Value Creation and Internal Capital Formation
Internal Capital Formation
The value created by DFCC Bank, DBB and the Group for themselves through activities, relationships and linkages lead to the formation of capital that is internal to and ‘owned’ by these entities. While what is most visible and quantifiable is financial performance that leads to financial capital formation, internal capital also includes several intangibles that constitute institutional capital.
FINANCIAL CAPITAL
Accounting Framework
The financial statements of DFCC Bank PLC and the Group have been prepared in conformity with the requirements of Sri Lanka Accounting Standards (SLFRSs and LKASs). The SLFRS and LKASs are aligned with corresponding International Financial Reporting Standards (IFRS).
Whenever new standards or amendments to existing standards are made by The Institute of Chartered Accountants of Sri Lanka (ICASL), where appropriate, the Group changes an existing accounting policy or introduces new accounting policies. In the event of a change of an existing accounting policy, the relevant accounting standard requires retrospective application of the amended accounting policy. Thus in the current year, consequent to adoption of Sri Lanka Accounting Standard SLFRS 11 – ‘Joint Arrangements’ the investment in Acuity Partners (Pvt) Ltd, the joint venture, was accounted using the equity method and as such the comparative information has been re–stated in the statement of financial position as at 1 April 2013 (beginning of the comparative year) and 31 March 2014 (end of the comparative year). There is no impact to equity of the Bank due to this re-statement.
Overview of Financial Performance of the Group
Contribution to the financial performance of the DFCC Group, measured at profit before tax level, is from the banking group comprising DFCC Bank PLC (‘DFCC Bank’ or ‘Bank’) and its 99.17%-owned commercial bank subsidiary DFCC Vardhana Bank PLC, which are collectively referred to as DBB, Lanka Industrial Estates Limited (‘LINDEL’), a 51.2%-owned subsidiary, Acuity Partners (Pvt) Limited (‘APL’), a joint venture company jointly controlled by DFCC Bank PLC and Hatton National Bank PLC, two other subsidiaries and National Asset Management Limited (‘NAMAL’), an associate company.
Results of DFCC Vardhana Bank PLC (‘DVB’), APL and subsidiary Synapsys Limited whose financial year ends on 31 December, have been consolidated with a three-month gap.
In this review, current year means the year ended 31 March 2015 and previous year means the year ended 31 March 2014.
Composition of Group Profit before Tax
|
31.03.2015
LKR million |
31.03.2014
LKR million |
YoY
Change,
% |
| Profit before tax – DBB |
|
5,176 |
|
3,982 |
30 |
| Profit before tax – subsidiaries |
|
|
|
|
|
| – LINDEL |
150 |
|
136 |
|
|
| – APL (50% share) |
138 |
|
91 |
|
|
| – Other subsidiaries |
14 |
|
(20) |
|
|
| – Sub total |
302 |
|
207 |
|
|
| – Consolidation adjustment |
(77) |
|
(78) |
|
|
| Total, subsidiaries |
|
225 |
|
129 |
75 |
| Profit before tax, total |
|
5,401 |
|
4,111 |
31 |
| Income Tax |
|
(977) |
|
(902) |
(8) |
| Profit after tax – sub total |
|
4,424 |
|
3,209 |
38 |
| Share of profit – associate company, NAMAL |
|
15 |
|
6 |
|
Overall, the profit after tax of the Group in the financial year under review was LKR 4,439 million, an increase of 38% over the LKR 3,215 million in the previous financial year.
The total assets of the Group recorded a growth of 20% and stood at LKR 210,610 million on 31 March 2015 compared to LKR 174,995 million on 31 March 2014.
Return on Assets (ROA) was 2.3% in the current year, improved from 2.0% in the previous year.
Financial Performance of DBB
By far the largest contribution to profits and assets was from DBB, and therefore, this review will mainly focus on the performance of DBB, which is also our core business.
This commentary is based on supplementary information (non-audited) on the consolidated income and statement of financial position of DBB. This information however is derived from the individual audited financial statements.
Profit of DBB
The profit after tax of DBB in the current year was LKR 4,220 million, a 36% increase over LKR 3,102 million in previous year. DBB’s profit drivers are net interest income of the credit portfolio, dividend income, gains from sale of non-affiliated share investments, fee and foreign exchange income and management of non-interest costs.
