The upgrade of Lanka ORIX Finance Company Ltd (LOFIN) in November 2008 reflects the increased level of integration with Lanka ORIX Leasing Company PLC (LOLC; ‘A(lka)’/Stable), of which it is a fully owned subsidiary, and in Fitch Ratings’ view, its increased strategic importance to LOLC. In addition to sharing the Lanka ORIX brand, the operations of the two entities are now highly integrated with both operating within the same premises and sharing personnel, product and pricing standards. LOFIN’s contribution to LOLC increased to 9.4% of LOLC net group funding and 10.8% of pre-tax profit at Q109.

Driven by LOLC’s brand name and customer franchise, LOFIN continued its steady growth trend with total advances growing 47.3% yoy in FY08 (80.3% in FY07), albeit from a low base. As seen across the group, there has been a shift in product mix with diversification into working capital loans and increases in hire purchase advances (HPs) from a portfolio hitherto dominated by lease products. Loans and HPs accounted for 48.6% (FYE07: 34.8%) and 18.1% (FYE07: 14.4%) of total advances respectively at FYE08. The remainder comprises mainly finance leases.

Asset quality weakened with the three‐month gross NPL ratio increasing to 10.3% at end-Q109 (FYE08: 8.1%) on account of a single large delinquency on LOFIN’s working capital loan portfolio, which is largely managed by an LOLC group factoring company. Nevertheless, net NPLs to equity at 37% at end-Q109 compares well with the registered finance company (RFC) sector figure of 54%.

Pre-tax ROA increased to 3.0% in FY08 (FY07: 1.2%), driven mainly by improved net interest margins of 8.6% in FY08 (7.0% in FY07). However, heavy increases in operating costs, driven mainly by an increase in IT and marketing expenses, resulted in a lower annualised pre‐tax ROA of 1.8% in Q109.

Deposits, accounting for 69% of LOFIN’s funding base at end-Q109, grew 91% yoy at FYE08 and 19% in Q109. Following approval from the regulatory authorities in June 2008, LOFIN commenced mobilising foreign currency deposits, allowing it to tap into the pool of inward remittances, largely untapped by RFCs. LOFIN had a high equity/assets ratio of 16.3% at end-Q109 (18.7% at FYE08) and a total capital adequacy ratio of 22% which is above the regulatory minimum of 10%.

Support

Fitch believes that support from LOLC would be forthcoming if required, given its 100% shareholding of LOFIN, and the strong operational and financial linkages between the two companies. However, this would be dependent on LOLC’s financial strength. State support is unlikely, given that LOFIN is of low systemic importance.

Key Rating Drivers

The Outlook on the rating is Stable. LOFIN’s rating is linked to that of its parent, LOLC. Any changes to the implied support from LOLC and level of integration and importance could apply downward pressure on the rating.

Profile

LOFIN was established in 2001 as an RFC and commenced operations in June 2003. It operates jointly with LOLC via a network of 22 branches and 10 service centres.