -10.1% -0.9% 3.0%
Source: CSE, Bloomberg
22 A capital market development initiative by the Colombo Stock Exchange in association with Copal Amba
DFCC Bank PLC Earnings release focus areas
Following is a checklist of items that investors should track in the next quarterly earnings release and subsequent releases. We will closely track SAMP’s performance across these key areas, revise our forecasts and update our valuation range in future earnings update notes.
Focus areas on company specific data 1. Loan book growth: total loan book growth rate QoQ and YoY, segmental growth rates – particularly corporate loans, SME loans and personal loans; composition of the loan book 2. Pawning portfolio 3. Change in funding structure: CASA ratio, change in bank borrowings and debentures, if any 4. Net interest margin and net interest spread; composition of the net interest margin 5. Impairment levels: overall impairment and impairment levels in key segments and the provision coverage level 6. Cost – to – income ratio 7. Profit margins: operating profit margin and net profit margin 8. Dividend payout ratio 9. Capital adequacy levels – Tier 1 and Tier 2 ratios 10. Change in branch and ATM network 11. Any announcements regarding the acquisitions of NBFIs to be undertaken in view of the CBSL proposed consolidation program.
Focus areas on macroeconomic data 1. CBSL imposed policy changes – policy rates, repo rates, lending ceilings, rate ceilings etc. 2. CBSL monthly data issues - Domestic private sector credit levels, inflation, sector loan growth data etc. 3. CBSL weekly data issues - LCB prime lending rates 4. GDP, FDI inflow, Fiscal and Current Account deficits – as disclosed periodically by the CBSL
23 A capital market development initiative by the Colombo Stock Exchange in association with Copal Amba
DFCC Bank PLC Appendix 1: Company overview
DFCC is currently the third-largest listed commercial bank on the CSE, with a market capitalization of LKR35.7bn as of 17 June 2015. DFCC is a licensed commercial bank that offers a wide range of products and services in development financing and commercial banking to personal, SME and corporate customers. It operates through 79 branches and 58 service points across the country, with a group asset base of LKR256bn.
DFCC’s roots date back to 1955 as a development bank; it is now a full- fledged commercial bank DFCC Bank PLC (DFCC) was founded in 1955 as the first specialized development bank in Sri Lanka. It was incorporated by way of an act of parliament (Act No. 35 of 1955) as The Development Finance Corporation of Ceylon. DFCC was initially formed as a government initiative to support the private sector with medium and long-term finance. In 2003, DFCC acquired a 94.0% stake in National Mercantile Bank, subsequently rebranded it as DFCC Vardhana Bank PLC (DVB), and thus entered the commercial banking business. DFCC improved its stake in DVB to 99.0% in 2011. Despite being two entities, banking operations of DFCC and DVB were carried out as one business unit. In March 2014, under the financial consolidation program, DFCC entered into an MOU with NDB to amalgamate DFCC, DVB and NDB, with a mandate to form a stronger financial institution, which would have expertise in development banking and commercial banking. Subsequently, parliament amended the DFCC act, and DFCC was incorporated as a public limited company in January 2015, having been granted approval to run its business as a licensed specialized bank. However, as a result of discontinuation of the financial consolidation program, DFCC and NDB terminated the MOU in May 2015. However, DFCC decided to proceed with the amalgamation of DFCC and DVB, and, as a result, DVB was delisted from the CSE. The merger was completed in October 2015, and DFCC survived as the amalgamated entity, with a license to operate as a licensed commercial bank. DFCC changed its financial year end from 31 March to 31 December as a result of the amalgamation.21
DFCC ranks No. 9 among banks in Sri Lanka22 DFCC holds a comparatively low 3.0% share of total assets of the banking industry. Its assets base grew at a 20.6% CAGR through FY12-2015. During FY12-2015, DFCC posted growth in gross loans and advances at a 21.6% CAGR, while deposits grew at a CAGR of 35.4% through the same period due largely to growth in time deposits. DFCC’s CASA ratio stood at 19.0% in 2015, depicting a slight improvement from 18.5% in FY12. DFCC’s CASA has ranged from 14.0-21.0% during the past five years. DFCC posted net interest income (NII) of LKR6.4bn in 2015 compared with LKR6.7bn in FY15 (up 27.2% YoY23), NII grew at a CAGR of 10.7% during FY12-2015. DFCC’s NIM gradually contracted to 4.0% in FY15 from 5.9% in FY12 as a result of low interest rates. However, interest rates moved upward in 2015, resulting in a marginal improvement of the NIM to 4.2%. DFCC’s non-interest income accounted for 20-30% of its net revenue during this period, as it grew at a 10.2% CAGR over FY12-2015. Non-interest income witnessed a 7.5% YoY drop in 2015 due to
21 DFCC reported its results for the 12 months ended 31 March 2015 (FY15) and for the nine months ended 31 December 2015 (2015). 22 As of 31 March 2016, in terms of total assets, the banking industry comprises both LCBs and LSBs. 23 2015 figure is annualized.