Revenue Mix of DBB
Key Components of Income
|
31.03.2015 |
31.03.2014 |
|
LKR
million |
% |
LKR
million |
% |
| Net interest income |
6,659 |
63.9 |
7,868 |
81.8 |
| Net fee and commission income |
1,040 |
10.0 |
814 |
8.5 |
| Gain on sale of securities |
1,140 |
10.9 |
189 |
2.0 |
| Others |
1,586 |
15.2 |
738 |
7.7 |
| Total |
10,425 |
100.0 |
9,609 |
100.0 |
Net Interest Income
The net interest income was LKR 6,659 million in the current year, a 15% decrease over LKR 7,868 million in the previous year. DBB’s interest income reduced by 13% compared to the previous year while the interest expense reduced only by 11% compared to the previous year due to the time lag in repricing of the long-term borrowings. As a result the interest margin reduced to 4.1% during the year down from 5.9% achieved in the previous year.
DBB posted a healthy 18% credit portfolio growth surpassing the industry growth rate from LKR 118 million to LKR 139 million. Further commitments for unutilised credit facilities amounting to LKR 39,365 million on 31 March 2015 augur well for potential improvement in the succeeding financial year 31 March 2016.
The overall interest margins for the banking sector declined during the year. However in the case of DBB it was also as a result of an aggressive customer acquisition policy adopted during the year by DBB resulting in a drop in lending interest rates which were warranted by market conditions due to intense competition in the banking sector.
Other Income
Other income of DBB in the current year amounted to LKR 3,766 million, an increase of 116% from LKR 1,741 million in the previous year. Other income comprises mainly of fee and commission income, gains on sale of securities, dividend income and gains from trading activities.
Net fee and commission income of DBB in the current period increased by 28% to LKR 1,040 million compared to LKR 814 million in the previous year as a result of DVB’s increased trade and remittance business volumes. Fee and commission income is derived largely from banking services provided to customers engaged in import, export activities and fees from guarantees issued on behalf of customers engaged in trade and construction activities.
Gain on sale of securities was LKR 1,140 million in the current year compared to LKR 189 million in the previous year. Capitalising on the upward momentum in the stock market, on 31 October 2014 the Bank divested the entire holding of 9.92% ordinary voting shares of Nations Trust Bank PLC and realised a capital gain of LKR 829 million. The Bank was able to divest some of the other mature equity holdings as well and generate a further capital gain of LKR 306 million during the year.
Dividend income received by DFCC Bank made a significant contribution to other income of DBB. This is derived largely from the investment in Commercial Bank of Ceylon PLC supplemented by dividend from other equity securities classified as available-for-sale.
Net gains from trading activities increased by 126% to LKR 480 million from LKR 212 million as a result of trading activities undertaken by treasury operations.
Cost Efficiency
DBB’s expenses including personnel expenses as a proportion of net interest and other income improved marginally to 39% compared to 40% in the previous financial year.
Composition of Operating Expenses
|
31.03.2015
% |
31.03.2014
% |
| Personnel cost |
49.1 |
48.1 |
| Depreciation and amortisation |
8.5 |
8.4 |
| Administration and establishment expenses |
18.6 |
17.8 |
| Others |
23.8 |
25.7 |
Operating expenses of DBB increased only by 8% during the year to LKR 4,107 million from the previous year’s LKR 3,804 million.
Approximately half of the operating expenses is on account of personnel compensation (current and deferred compensation relating to retirement) and the main reason for a 10% year-on-year increase was due to a salary revision which was effected during the year to be in line with the market, based on a comprehensive remuneration survey carried out by an external consultant among comparable institutions.
Due to stringent cost management, operating expenses excluding personnel cost increased only by 6% during the year. This increase was largely due to costs associated with branch expansion (one new branch was opened, whilst four extension offices were converted to fully-fledged branches). These costs incurred on expansion of branch network will be eventually recovered by additional revenue generation by these new branches.
Taxation
Income tax liability is based on the accounting profit computed under SLFRS adjusted for disallowable expenses and exempt income as per the provisions of the Inland Revenue Act No. 10 of 2006 (as amended).
In common with banks, DBB is liable for Value Added Tax and Nation Building Tax (NBT) on financial services (effective rate 11.5%) and income tax (nominal rate 28%). The value addition from the supply of financial services is computed as the accounting profit plus salaries minus economic depreciation on assets replacing accounting depreciation. Value Added Tax and NBT on financial services are non-deductible expenses for computing the taxable profit for income tax purposes.
The total of Value Added Tax and NBT on financial services and income tax expense as a percentage of profit before these taxes was 30% in the current financial year compared with 32% in the previous financial year.
