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Results for the Half year ended 30 September 2012

This commentary relates to the interim non-audited financial statements for half year ended 30 September 2012.

Group Performance

The DFCC Group recorded a consolidated profit after tax of LKR 1558m for the half year ended 30 September 2012 compared with LKR 1249m in the corresponding period of the previous year (comparable period).

Apart from the Banking Business which contributed LKR 1442m to profit after tax (based on partial consolidation in the supplementary income statement of DBB) and is analyzed below, the investment banking joint venture, Acuity Partners (Pvt) Ltd (APL) contributed LKR 87m in the current period marginally lower than LKR 90m in the comparable period. The current period however includes a deemed disposal gain of LKR 83m(50% of the total recorded by APL) arising from a transaction by its subsidiary Lanka Ventures PLC accounted in the income statement as per the previous Sri Lanka Accounting Standards. However, at the end of the current financial year consequent to representation of financial statements under the new accounting standards this amount of deemed disposal gain would be accounted as other comprehensive income in the equity and not in the income statement as currently presented. The environment was not conducive for investment banking business and the contribution from APL’s core activities was significantly lower than in the previous period. The contribution from all other subsidiaries and associate company collectively was LKR 78m in the current period (LKR 65m in the comparable period).

Banking Business

The Banking Business of the DFCC Group is undertaken by DFCC Bank (DFCC), a licensed specialized bank and 99 % owned subsidiary DFCC Vardhana Bank (DVB), a licensed commercial bank. Both banks function as one economic entity and as such it is appropriate to analyse the consolidated performance of the two banks as DFCC Banking Business (DBB). A consolidated Income statement for DBB has been released to the Colombo Stock Exchange as supplementary financial information. This statement was derived from the interim financial statements with certain adjustments for ease of analysis. Since the financial year of DVB ends in December, the accounts of DVB are consolidated with a 3 month lag.

The interest income of DBB in the current period was LKR 6,929m, an increase of 61% over LKR 4,303m in the previous comparable period. Thus the second quarter was an improvement over the 54% increase recorded in the first quarter over the previous comparable period. The higher interest income in the current period was the result of portfolio growth with total loans and advances (excluding interest receivable) increasing 33% from LKR 72,426m on 30 September 2011 to LKR 96,468m on 30 September 2012, as well as due to the increase in market interest rates. As in the first quarter, the funding cost in DVB was also correspondingly high, but there was a marginal improvement in the interest margin.

DVB reached the 18% maximum LKR credit growth ceiling for 2012 imposed by the Central Bank of Sri Lanka by 30 June 2012 which is consolidated with half year ended 30 September 2012 of DFCC Bank with a 3 month gap. It recently obtained a foreign currency line of credit which was converted to LKR on a hedged basis which enables it to increase its LKR advances portfolio by about LKR 1 billion during the period leading up to December 2012;DVB’s customer deposit base increased from LKR 24,041m on 30 September 2011 to LKR 43,022m on 30 September 2012, an increase of 79% resulting in reducing its exposure to inter bank borrowing and significant improvement to the cash equivalent on 30 September 2012 to LKR 8,278m compared to LKR 4,112m one year ago. DFCC also increased its customer deposit base from LKR 5,787m on 30 September 2011 to LKR 15,269m on 30 September 2012. Thus both constituent banks of the DBB made use of reduced domestic investor appetite for medium and long term funds in the relative volatility of interest rates by growing its customer deposit base. Depending on future market conditions and credit demand, DFCC will replace or supplement these deposits with longer term funding from domestic or international sources. Other income of DBB was LKR 645m in the current period, 10% higher when compared to the comparable period. Main contributors were dividend income, fees and commission income which offset lower gains from sale of listed shares and a marginal net loss in foreign exchange operations. Foreign exchange income of the DBB is primarily derived from DVB, the commercial banking arm The income generated from trading activities was slightly lower than the cost of hedging swaps of foreign currencies to LKR for a higher interest yield and net interest income. this funding strategy was overall beneficial to DBB. The gross non-performing loan ratio of DBB marginally increased to 4.9% as at 30 September 2012 compared with 4.3%, on 31 March 2012. This is however much lower than 5.8% one year ago. The ratio of operating expenses to operating income was 42% in the current period compared with 45% in the comparable period. The 13% increase in operating expenses in the current period was compensated by additional income. The increase in operating cost was largely due to personnel cost. As explained in my previous commentary, concomitant with expansion of branch network and diversification of product and services particularly in DVB, there was an increase in head count from 1316 employees in the group one year ago to 1463 employees in the group as at 30 September 2012. This head count increase included strengthening of management positions with a few external recruits. These factors contributed to an increase in the personnel cost on a year on year basis.

The DBB recorded LKR 1961m as operating profit before taxes which was an increase of 21% over the comparable period, an improvement over 11% recorded in the first quarter. Profit after tax (both VAT on financial services and income tax) was LKR 1,442m, an increase of 28% over the Rs 1,128 m recorded in the comparable period. The current quarter included an adjustment for a one off, non recurrent financial services value added tax over provision for the prior year amounting to LKR 184m. Without this, DBB’s profit after tax for the current period was LKR 1,257 m, an increase of 11% over the comparable period. As stated in my previous commentary, going forward, the credit ceiling will have an adverse impact on the growth of DVB during the remainder of the year since because of its smaller base than DFCC at the end of December 2011. DFCC has room and can expect to grow as previously approved project loans are progressively disbursed, although there is a general slowdown in the demand for new project loans.

Investments

The quoted equity investment securities of DFCC are carried at a cost of LKR 4,969m as at 30 September 2012. The aggregate market value of the investments on 30 September 2012 amounted to LKR 16,365m with an unrealized gain of LKR 11,396m. Thus the unrealized gain during the quarter ended 30 September 2012 has increased by LKR 2,634m or 30%. However, given vagaries of the domestic and global stock markets the current increase may not be indicative of future performance of this portfolio and in fact as at 31 October 2011, the unrealized gain has reduced to LKR 1124m. The interim non-audited financial statements are not based on the new accounting standards and therefore the unrealized gain is currently not recognized in the financial statements. However, under the new accounting standards all listed shares currently classified as investment securities would be reclassified as available for sale and marked to market and the unrealized gains recognized in the equity of DBB.

Prudential Indicators

The capital adequacy and liquidity ratios continued to be well above the stipulated regulatory minimum. Specific provision cover for the DBB was 73% and unprovided NPL s as a proportion of equity was under 8%.

Nihal Fonseka
Chief Executive Officer
5 November 2012