24 A capital market development initiative by the Colombo Stock Exchange in association with Copal Amba
DFCC Bank PLC lower trading and other income. DFCC receives most of its annual dividend income during the quarter ending 31 March. The group’s CIR increased to 43.6% in FY15 from 41.7% in FY12 due to DVB’s branch expansion and increase in staff numbers, while the CIR increased notably to 55.0% in 2015 due to one-off expenses24 related to amalgamation. DFCC recorded healthy operating profit growth at an 8.9% CAGR through FY12-FY15, supported well by its top-line growth despite a slight decline in FY14 due to higher impairment charges. DFCC’s recurring net profit grew at a 14.1% CAGR through the same period, benefitting from a decline in the corporate tax rate from 35.0% to 28.0% in FY12. However, in 2015, operating profit and recurring net profit declined 23.2% and 39.9%YoY25, respectively, due to increased amalgamation expenses. Furthermore, net profit had an impact through increased income tax expenses, which included tax adjustments for the full year. DFCC reported ROE of 8.8% in FY12, which slightly decreased to 8.0% in FY15 and further declined to 4.6%6 in 2015.
The loan book grew at a 21.6% CAGR** …while deposits grew at a higher 35.4% CAGR**
LKRbn YoY LKRbn YoY growth growth 200 60% 120 80%
150 60% 40% 80 100 40% 20% 40 50 20%
0 0% 0 0% FY12 FY13 FY14 FY15 2015* FY12 FY13 FY14 FY15 2015* Term loans (LHS) Overdrafts (LHS) Current deposits (LHS) Savings deposits (LHS) Trade finance (LHS) Lease & HP (LHS) Asset backed loans (LHS) Other (LHS) Time deposits (LHS) Other deposits (LHS) Gross loans growth (RHS) Deposits growth (RHS)
Source: DFCC Source: DFCC *YTD growth, **FY12-2015 CAGR over 4.75 years *YTD growth, **FY12-2015 CAGR over 4.75 years NIM contracted due to the low interest rate regime Amalgamation resulted in lower reported ROE
LKRbn NIM CIR ROE 10 8.0% 60% 12%
8 6.0% 10% 50% 6 4.0% 8% 4 40% 6% 2.0% 2 30% 4% 0 0.0% FY12 FY13 FY14 FY15 2015* FY12 FY13 FY14 FY15 2015* CIR (LHS) ROE (RHS) Net interest income (LHS) NIM (RHS)
Source: DFCC Source: DFCC *2015 NIM is annualized *2015 ROE is annualized and FY15 figures exclude the impact from gain on disposal of shares of NTB
24 DFCC has not disclosed the amalgamation expenses incurred, which needs to be removed from the recurring profit as a one- off expenses. 25 2015 figures are annualized.
25 A capital market development initiative by the Colombo Stock Exchange in association with Copal Amba
DFCC Bank PLC DFCC’s key business units DFCC offers many banking and financing services through the following strategic business units (SBUs). Corporate banking: This unit provides mainly long-term project financing facilities to large corporate entities spread across the manufacturing, trade, construction, energy, tourism, agriculture and service sectors. Some of the products and services offered include project financing for start-ups, expansion and relocation, diversification loans, working capital loans, bridging finance, balance sheet restructuring via debt refinancing, investment via preference shares and guarantees. SME banking: This division primarily caters to SMEs in various sectors ranging from manufacturing and agriculture to tourism, healthcare, transportation and logistics and education, with project financing and medium to long-term lending. Business banking: This unit combines features of corporate banking and branch banking, serving lower-end corporate clients, higher-end SME clients and retail customers. Its offerings vary from project loans to personal financial services. Personal banking: This segment comprises lending products to individuals (pawning, leasing, credit card services, housing, personal and educational loans), private banking services (such as wealth management and priority banking) and deposit products (including current accounts, savings accounts and fixed deposits). Treasury: The treasury department offers various money-market and fixed-income products such as dual-currency deposits, Treasury bills, Treasury bonds, repos and reverse repos and Sri Lanka development bonds. International banking: This division provides a range of international banking services such as FX services, import and export services, offshore banking, international payment services and correspondent banking.