Credit Quality
Analysis of Impaired Loans
|
31.03.2015
LKR million |
31.03.2014
LKR million |
| Impaired loans to customers |
8,658 |
8,029 |
| Impairment allowance |
6,010 |
6,892 |
| Ratios: |
|
|
| Impairment allowance/ impaired loans (%) |
69.4 |
85.8 |
| Impaired loans/total loans (%) |
6.0 |
6.4 |
The ratio of impaired loans to total loans on 31 March 2015 was 6.0%, lower than 6.4% on 31 March 2014, indicating an improvement in credit quality. The cumulative allowance for impairment for loans and advances of DBB was maintained at a healthy level of 69.4% as at the year end. The impairment allowance coverage for impaired loans is adequate when fair value of the underlying collateral is taken into account.
The SLFRS based impairment assessment, both on individual assessment and collective assessment, is to a large extent based on historical evidence modified by an experience adjustment by management, to take into account current economic conditions. Interest income is recognised on an accrual basis and therefore, impairment allowance is for both principal and interest. During the quarter ended 30 June 2014, DBB re-examined the impairment assessment processes in the light of experience gained over the past 2 years, in particular the methodology adopted with regard to the collective impairment assessment process. The revised impairment assessment methodology adopted during the first quarter has been consistently applied during the year.
Composition of Total Assets
|
31.03.2015
% |
31.03.2014
% |
| Earning assets |
|
|
| Loans and advances to and receivable from customers |
64.5 |
64.3 |
| Loans and advances to and receivable from banks |
1.6 |
3.1 |
| Other interest-bearing financial assets |
6.6 |
3.6 |
| Available-for-sale investments |
21.8 |
22.9 |
| Non-earning assets |
|
|
| Property, plant and equipment |
0.5 |
0.6 |
| Goodwill and intangible assets |
0.2 |
0.2 |
| Others |
4.8 |
5.3 |
| Total assets |
100.0 |
100.0 |
Of the total assets 92% were denominated in LKR and the balance comprised mainly of USD denominated assets.
Total assets of DBB recorded a healthy Year on Year growth of 20.3% and amounted to LKR 209,768 million as at 31 March 2015 compared to LKR 174,350 million as at end of previous year.
Composition of Interest-Bearing Liabilities
|
31.03.2015 |
31.03.2014 |
|
LKR
million |
% |
LKR
million |
% |
| Borrowing sourced from |
|
|
|
|
| Multilateral lending agencies |
18,460 |
11.6 |
17,826 |
13.6 |
| Bilateral lenders |
5,902 |
3.7 |
7,607 |
5.8 |
| International capital market |
13,746 |
8.7 |
13,446 |
10.2 |
| Domestic capital market |
6,783 |
4.3 |
1,610 |
1.2 |
| Debenture issue private placement |
526 |
0.3 |
563 |
0.4 |
| Borrowing from banks |
4,820 |
3.0 |
4,285 |
3.3 |
| Customer deposits |
92,840 |
58.4 |
81,230 |
61.9 |
| Repos |
15,803 |
10.0 |
4,735 |
3.6 |
| Total |
158,880 |
100.0 |
131,302 |
100.0 |
Liabilities of DBB are mainly in LKR but it also has foreign currency liabilities, mainly USD.
In August 2014, the Bank successfully raised funds with a tenor of three years by way of senior, unsecured redeemable rated debentures. The initial issue was for LKR Three billion with an option to raise a further LKR Two billion. This was the first debenture to be issued to the market with a single digit interest rate and the issue was three times oversubscribed on the first day itself. Due to the favourable response received, Bank issued debentures to the total value of LKR Five billion.
The USD 100 million five year notes issued to non-resident investors in October 2013 continues to be supported by the Government with a foreign exchange cover up to USD 75 million from the Central Bank of Sri Lanka, to neutralize any change in exchange rates. As the proceeds of these notes are deployed predominantly in LKR denominated monetary assets, in order to mitigate market risk arising from any fluctuation in the USD/LKR exchange rate DFCC Bank has entered into an arrangement with CBSL for 75% of the principal amount of US Dollar (USD) denominated liability. On an annual basis CBSL will compensate DFCC Bank for any loss arising from the depreciation against USD or conversely DFCC Bank will pay CBSL any gain arising from LKR appreciation against USD.
The accounting treatment is based on the recognition and measurement criteria of forward exchange USD purchase contract, a derivative asset and recognition and measurement of income grant by Government via CBSL.
Upon the renewal of the contract at the end of the first year, USD 75 million was sold to CBSL for LKR 130.80 per USD. As per the renewed contract CBSL will swap USD to LKR in November 2015 for LKR 130.80 per Dollar irrespective of market price of USD at that time.
