Fitch downgrades Lanka ORIX Leasing to ‘A-’; Outlook Negative

Fitch Ratings Lanka has downgraded Lanka ORIX Leasing Company PLC’s (LOLC) National Long-term rating to ‘A-(lka)’ from ‘A(lka)’ with a Negative Outlook.

At the same time, the agency has assigned LOLC’s proposed senior debentures of upto LKR750m a National rating of ‘A-(lka)’. Fitch has also downgraded LOLC’s proposed commercial paper’s National short-term rating to ‘F2(lka)’ from ‘F1(lka) and simultaneously withdrawn the rating as the issuance is no longer expected to proceed as previously envisaged.

The downgrade reflects the weakening of LOLC’s risk profile due to significant debt funded equity investments in group companies, as indicated by double leverage (measured as equity investments in group companies/own equity) which increased to 166% at Q311.

Further, LOLC’s ongoing transition to a holding company (HoldCo) structure over the medium term increases the structural subordination for the HoldCo’s creditors, whereby it would have to rely on cash flows from investments to service obligations.

In the agency’s view, any meaningful cash flows from investments, at least in the near term, will likely be largely limited to its key financial-services subsidiaries Lanka ORIX Finance Company Ltd (LOFIN, rated ‘A-(lka)’/Negative, 100% ownership), and Commercial Leasing Company Ltd (CLC, rated A-(lka)/Stable, 100% ownership), both of which are subject to regulatory restrictions.

The ‘A-(lka)’ rating also factors in the company’s commitment to materially reducing its indebtedness through selective divestments of some of its investment portfolio over the near term.

The Negative Outlook indicates that LOLC’s rating could be downgraded further if the planned reduction in double leverage fails to materialise, or, upon achieving a HoldCo structure, if leverage is not reduced to a level that can be comfortably serviced by sustainable cash flows from its investments, and a debt maturity profile and capital structure appropriate for an investment holding company is not achieved.

Fitch notes that there is no track record of equity infusion at the HoldCo-level to fund investments in group companies although dividends have not been declared for FY09 and FY10. The agency also notes that some of the subsidiaries may need capital infusion to fund expansions. Fitch further notes that future divestments of investments are subject to market risk at the point of exit.

LOLC’s ratings could also come under pressure if the financial profile of its key subsidiary LOFIN deteriorated (LOFIN’s National Long-term rating has a Negative Outlook). This is also based on the agency’s view that LOFIN and CLC are two of the HoldCo’s key cash generating subsidiaries, while most other investments are in a growth phase, or are otherwise limited in their cash distributions to the HoldCo.

LOLC continues to have strong access to funding from foreign funding agencies in the group’s core business of SME finance. Foreign credit lines accounted for 25% of borrowings at Q311. Furthermore, LOLC has developed a strong retail deposit franchise over the past few years, through its registered finance company LOFIN, improving its funding diversity further. The proposed senior debenture issuance is to be used to fund LOLC’s business expansion and investments.

Established in 1980, LOLC was Sri Lanka’s pioneer specialised leasing company. LOLC is listed on the Colombo Stock Exchange. LOLC’s management expects the transition to a HoldCo to occur over the medium-term whereby its loan portfolio would continue to contract with collections spanning over the next few years, or be transferred to financial services subsidiaries.

Fitch revises Lanka ORIX Finance’s outlook to negative; Affirms ‘A-’

Fitch Ratings Lanka has changed Lanka ORIX Finance Company Limited’s (LOFIN) Outlook to Negative from Stable.

Its National Long-term rating has been affirmed at ‘A-(lka)’.

The Outlook revision reflects LOFIN’s weakened capitalisation following rapid growth since the financial year ended 31 March 2009. Capitalisation, as measured by equity/assets, gradually decreased to 9.2% at FYE10 from 14.3% at FYE09 before increasing to 13% in Q3FY11 following an equity infusion of Rs. 1 b from LOLC. The rating may be downgraded in the absence of a sustained improvement in capitalisation.

The rating is driven by LOFIN’s standalone financial strength rather than support from its parent Lanka ORIX Leasing Company PLC (LOLC; A-(lka)/Negative). The rating reflects its strong franchise among registered finance companies (RFCS), healthy profitability, good and improving asset quality, as well as a planned improvement in capitalisation.

In line with the broader strategy for the LOLC group, most new disbursements are booked at LOFIN instead of LOLC. LOFIN recorded significant portfolio growth of 135% in the financial year ended 31 March 2010 and 62% in H1FY11. Its deposit base grew by 91% in FY10 and 26% in H1FY11.

LOFIN’s return on assets increased to an annualised 6% in H1FY11 and compared well with peers.

A sustained improvement in LOFIN’s capitalisation and ability to maintain other credit metrics consistent with the current rating may result in the Outlook being revised to Stable.

LOFIN is a registered finance company and a 100% subsidiary of LOLC.

LOFIN has the same branch presence as LOLC. LOFIN is to be listed on the Colombo Stock Exchange before end- June 2011 in line with the regulatory requirement for RFCs.