DFCC Consulting (Pvt) Ltd (DCL) DCL was established in September 2004 as a fully owned subsidiary of DFCC. The company offers consultancy services primarily in the renewable energy sector and provides services such as carrying out due diligence, financial evaluation work, sourcing and syndication of funding and locating investors or developers for identified sites. Lanka Industrial Estates Ltd (LINDEL) LINDEL is located in Sapugaskanda on 125 acres of land, in proximity to the Colombo harbor (18km) and the Katunayake international airport (25km). Currently, about 80.0% of LINDEL’s leasable land has been let to industries. DFCC has a 51.0% interest in LINDEL. Synapsys Ltd (Synapsys) Synapsys was established as a fully owned subsidiary of DFCC in October 2006. Synapsys focuses on the financial services, retail, travel and leisure industries, providing a range of services in the consulting, business solutions, managed services and disaster recovery verticals. Acuity Partners (Pvt) Ltd (Acuity Partners) Acuity Partners is an equally owned venture with Hatton National Bank PLC and was incorporated in February 2008. It is the holding company for Acuity Stockbrokers (Pvt) Ltd, Acuity Securities Ltd and Lanka Ventures PLC. Acuity Partners is an integrated investment bank that offers a comprehensive suite of products and services including stockbroking, corporate finance, fixed income securities, asset management, debt structuring, equity trading and venture capital financing. National Asset Management Ltd (NAMAL) NAMAL is a unit trust management company and was incorporated in September 1990. DFCC owns a 30.0% interest in the company.
Shareholding structure Domestic investors own 74.3% of DFCC’s ordinary shares (as of 31 December 2015), while institutional shareholders (domestic and international) hold 85.9%. Bank of Ceylon is the largest
26 A capital market development initiative by the Colombo Stock Exchange in association with Copal Amba
DFCC Bank PLC shareholder, with a 14.4% stake in voting ordinary shares, while the top 20 shareholders accounted for 86.0% of the total shareholding (as of 31 March 2016).
Domestic investors own 74.3% of DFCC, with the top Institutional investors hold 85.9% of DFCC’s shares 20 investors accounting for 86.0% of total shares
Foreign Individuals 26% 14%
Local Institutions 74% 86%
Source: DFCC Source: DFCC
The top five shareholders as of 31 March 2016 are presented below:
Name of shareholder Description Stake Bank of Ceylon – No. 2 A/C A government-owned, leading commercial bank in Sri Lanka 14.35% Hatton National Bank PLC – A/C No. 1 A leading private bank in Sri Lanka 12.22% Sri Lanka Insurance Corporation Ltd – Life Fund The largest state-owned insurance company in Sri Lanka 10.00% Employees’ Provident Fund The largest pension fund in Sri Lanka 9.19% Mr. M.A. Yaseen A domestic high-net-worth investor 7.66% Source: DFCC
Board of directors As of June 2016, DFCC’s board comprised twelve directors. Their details are provided below:
Name of Director Description Mr. C.R. Jansz Chairman/Non-executive director (NED); he was appointed to the Board of DFCC in July 2010 and appointed chairman in March 2014. He also serves on the boards of the Distilleries Company of Sri Lanka PLC, Balangoda Plantations PLC, Lanka Milk Foods (CWE) PLC and several other companies of the Distilleries Group. Mr. A.R. Fernando Chief executive officer (CEO)/ex-officio director; he has 30 years of experience in the banking and financial industry and joined DFCC in October 2013. He serves as the chairman of DFCC Consulting (Pvt) Ltd, Lanka Industrial Estates Ltd, Synapsys Ltd and Acuity Partners (Pvt) Ltd. He also serves as a director of Lanka Ventures Ltd and the Home Finance Company Ltd in Fiji. Mr. P.M.B. Fernando Senior independent non-executive director (INED); he was appointed to the Board of DFCC in July 2013. He serves as the director and CEO of Laugfs Capital Ltd and is also a member of the Financial System Stability Consultative Committee of the Central Bank of Sri Lanka. Mr. T. Dharmarajah INED; appointed to the Board of DFCC in July 2014. He is a senior partner at Messrs Amarasekera & Company and serves as a director of DVB, Raigam Wayamba Salterns PLC, TKS Finance Ltd and TKS Securities (Pvt) Ltd.