The fair value of the renewed contract on 30 October 2014 was based on equivalent one year USD forward purchase contract price maturing in November 2015 and was obtained from quotes from market participants. This forward price was LKR 135.9583 per Dollar. Thus a fair value gain of (135.9583 - 130.80) x USD 75 million = LKR 386.873 million was recognised as Government grant receivable and deferred income of an equivalent amount in the statement of financial position on 30 October 2014. Subsequent changes in the fair value of CBSL contract was recognised as changes in the fair value of the financial instrument while amortisation of the deferred income of the Government grant that compensated for the changes of the fair value of CBSL contract was recognised in other income.
The essence of this accounting treatment in the income statement is as follows:
|
LKR million |
| Fair value gain of CBSL contract on 1 November 2013 |
754.96 |
| Less: Fair value gain of CBSL contract on 31 March 2014 |
276.88 |
| Reversal of loss recognised during previous year |
478.08 |
| Fair value gain of CBSL contract on 31 March 2015 |
483.73 |
| Less: Fair value gain on renewal of contract on 30 October 2014 |
386.87 |
| Fair value gain disclosed as changes in financial Instruments fair value through profit/loss |
574.94 |
| Amortisation of deferred income on grant disclosed as other operating income |
(376.19) |
| Net gain that offset LKR depreciation |
198.75 |
Investment in DFCC Vardhana Bank PLC
The cumulative investment in DVB on 31 March 2015 was LKR 5,823 million. The net worth of DVB as at 31 March 2015 represented by net assets was LKR 8,839 million.
DVB had surplus distributable reserves of LKR 3,255 million on 31 March 2015. The return on this investment based on year ended 31 December 2014 results of DVB was 13.4 %.
Profit Contribution from Other Members of the Group
This comprises the profit contribution from LINDEL, DFCC Consulting (Pvt) Ltd, APL and NAMAL. APL the joint venture company outperformed all others in the Group. Amongst the subsidiaries, LINDEL continues to be profitable with a return on investment of 24.4% during the current financial year compared with 21.8% during the previous financial year. Synapsys Limited, the information technology provider to DBB turned around its performance during the year and recorded a profit after tax of LKR 15 million compared to a loss of LKR 24 million in the previous year. The profit contribution from the other members was LKR 11 million.
Financial Assistance Received from Government
The Government has acted as a conduit for direct funds raised from multilateral and bilateral agencies for lending to eligible sectors. The amount outstanding on 31 March 2015 was LKR 19,871 million.
The exchange loss cover provided by Central Bank of Sri Lanka is a de-facto grant to the extent of USD 75 million international Note issue. As at 31 March 2015 due to depreciation of LKR vis-a-vis USD there was a probable compensation receivable of LKR 180 million. However the exact amount will be determined only in November 2015, on the renewal of the contract.
The Government does not own direct equity but entities over which the Government exercises control have continued to own shares of DFCC Bank. As of 31 March 2015 the aggregate shareholding was approximately 35%.
Critical Accounting Policies and Estimation of Uncertainties
The results of DFCC Bank and Group are sensitive to the accounting policies, assumptions and estimates that underlie the preparation of financial statements.
Directors have the responsibility to select suitable accounting policies and to make judgments and estimates that are reasonable and prudent. These accounting policies, judgments etc. are explained in the notes to financial statements.
Impairment allowances for loans and advances are based on estimates and judgment and it is possible that the outcomes in the future could differ from the assumptions used, and this could result in adjustments to the carrying amount to the loans and advances.
Current Year Changes and Impending Changes to Financial Reporting
These are disclosed in Notes to the financial statements.
Management of Equity
Dividend Performance
Dividend per share in the current year is LKR 6.00 per share, an increase of 9.09% over LKR 5.50 per share in the previous year.
The payout ratio based on the dividend recommended by the Directors is 49% in the current year compared to 56% in the previous year.
Certain reserves of DFCC Bank are non-distributable as per Central Bank of Sri Lanka directions/statutory provisions. If these reserves are excluded the payout ratio increases to 52% in the current year compared to 66% in the previous year.
Return on Equity
Return on equity for the current year was 10%. The equity of the Group is significantly augmented due to the recognition of unrealised gains on listed ordinary shares and Government securities classified under ‘available-for-sale’ as required under SLFRS and the resultant increase in equity on 31 March 2015 is LKR 15,113 million. The return on equity will improve to 14% if this unrealised gain is not taken into account.
Return on equity is expected to improve with expansion of earning assets financed with borrowing. DFCC Bank will balance higher risk associated with gearing with the need to hold capital cushion commensurate with risk and maintain a prudent dividend distribution policy.
Regulatory Minimum Capital Requirement
DFCC Bank’s capital is well over the minimum requirement.
Financial Value Added
The total value added by DFCC Bank during the year amounted to LKR 5,440 million (FY 2013/14: LKR 4,687 million). Details of value added and distributed are given under Supplementary Information.
