ICRA Lanka Limited, a wholly owned subsidiary of ICRA Ltd., an associate of Moody’s Investors Service, has assigned an Issuer rating of ‘[SL] A-’ (pronounced SL A minus) with stable outlook to Lanka Orix Finance PLC. The rating indicates adequate-credit-quality and the rated entity carries 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 factors LOFC’s close operational and financial linkages with the LOLC Group in its position as the flagship subsidiary of Lanka ORIX Leasing Company PLC (HoldCo), which is rated [SL]A-/stable by ICRA Lanka. Given this, ICRA Lanka has taken a consolidated rating view of the HoldCo and its key asset financing subsidiaries. The rating also factors LOFC’s robust franchise, healthy competitive position given its superior market share and a professional and experienced management team. ICRA has taken note of the significant gaps in LOFC’s asset-liability maturity profile, particularly in the short term buckets, arising from the short term nature of funding, both retail deposits and institutional funds. While LOFC’s refinancing ability remains good through retail and institutional franchise, ICRA Lanka expects the company to raise longer-tenure funds to progressively address this gap. LOFC’s financial leverage has increased as a result of rapid portfolio growth despite capital infusion from the Parent. However, lower incremental portfolio growth, stable internal accruals are expected to support capitalization levels. The core profitability has been improving in the past few years backed by higher interest spreads, while operating costs have reduced because of economies of scale. Incrementally, interest spreads could shrink marginally in light of the prevailing interest rate environment; nonetheless ICRA Lanka expects profitability to remain steady provided the level of credit costs are kept under control.LOFC focuses on lending against Commercial vehicles (63% of portfolio as on March 2012), Working Capital (21%), Equipment Finance (8%), Tractors and others (8%). The company registered a compounded annual growth rate (CAGR) of 56% over the past 5 years, but has been substantially supported by the transfer of incremental business from the HoldCo to LOFC as part of the group reorganization process. The portfolio growth for the LOLC Group remains moderate at a 4-year CAGR of 16%. Given the volatility in systemic interest rates, LOFC has been focusing increasingly on loans, rather than fixed-rate hire purchases and leases, which gives the company flexibility to adjust interest rates according to its cost of funds. Asset quality, as measured through Gross NPAs, improved from 2.24% in FY11 to 1.02% in FY12 through focused recoveries and structured collections process. However, it would be important to continue to maintain strict control over asset quality through economic downturns and hardening interest rate cycles.LOFC’s Capital Adequacy Ratio stood at 14.4% as on March 31, 2012 compared to 17.0% as on March 31, 2011, broadly in line with the sector average. While there are no equity infusion plans in the near term, portfolio growth is expected to slow down progressively and the capital requirements would be met through internal accruals. ICRA Lanka, nonetheless, expects LOFC’s capitalization to moderate in the near term with expected portfolio growth.LOFC’s Return on Average Assets (excluding one-time gains) have registered steady improvement to 4.0% in fiscal 2012 from 1.1% in fiscal 2009 supported by a corresponding improvement in interest spreads. The operating cost levels also remain competitive in relation to industry levels. Incrementally, LOFC could face pressure on cost of domestically mobilized funds given the hardening interest rate scenario, but the long term overseas funding lines being pursued by the management could help control the overall cost levels. ICRA Lanka expects profitability levels to remain stable, provided the company manages to keep credit costs under tight control.Company ProfileLanka ORIX Finance PLC (LOFC), (set up in 2001) established initially as a wholly owned subsidiary of LOLC, has a strong Retail Franchise among Licensed Finance Companies (LFCs) in Sri Lanka. The LOLC Group as a whole is one of the Largest Financial Services conglomerate in the country, with the parent being the first leasing company to be established in Sri Lanka. LOFC being the largest operational financial services subsidiary (22% of Group Assets as at Mar-12) of the LOLC Group offers Savings and Deposits in Local and Foreign Currency, Leasing and Hire Purchase Loans mainly for financing Auto Vehicles for commercial use. In July 2011, as per the Central Bank of Sri Lanka (CBSL) directions, LOLC divested 10% of its stake in LOFC and obtained a listing on the Colombo Stock Exchange (CSE).During the year ended March 2012, LOFC reported a net profit of Rs. 1.25 billion on a total income of Rs. 6.35 billion compared to net profit of Rs. 1.25 billion on a total income of Rs. 4.01 billion in the previous fiscal.