Fitch revises Ceylease Financial Services' outlook to stable

Fitch Ratings Lanka has revised Ceylease Financial Services Ltd's (CFS) Outlook to Stable from Negative. Its National Long-Term rating has been affirmed at 'BB+(lka)'.

The Outlook revision reflects CFS's improving financial profile, underpinned by better credit controls and more stringent recovery efforts. Its Long-Term rating benefits from the fact that Bank of Ceylon (BoC, 'AA(lka)'/Positive, 55 percent shareholding of CFS) intends to retain CFS within its wider group through merger with its several other group companies.

A majority of CFS's board consists of senior BoC officials, including a Director (Chairman of CFS) and Chief Financial Officer. BoC also appoints CFS's Managing Director. BoC also continues to be a key creditor to CFS (20 percent of borrowings at end-December 2010 (FYE10)), and subscribed to its rights issue that brought in Rs100m of fresh equity in late 2009.

In August 2010, Merchant Bank of Sri Lanka (a 72 percent-owned subsidiary of BoC) said that it intends to merge with CFS and Merchant Credit of Sri Lanka (MCSL, 'BBB (lka)'/Stable, 88 percent effective ownership by BoC), subject to regulatory clearances and statutory approvals.

CFS's rating could be downgraded should BoC's willingness to support CFS wanes, which may include a considerable dilution in its shareholding or the withdrawal of board-level controls and input.

Conversely, the rating could be upgraded if there is an increase in CFS's strategic importance to BoC, or an improvement in the latter's perceived ability to support CFS, or a significant improvement of CFS's stand-alone financial profile; however, the latter is less likely over the medium-term. In 2010, CFS reported a reduction in non-performing advances (NPA) in absolute terms.

However, its loan book contracted at a faster pace, partly due to the management's cautious approach to lending and greater focus on recoveries, and partly due to CFS's still limited marketing reach.

Driven by the strong recovery of impaired assets, profits turned around with return on assets of 1.05 percent in 2010 (2009: -6.53 percent) while a decrease in funding cost, in line with market interest rates, also benefited its profitability

Fitch expects the favourable trend in recoveries to continue in 2011 given its strengthened credit management and generally improved macro economic conditions. Loans may begin to grow in 2011 as the company has deployed a team of field-sales staff to develop new businesses.

The growth is subject to greater credit control, as all disbursements now require approval by the Managing Director, or the Board credit committee.

While CFS acquired real-estate stock in early-2007 to develop and resell, progress in this respect has been slow, largely due to suppressed real estate prices during the last few years.

At FYE10, the carrying value of real-estate stock and loans amounted to 4.6 percent of assets and 34 percent of equity. In late-2010, CFS acquired an equity trading portfolio to capitalise on the bull-run in equity markets during 2009-2010.

However, at end-December 2010, its share portfolio, which accounted for 34 percent of its equity, accumulated a market-to-market loss of Rs 3.3m.

Fitch notes that an increase in CFS's real-estate stocks or its share trading book could weaken recurring profitability, thereby constraining its ability to service its creditors.