Fitch said the downgrade came from a "higher appetite for market risks" at the holding company with debt funded equity to 11.7 billion rupees in the year to December 2011 from 7.1 billion a year earlier.
LOLC has said it has taken a number of measures by February 27, to cut debt funded investments at the holding company to 5.6 billion rupees.
The full statement is reproduced below
Fitch Downgrades LOLC to 'BBB+(lka)'/Negative Outlook
Fitch Ratings-Colombo/Taipei/Mumbai-28 February 2012: Fitch Ratings has downgraded Lanka ORIX Leasing Company PLC's (LOLC, HoldCo) National Long-term rating to 'BBB+(lka)' from 'A- (lka)'.
The Outlook is Negative. The agency also downgraded LOLC's outstanding LKR1.25bn senior unsecured redeemable debentures due in 2015, to 'BBB+(lka)' from 'A-(lka)'.
"The downgrade reflects LOLC's higher appetite for market risks at the HoldCo, as demonstrated by the increase in debt-funded group- and trading-equity investments to an estimated LKR11.7bn during the 12 months to 31 December 2011 (31 December 2010: LKR7.1bn). As a result, financial leverage at the HoldCo (net debt/cash operating profit from recurring sources before interest expenses) increased to 14.5x at FYE11 (FYE10: 10.2x).
LOLC has confirmed that a number of measures were taken as at 27 February 2012 which it expects will reduce debt-funded investments at the HoldCo to reduce to an estimated LKR5.6bn. However it is the agency's view that, LOLC has not demonstrated its sustained ability / willingness to maintain a capital structure and debt maturity profile in line with a higher rating, and that the company could resort to debt-financing a considerable proportion of future acquisitions or expansions.
The Negative Outlook reflects the uncertainty surrounding LOLC's strategy of funding future investments and expansions of the group, and its implications on HoldCo creditors. While a demonstrated and sustained reduction in debt-funded equity investments and financial leverage at the HoldCo over the next 12 - 24 months could result in a Stable Outlook, LOLC's limited ability or willingness to do so could result in further negative rating action.
As LOLC is progressing towards a HoldCo structure, the company will increasingly have to rely on cash (in the form of dividends and fees) from operating subsidiaries for timely repayment of its own obligations. However, most of its key subsidiaries are experiencing rapid asset growth or are otherwise limited in their ability to payout adequate dividends and fees to the HoldCo over the medium-term.
At end-December 2011, the HoldCo's short-term interest bearing liabilities maturing in less than 12 months exceeded estimated interest earning assets of the same maturity by over LKR9.3bn, exposing the company to high refinancing- and interest rate risks. Given this mismatch, Fitch estimates that HoldCo borrowing costs will rise by around LKR91m (+6%) if market interest rates were to increase by 100bps across short-term maturities.
Recurring profitability at LOLC is evolving as it transitions to a HoldCo. Operating cash profit from recurring sources, before interest expense at the HoldCo, covered interest payments by 1.49x at end-December 2011, providing limited headroom to service interest payments if market interest rates rise. LOLC group's financial services subsidiaries, which accounted for 80% of the group's operating profit at end-December 2011, continue to be well managed, with credit quality, profitability, and a funding/lending franchise similar to, or better-than, rating peers. However, higher-thanpeer leverage fueled by a rapid asset expansion at many such subsidiaries will limit the quantum of dividends that the HoldCo can extract in a stressed scenario.
LOLC expects to increase medium-term capital expenditure in the leisure and power & energy sectors, as newly acquired resorts are refurbished and new power-generation capacity is brought online. Fitch notes that the leisure sector, in particular, is unlikely to sustain high leverage given that cash flows are more susceptible to economic downturns, and may indirectly burden LOLC and its better-performing subsidiaries.
In accordance with Fitch's policies the issuer appealed and provided additional information to Fitch that resulted in a rating action that is different than the original rating committee outcome.