Fitch affirms Lanka ORIX Finance at ‘A-’/Negative

Fitch Ratings Lanka has affirmed Lanka ORIX Finance Plc’s (LOFIN) National Long-Term rating at ‘A-(lka)’. The Outlook remains Negative.

LOFIN’s rating reflects its strong franchise amongst Sri Lanka’s registered finance companies (RFCs), in addition to its satisfactory financial profile.

The Negative Outlook reflects the heightened risk profile of LOFIN’s parent – Lanka ORIX Leasing Company Plc (LOLC; ‘BBB+(lka)’/Negative). LOFIN’s franchise remains linked to that of LOLC, and as one of the main operating subsidiaries of the group, its strategic and operational ties with LOLC remain intact.

Consequently, a further deterioration of LOLC’s financial profile may result in a downgrade of LOFIN’s rating. A deterioration of LOFIN’s financial profile, particularly in terms of its capitalisation, may also result in a downgrade. A significant reduction in risk stemming from the holding company may result in a revision of the Outlook to Stable.

LOLC injected capital of Rs. 1 b into LOFIN in Q3FY11. However, the strong increase in assets resulted in equity/assets decreasing to 12.0% at 9MFY12 (nine months ended 31 December 2011) from 14.5% at FYE11.

Fitch expects capitalisation to remain close to this level alongside an expected slowdown in portfolio expansion and improved profitability. Dividends have not been paid out since FY09; consequently, capital generation is likely to take place through profit retention rather than an injection.

Fitch notes that LOFIN sustained strong portfolio expansion of 55% in 9MFY12 and 132% in FY11 (FY10:134%) along with the transfer of its parent’s franchise as a leasing company. LOFIN’s portfolio profile continued to reflect a higher share of loans (9MFY12: 59%, FY11: 62%) coupled with a decrease in the share of hire purchase (HP) facilities (10%, 17%).

Fitch expects this trend to continue as loans provide greater repricing flexibility that to an extent protects net interest margins in a scenario of increasing market interest rates. LOFIN’s gross non-performing loans (NPL) ratio increased to 3.7% 9MFY12 from 2.2% at FYE11 due to the seasoning of its portfolio subsequent to rapid expansion. This contributed to LOFIN’s net NPLs/equity ratio increasing above that of peers to 21.4% at 9MFY12 from 6.7% at FYE11.

LOFIN’s recorded a strong increase in its deposit base by 35% yoy in 9MFY12 to Rs. 23.4 b and 72% yoy to Rs. 17.4 b in FY11, which is amongst the largest in the RFC sector. Fitch notes that due to the strong expansion in its portfolio, LOFIN’s loans/deposits and borrowings breached the 100% mark.

Non-recurring profits on the disposal of the pawning portfolio and capital gains on its government securities portfolio boosted LOFIN’s net income by Rs. 888m yoy to Rs. 1.2 b in FY11.

Pre-tax return on assets increased to 6.5% (annualised) in 9MFY12 from 3.8% (adjusted for non-recurring items) in FY11, although remaining under that of better capitalised peers. Fitch notes that although LOFIN’s profitability is supported by its cost structure, increased cost allocations could constrain its profitability.

Established in December 2001, LOFIN is a 90%-held financial services subsidiary of LOLC. LOFIN listed on the Colombo Stock Exchange in July 2011.