'AA (lka)' for DFCC Vardhana Bank

Fitch Ratings Lanka has affirmed DFCC Vardhana Bank Ltd's (DVB) National Long-term rating at 'AA-(lka)'. The Outlook remains Stable.

The rating is driven primarily by the implied support assumed to be available from its parent, DFCC Bank (DFCC; 'AA(lka)'/Stable). DVB currently accounts for 29 percent of DFCC group's assets, and is expected to play an important strategic role in DFCC's plans in enabling it to diversify its product and funding base. In addition to the common franchise shared by the banks, operations are closely linked with an integration of treasury and back office functions, as well as shared personnel and input on key decision-making committees. Asset quality deteriorated sharply (along with the sector) in the 18 months to end-H109 given the effects of falling domestic and global demand on DVB's customer base. However the bank has stepped up recovery and monitoring, resulting in a lower rate of NPL accretion in Q2 09.

It has also curtailed loan growth from June 2009 in view of the weak credit environment.

Fitch notes that DVB follows a more stringent policy on classification of non performing advances and reclassification of non-performing overdrafts than current regulatory guidelines. Fitch expects asset quality to remain stressed over the next six to twelve months as borrowers take time to recover from strained cash-flows, before improving in the medium- term.

Profitability was lower in FY08 despite an improvement in margins, on account of higher provisioning costs (40 percent of pre-provision income in FY09 versus 23 percent in FY07) and higher effective tax rates incurred during the year. The provisioning policy of DVB is more stringent than what is required by the regulator, with the bank providing over and above statutory provisions based on its own estimate of recoverability of each loan.

However, Fitch notes that as provisioning costs increase, DVB's effective tax rate will increase as provisions of only a maximum of 1 percent of loans are tax deductible. Falling profits have also affected the bank's ability to grow its equity buffer. Net NPLs/equity rose to 42.6 percent at H1 09 (FYE08: 29.2 percent). Equity to assets, though still comparing well with the sector has been on a decreasing trend since 2007.