DFCC Looking for growth through M and A activities
DFCC Bank is planning to strengthen its business model through
external growth opportunities that may arise in the back of the recent
regulatory changes on the minimum capital requirement of the banking
industry.
DFCC's newly established commercial banking arm DFCC Vardhana Bank (DVB),
which has a total capital of Rs. 325 million, will be affected by the
new regulation thus the Bank is closely evaluating options available to
overcome this issue.
At a recent company visit, the management emphasised that DFCC is
open to M and A activities (Mergers and Acquisitions) that may add value
to the overall growth strategy of the entity. Management believes that
the recent signals from the regulator appear to favour consolidation in
the industry. Management also expressed their commitment towards
improved automation in its banking services, careful expansion and
enhancing the treasury operations.
DVB, which started operations little over a year ago, is already
generating profits on a monthly basis since November 2004. The DVB's
loan book stood at Rs. 2.5 billion at the end of FY2004, which was below
the original target of Rs. 3 billion. However management expressed their
confidence that DVB's loan book would grow to Rs. 4 billion by the end
of FY2005.
The DVB and DFCC function under different accounting periods where
former is December company and the latter is a March company.
The DVB gradually expanded over the past two years and now possess 10
branches, eight of these being established within the DFCC's original
branches. In addition DVB has two separate branches in Gangodawila and
Malabe.
Management expects to increase the Vardhana branch network to 15 by
the end of FY2006, focusing mainly on the suburbs. According to the
management the Vardhana has a slight advantage over the other commercial
banks in terms of resource utilisation, having only 3-4 additional staff
members in DFCC branches (8 branches) to handle the commercial banking
activities. This model is based on DFCC concentrating for the present on
cross selling commercial banking products to its existing customers.
However, we believe that it's important to have separate staff,
specialized in commercial banking activities in order to provide a
quality service to the customers.
DVB had a Tier 1 capital level of Rs. 325 million at the end of
FY2004, well below the revised minimum capital requirement of Rs. 2.5
billion. DVB has more than two years to achieve this target (before
December 2007), and the management was optimistic on accomplishing this
challenge. DFCC could support Vardhana in achieving this target but the
management is of the view that DVB should try to cover as much ground as
possible on its own.
We believe that infusion of such a mammoth capital into a bank that
is at such an infant stage is not the most suitable strategy. Thus we
are of the opinion that a merger between DFCC and DVB is also a more
appropriate option, given DFCC's strong capital base.
DFCC is in the process of investing Rs. 140 million in enhancing its
new banking software " Net Symbols" to enable Vardhana to operate on the
same platform as DFCC. According to the management the new modules are
expected to be in place in September 2005.
The enhancement will facilitate DFCC's core banking activities as
well as DVB's commercial banking activities to operate in the same
platform, enabling them to better serve the customers with improved
efficiency and straight through processing between the two entities. The
investment will be amortized over a period of five years resulting an
annual charge of approximately Rs. 28 million.
DFCC has recognised the need to strengthen its investment banking arm
and is taking step to add more muscle into this area. The Bank has
already taken measures to exploit the potential in the debt market
operations. The Company has been involved in the operations of
short-term debt instruments such as commercial papers but the new
dealing room is likely to enable trading in long-term debt instruments
such as treasury bonds.
The Bank has increased its exposure to equity investments, thus the
investments in listed equities currently stand at approximately Rs. 500
million. Working towards a single digit NPL ratio DFCC expect to improve
its NPL ratio (NPL: gross loans), which stood at 10.8% as at March 31,
2004 and are keen on bringing the gross NPL ratio down to a single
digit.
The performance based collection plan, which is already in place,
would help DFCC to get close to this target. The Company was able to
recover three large loans, which were classified as NPLs during FY2004,
which is a positive sign, when looking at the heavy provisioning carried
out by DFCC over the last 3 years, which averages to Rs. 404.7 million
pa. DFCC points out that they classify loans as non-performing one month
earlier when compared with most other banks.
DFCC expect a loan growth of 18% during FY2006 and we believe that
this is within the Company's reach considering the expansion plans of
Vardhana.
However, being a development bank the macro factors such as political
stability and the economic environment in the county will play a vital
role in achieving these targets in terms of loan growth and
profitability. The dividend payout ratio of DFCC has been around 23% on
average over the last three years and we believe that the Company will
continue to maintain this ratio over the next 2-3 years.
An in-depth analysis into DFCC and its future in the Sri Lankan
banking environment will be featured in our upcoming banking sector
report. |