Fitch Ratings-Colombo/Mumbai/Singapore-04 November 2008: Fitch Ratings Lanka has today upgraded Lanka ORIX Finance Company Ltd's (LOFIN) National Long-term rating to 'A-(lka)' (A minus (lka)) from 'BBB+(lka)'. The Outlook is Stable.

The upgrade of LOFIN's rating reflects the increased level of integration with its parent, Lanka ORIX Leasing Company PLC. (LOLC, 'A(lka)'/Stable) and in the agency's view, its increased strategic importance to the latter. Over the last 12 months the operations of both entities have become closely integrated, functioning almost as if they are a single entity. Both now operate within the same premises and share personnel, product standards, operational procedures and processes, and pricing. Furthermore, LOFIN's contribution to net group funding rose to a strategically important 9.4% of total net funding and its contribution to pre-tax profits rose to 10.8% for Q109.

LOFIN continued its steady growth trend, driven almost entirely by LOLC's brand name and customer franchise, with total advances growing 47.3% yoy in FY08. Placement of assets within either portfolio is determined by a central treasury based on funding, liquidity and statutory guidelines. LOFIN's lending portfolio composition is closely aligned to its parent's; although unlike LOLC, LOFIN does not engage operating lease business and its microfinance activity has been confined to pawning. As seen across the LOLC group, there has been an increase in the proportion of Working Capital loans and Hire Purchase facilities (HPs) within LOFIN's portfolio, which has hitherto been dominated by lease products. Working capital loans and HPs accounted for 48.6% (FYE07: 34.8%) and 18.1% (FYE07: 14.4%) of total advances respectively at FYE08. The remainder of the portfolio comprises mainly finance leases, though the company also has a small margin trading portfolio.

The Netherlands Development Finance Company (FMO) is the international development bank of the Netherlands and they invest risk capital in companies and financial institutions in developing countries. FMO's investment portfolio is about EUR 3.4 billion and it is one of the largest bilateral development banks worldwide. FMO is able to take risks which commercial financiers are not - or not yet prepared to take due to their strong relationship with the Dutch government. FMO's mission is to create flourishing enterprises world wide which can serve as engines of sustainable growth in their respective countries, which gels well with LOLC’s vision and commitment to make a significant contribution towards the Microfinance industry.

Asset quality weakened in Q109 with three-month NPLs increasing to 10.3% of gross loans, on account of a single large delinquency on LOFIN's working capital loan book; without which the company's gross NPL ratio would be closer to its parent's of 8.2% at Q109. Given that credit evaluation and recovery operations for both entities have now been centralised, Fitch expects the asset quality of LOFIN to move in line with its parent in the medium term, with any difference arising only on account of variations in product mix. While rapid loan growth in the face of a weakening macroeconomy could be a further stress on asset quality, the agency notes that the company's strong capital base has placed it in a good position to absorb sudden shocks. Net NPLs to equity at 37.0% at Q109 compares well with the registered finance company (RFC) sector figure of 54.1%.

LOFIN's profitability has historically been below the sector on lower levels of non-interest income, combined with marginally lower net interest margins (NIM). This gap narrowed somewhat in FY08 with pre-tax ROA increasing to 3.0% (RFC sector: 3.4%) from 1.2% in FY07 (RFC Sector: 4.7%) driven mainly by improved NIMs. However, heavy increases in operating costs driven mainly by an increase in IT expenses and investment in deposit marketing, resulted in a lower annualised pre-tax ROA of 1.8% in Q109.

The company successfully leveraged the Lanka ORIX brand to grow deposits 91% yoy at FYE08 and a further 19% in Q109. Following approval from the regulatory authorities in June 2008, LOFIN commenced mobilising foreign currency deposits, allowing it to tap into the largely untouched pool of remittances. The company is well capitalised as evidenced by an equity/assets ratio of 16.3% at Q109 (18.7% at FYE08).

LOFIN is a RFC which commenced commercial operations in mid 2003. It operates through a 22- branch network and 10 Service Centres. LOFIN is a fully-owned subsidiary of LOLC and was established with the aim of broadening and diversifying the LOLC group's funding channels, as leasing companies are restricted from mobilising public deposits.

A detailed credit update report will be available shortly on Fitch Ratings websites: www.fitchratings.com and www.fitchratings.lk.