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DFCC Bank PLC Ms. S.R. Thambiayah INED; she was appointed to the Board of DFCC in March 2015. She serves as a joint managing director of Renuka hotels Ltd and Renuka City Hotels PLC. She is also a director of Cargo Boat Development Company PLC. Mr. K.P. Cooray INED; he was appointed to the Board of DFCC in March 2015. He serves as a director of Sri Lanka Telecom PLC. Mr. A.W. Atukorala INED; appointed to the Board of DFCC in April 2015. He serves as the deputy chairman of UB Finance Company Ltd and as a director of Orient Finance PLC, Bartleet finance PLC, United Motors Lanka PLC and several other companies. Mr. K.D.N.R. Asoka NED; he was appointed to the Board of DFCC in June 2015 and was nominated by the Minister of Finance. He is the director general of the Department of Trade and Investment Policy of the Ministry of Finance. He has held several senior positions in the public sector. Ms. V.J. Senaratne NED; she was appointed to the Board of DFCC in July 2015. She is the chief legal officer and company secretary of Distilleries Company of Sri Lanka PLC and Periceyl (Pvt) Ltd. Mr. A.N Fonseka NED; he was appointed to the Board of DFCC in October 2015. He is a director of John Keells Holdings PLC. He served as the CEO of DVB until September 2013 and as a director from February 2009 to September 2015. He also served as the chairman of several DFCC group companies. Mr. L.H.A.L. Silva Deputy CEO/Executive director (ED); he was appointed to the Board of DFCC in October 2015. He was the former CEO of DVB and served as a director from January 2010 to September 2015 and as the chief operating officer from 2003. He is a director of Lanka Financial Services Bureau. Mr. L.N.de.S. Wijeyeratne INED; he was appointed to the Board of DFCC in October 2015 and served as a director of DVB from October 2008 to September 2015. He serves as a director of several listed companies.
Source: DFCC
DFCC’s corporate holding structure
Corporate banking
SME banking
Business banking Banking Personal banking
Treasury
International banking
Consultancy DFCC Consulting (Pvt) Ltd (100%) DFCC Bank PLC Industrial estate Lanka Industrial Estates Ltd (51%) operation
IT services Synapsys Ltd (100%)
Investment Acuity Partners (Pvt) Ltd (50%) banking
Fund National Asset Management Ltd (30%) management
Source: DFCC
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DFCC Bank PLC Appendix 2: Key financial data
Summary group financials (LKRm) Income statement FY14 FY15 2015* 2016E 2017E 2018E (For the year ended) 31-Mar 31-Mar 31-Dec 31-Dec 31-Dec 31-Dec Net interest income 7,919 6,691 6,385 9,873 12,368 15,757 Net revenue 9,809 9,840 8,570 12,593 15,502 19,125 Operating profit 4,623 5,318 3,064 6,003 7,792 9,848 Earnings before income taxes 4,117 4,587 2,553 5,102 6,566 8,275 Net income available to equity holders 3,151 3,533 1,592 3,761 4,586 5,779
Balance sheet FY14 FY15 2015* 2016E 2017E 2018E (As at) 31-Mar 31-Mar 31-Dec 31-Dec 31-Dec 31-Dec Assets Cash and due from banks 6,072 5,386 4,316 3,759 4,313 4,950 Treasury bills & bonds 26,065 35,562 46,610 51,301 51,506 51,713 Net loans 115,595 136,088 160,573 184,837 215,765 252,164 Premises and equipment 1,272 1,238 1,238 1,224 1,208 1,184 Goodwill and intangible assets 394 436 404 373 344 317 Total assets 174,995 210,610 247,109 278,847 312,943 353,657
Liabilities Total deposits 80,917 92,712 110,551 128,665 151,262 182,458 Bank borrowings 29,720 29,183 40,089 47,266 56,365 67,638 Other borrowings 20,355 36,691 47,292 52,008 54,855 52,545 Total liabilities 134,541 162,348 203,140 234,467 265,294 301,641
