Fitch affirms Edirisinghe Trust at 'Bb-(lka)'/stable

Fitch Ratings Lanka has affirmed Edirisinghe Trust Investment Ltd.'s (ETI) National Long-term rating at ' Bb-(lka)' with a Stable Outlook.

The rating reflects ETI'S weak core-equity position and its significant exposure to real estate (1.02x capital base), which has weighed down on its profitability. The rating also reflects ETI'S established franchise and its large exposure to pawn-broking leading to strong asset quality.

Core equity/assets (excluding fair-value gains on investment properties), although improving to 7.1% at end-december 2011 (9MFY12; FYE11: 5.1%), remains below that of rating peers. ETI'S shareholders expect to inject LKR1BN of capital in 2012, which could increase this ratio to over 10%. An increase in its core capitalization, while maintaining asset quality and profitability and reducing its real estate exposure could result in an upgrade of ETI'S rating.

ETI'S real estate exposure although decreasing still remains significant, and accounted for 13% of assets at end-9mfy12 (FYE11: 22%). These assets are debt-funded and due to their slow-to-yield nature have continued to drag down profitability. The company has indicated that it will not undertake any further real-estate investments in the medium term.

Despite higher net interest margins (NIMS: 13.9% in 9MFY12, 12.9% in FY11), pre-tax return on assets improved only marginally to 3.0% in 9MFY12 (FY11: 2.8%) due to a LKR68M loss on property disposal. Total gross advances accounted for only 58% of ETI'S assets compared with 78% for Fitch-rated registered finance companies (RFCS), indicating the company's lower proportion of high-yielding assets. Fitch expects ETI'S profitability to improve as it winds down its real estate portfolio and increases its lending book.

The company's substantial pawn-broking portfolio (73% of advances at end-9mfy12) benefits its regulatory Capital Adequacy Ratios (CARS) due to the low risk weight on gold-backed lending. As such, CARS were above the minimum 5% (Tier 1) and 10% (total) in 9MFY12, as stipulated by the regulator. The low credit risk on its pawning book has also enabled ETI to consistently maintain lower non-performing loan (NPL) ratios compared with the sector. Although potential volatility in gold prices exposes the company to market risks, Fitch notes that gold prices have been on an upward trend and that the company maintains a more conservative loan-to-value ratio compared with peers.

Gross three-month NPLS accounted for only 3.0% of advances at end-9mfy12 (FYE11: 3.1%) compared with 5.8% for other Fitch-rated RFCS. This enabled ETI to hold a comfortable equity buffer to meet potential loan losses, with un-provided-forNPLS accounting for just 4.1% (Fitch-rated RFCS: 19.3%). However, Fitch notes that ETI'S net Npl/equity position could weaken as its vehicle finance portfolio (22% of advances and with an NPL ratio of 7.8%) grows, given the current levels of capital.

ETI is a mid-sized RFC, and has been a closely held family-owned company since its establishment in 1967. The Edirisinghe family, which also has interests in manufacturing and retailing of gold jewellery, pawning and film production, owns 99.2% of ETI. This holding would be diluted once the company lists its shares on the Colombo Stock Exchange.