DFCC BANK PLC
Fitch Ratings has maintained
Fitch has also maintained the bank's senior and subordinated debt ratings of 'A-(lka)' and 'BBB(lka)', respectively, on RWN.
Key Rating Drivers
RWN Maintained: The RWN on the National-Long Term Rating reflects the potential for the bank's creditworthiness relative to other entities on our Sri Lankan National Ratings scale to deteriorate. This reflects heightened near-term downside risks to its credit profile from potential capital and funding stress from the restructuring of the sovereign's debt obligations while access to foreign-currency funding remains constrained.
The resolution of the RWN with an affirmation of the ratings could result when there is further clarity around the sovereign debt restructuring process pointing to a reduction in stresses that have affected the banking sector in the past several quarters.
Debt Restructuring Weighs on Operating Environment: We believe risks to the operating environment (OE) of banks are high, even though bank holdings of rupee-denominated government securities are excluded from the sovereign's domestic-debt restructuring. This is because the banks remain exposed to the frail domestic economy and the sovereign's debilitated credit profile (Long-Term Issuer Default Rating (IDR): RD; Short-Term IDR: C), which hinders banks' operational flexibility.
The impact of the impending restructuring of the sovereign's foreign-currency denominated debt also weighs on banks' credit profiles.
OE Risks Pressure Business Profile: DFCC's business profile reflects elevated vulnerability to heightened domestic market risks, which impact the bank's ability to generate and defend business volume. Limited lending opportunities and tight liquidity, together with low capital buffers, saw DFCC's share of net loans in total assets drop to 61.6% in 1Q23, from 74.9% at end-2021, while securities investments rose to 25.5% of total assets (end-2021: 16.6%), similar to peers.
Sovereign Exposure Risk: DFCC's risk profile is constrained by its exposure to the sovereign's debilitated credit profile via its investment securities. This makes the bank vulnerable to the sovereign's repayment capacity and liquidity position. This is despite the bank holdings of rupee-denominated debt being excluded from any debt restructuring or optimisation exercise. The bank's holdings of foreign- and local-currency denominated government securities amounted to nearly 20% of assets at end-2022.
Asset Quality Woes Remain: We expect DFCC's asset-quality metrics to remain under pressure from rising impaired loans amid the challenging OE and its large exposure to the sovereign's weak credit profile through investments in foreign- and local-currency denominated government securities. We estimate that the bank's impaired (Stage 3) loan ratio reached 12.7% in 1Q23, from 11.4% at end-2022, but this is still below that of the Fitch-rated large Sri Lankan bank peer average.
Profitability Challenged: We expect DFCC's earnings and profitability to remain challenged by weakening asset quality, muted loan growth, a sharp downward adjustment of interest rates and any potential impact to earnings from the impending foreign-debt restructuring. DFCC's operating profit/risk-weighted assets ratio improved to 4.3% in 1Q23 (end-2022: 1.2%) to be among the highest of Sri Lankan Fitch-rated large banks.
Capital Buffers Under Pressure: DFCC's regulatory common equity Tier 1 (CET1) ratio of 10.0% at end-1Q23. We estimate that the ratio would have been only 57bp higher had 1Q23 profits been included; among the lowest level of Fitch-rated
Funding and Liquidity Risks Persist: We believe DFCC's funding and liquidity position is prone to sudden changes amid already-weak creditor sentiment, similar to peers. Stress on foreign-currency liquidity has somewhat eased, but access to foreign-currency wholesale funding remains constrained by the sovereign's weak credit profile. The bank's local-currency funding and liquidity position is also susceptible to any setbacks in the domestic debt restructuring exercise.
Rating Sensitivities
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
DFCC's National Rating is sensitive to a change in the bank's creditworthiness relative to other Sri Lankan issuers.
The RWN reflects rising risks to the bank's rating from funding stresses, which could lead to a multiple-notch downgrade. We expect to resolve the RWN once the impact on bank's credit profiles becomes more apparent, which may take more than six months. Developments that could lead to a multiple-notch downgrade include:
funding stress that impedes the bank's repayment ability;
significant banking-sector intervention by authorities that constrains the bank's ability to service its obligations;
a temporary negotiated waiver or standstill agreement following a payment default on a large financial obligation;
our belief that the bank has entered into a grace or cure period following non-payment of a large financial obligation.
A deterioration in DFCC's key credit metrics beyond our base-case expectations relative to peers would also increase downward pressure on the bank's rating, which is driven by its intrinsic financial strength.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
There is limited scope for a rating upgrade given the RWN. A resolution of the RWN with an affirmation could be driven by our view that risks from funding and capital stresses have abated, at both the individual bank and sector level, to the extent that the bank's ability to service its obligations in local- and foreign-currency is not hindered or that banks are able to continue as going concerns and avoid failure.
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 our criteria. This is because the issue ranks equally with the claims of the bank's other senior unsecured creditors. The RWN on the senior debt rating stems from the RWN on the National Long-Term Rating.
SUBORDINATED DEBT
DFCC's Basel II and 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 risk, as the notes do not incorporate going-concern loss-absorption features. The RWN on the subordinated debt rating stems from the RWN on the National Long-Term Rating.
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.
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