ICRA Lanka assigns BBB- rating with stable outlook to Orient Finance

ICRA Lanka Ltd., a wholly owned subsidiary of ICRA Ltd., an associate of Moody’s Investors Service, has assigned an Issuer rating of ‘[SL] BBB-’ with stable outlook to Orient Finance PLC (OFP or the Company).

The rating indicates moderate-credit-quality and the rated entity carries higher than average credit risk. The rating in Sri Lanka is assigned on an eight-point scale developed specifically for the country, and ranges from ‘[SL] AAA’ to ‘[SL] D’. This rating scale ranks the relative default risk associated with issuers in Sri Lanka.

The rating is based on the strength of the Janashakthi Group and the financial, operational and management support OFP is expected to receive from the group. The Janashakthi group took over OFP in February 2011.

The group flagship – Janashakthi Insurance PLC – is the third largest general insurer in Sri Lanka and has a demonstrated track record of profitable operations in a competitive market. The rating also factors in the experienced and professional management team coupled with the improvements in risk management systems.

Moderate leverage and healthy profitability add further comfort to the rating. The key rating constraints are the relatively small size of operations and limited track record for the Janashakthi group in NBFC operations.

OFP lending operations are mainly into auto financing (84% of total portfolio), equipment financing (2% of total portfolio) and factoring (14% of total portfolio). OFP auto financing portfolio as at March 2012 comprises two-wheelers (34%), three-wheelers (10%), cars (16%), and other four-wheelers (39%).

OFP operates a traditional branch based lending model with marketing executives assigned at branch level to source business. 100% of OFP’s lending is on fixed rates, though its factoring portfolio carries re-pricing flexibility due to the short term nature of the business.

ICRA also notes that the factoring portfolio carries a high concentration risk with the top 10 customers accounting for more than 45% of the total factoring portfolio (26% of net worth).

OFP has embarked on a rapid expansion phase with plans to introduce new products including pawning and group lending which would expose the company to higher financial and operational risks over the medium term. It would be important to maintain adequate capitalisation and strict control over asset quality, while growing profitably during this phase, given the highly competitive operating environment.

The asset quality indicators in fresh originations are good; however, the portfolio is largely unseasoned. While conversion into a licensed finance company (LFC) in July 2012 enables OFP to raise resources from the public, it would be largely for short tenures. It would be important to expand its institutional relationships to tap longer duration funds and maintain an adequate liquidity profile.

Even as profitability in fiscal 2012 was strong, incremental interest margins could shrink in line with the volatile interest rate scenario. Correspondingly profitability margins could also be impacted as operating costs are likely to remain high during the expansion phase.

OFP reported moderate asset quality with Gross NPA Ratio of 4.56% as at March 2012 (27.87% March 2011).

ICRA notes that out of the reported gross NPAs of 4.56%, NPAs from the core lending portfolio was only 1.29% with the remaining 3.27% being legacy NPAs from distressed portfolio prior to FY 2009 and fully provided for. Delinquencies in the 90+ dpd bucket recorded steady improvements from 5.6% as of March 2011 to 1.8% as of March 2012 however recorded a decline to 3.0% in the quarter ending June 2012 due to the seasoning effect of the portfolio. The portfolio is rapidly expanding and is largely unseasoned; the level of life-time loss is yet to be ascertained.

Current capitalisation levels remain comfortable with OFP’s Regulatory Capital Adequacy ratio as at March 2012 at 35.62% well over the regulatory requirement of 10%. Its gearing was moderate at 2.81 times as on July 2012 following an equity infusion of Rs. 222.5 m in fiscal 2012 by the Janashakthi Group subsequent to the takeover.

ICRA expects an increase in gearing levels over the medium term given the planned growth in business volumes, although steady internal capital generation and committed support from the promoter group should aid in maintaining moderate gearing.

OFP has reported profits for eight years out of the 10 years it has been in operation with the current year recording the highest ever profits reported by the company. Profitability has significantly improved subsequent to the takeover by Janashakthi Group with PBT growing from Rs. 63.3 m to Rs. 203.1 m (221% growth) and PAT growing from Rs. 71.9 m to Rs. 136.5 m (89.8% growth). ROA for FY 2012 was recorded at 6.40% up from 4.08% in FY 2011. Positive growth was also seen for ROE which stood at 28.93% for FY2012 up from 25.96% in FY 2011.

OFP is in a position to achieve incremental profitability of above 3% through its current lending strategy provided it could maintain its current margins during interest rate volatile periods. ICRA Lanka expects operating costs to continue to remain high (8%-9% of total assets) in the medium-term due to the aggressive expansion plans of the company. Strict controls in asset quality could also curb credit provisioning costs.