Equity Common share capital 4,716 4,716 4,716 4,716 4,716 4,716 Retained earnings 9,163 12,753 11,506 14,416 17,314 21,214 Minority interest 334 354 252 354 496 675 Total equity 40,454 48,263 43,968 44,380 47,649 52,017 Total liabilities and equity 174,995 210,610 247,109 278,847 312,943 353,657 Source: DFCC, Copal Amba estimates
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DFCC Bank PLC Key ratios Key ratios FY14 FY15 2015* 2016E 2017E 2018E Growth Loan growth 15.0% 16.0% 17.3% 15.2% 16.7% 16.8% Net interest income growth 13.1% -15.5% 27.2% 16.0% 25.3% 27.4% Operating profit growth -4.2% 15.0% -23.2% 46.9% 29.8% 26.4% Net profit growth -9.8% 12.1% -39.9% 77.1% 21.9% 26.0% Recurrent diluted EPS growth -9.8% 12.1% -39.9% 77.1% 21.9% 26.0% Margins and profitability Net interest margin 5.4% 3.9% 4.1% 4.0% 4.5% 5.0% Operating profit margin 47.1% 54.0% 35.8% 47.7% 50.3% 51.5% PBT margin 42.0% 46.6% 29.8% 40.5% 42.4% 43.3% Net profit margin 32.8% 36.7% 19.2% 30.7% 30.5% 31.2% ROE 8.2% 8.0% 4.6% 8.6% 10.1% 11.7% ROA 1.9% 1.8% 0.9% 1.4% 1.5% 1.7% Capital adequacy and allocation Tier 1 ratio 18.7% 18.8% 15.4% 15.4% 15.2% 15.3% Tier 2 ratio -1.5% -1.2% -0.1% 0.0% 0.0% 0.1% Total CAR ratio 17.2% 17.7% 15.3% 15.4% 15.3% 15.3% Total equity/total assets 22.9% 22.7% 17.7% 15.8% 15.1% 14.5% Leverage ratio 15.2% 14.1% 11.5% 11.5% 11.3% 11.2% Asset quality and liquidity NPL ratio 4.6% 4.2% 3.7% 3.6% 3.5% 3.4% Impaired loans ratio 6.6% 6.1% 5.1% 5.1% 5.0% 4.8% Impairment cover 85.8% 69.4% 72.1% 73.3% 74.2% 76.8% Loans to deposit ratio 1.5x 1.5x 1.5x 1.5x 1.5x 1.4x Deposits to interest bearing funding ratio 61.8% 58.5% 55.9% 56.4% 57.6% 60.3% Valuation P/BV 0.9x 1.1x 1.0x 0.8x 0.7x 0.7x P/E 12.0x 15.2x 28.1x 9.1x 7.4x 5.9x Dividend yield 3.8% 3.0% 1.5% 4.3% 4.7% 5.0%
Per share data (LKR) FY14 FY15 2015* 2016E 2017E 2018E Reported diluted EPS 8.83 16.46 6.01 14.19 17.30 21.80 Common dividend per share 5.50 6.00 2.50 5.50 6.00 6.50 Book value per share (BVPS) 151.34 180.72 164.90 166.07 177.87 193.67 Source: DFCC, Copal Amba estimates Note: All figures are for the group unless otherwise stated. Also, we have used bank data where group data is not available. *For the nine months ending 31 December 2015 DFCC changed its reporting period to December 31 from March 31, in line with other local commercial banks, after the amalgamation with its subsidiary DFCC Vardhana Bank PLC (DVB) on 30 October 2015. Therefore, DFCC reported its results for the nine months ending 31 December 2015 YoY growth on income statement items are calculated using annualized 2015 figures while 2015 balance sheet items are YTD (from 31 March 2015 to 31 December 2015). Ratios calculated using both income statement and balance sheet items are calculated using annualized 2015 income statement figures Results reported in nine months ending 31 December 2015, includes significant costs related to the amalgamation, which should be excluded from recurring expenses and profits. However, DFCC has not reported the specific amount spent on amalgamation. When calculating historical and forecst CAGR, 2015 income statement items are annualized. Prior to the amalgamation, DFCC consolidated its results with a three month lag for December 31 ending companies. After the amalgamation, DFCC consolidates its results with a three month lag for March 31 ending companies.
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DFCC Bank PLC
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31 A capital market development initiative by the Colombo Stock Exchange in association with Copal Amba