Fitch Affirms Sri Lanka's Vallibel Finance Ltd at 'B+ (lka)'

Fitch Ratings-Colombo/Singapore-26 January 2010: Fitch Ratings Lanka has today affirmed Vallibel Finance Ltd.'s (VFL) National Long-term rating at 'B+(lka)'. The Outlook is Stable.

The rating of Vallibel Finance Limited (VFL) factors in its relatively small asset base, relatively weak asset quality and modest financial profile. Although VFL has been successful in increasing its scale of operations while maintaining profitability, asset quality continued to weaken between March 2007 and September 2009. Fitch notes that as non-performing loans (NPLs) rise and arrearage increases, VFL's small equity base could come under stress.

Profitability as measured by return on assets (ROA) increased to 2.7% in FY09 (financial year ended 31 March 2009) compared to 2.2% in FY08, due to rapid loan growth early in the year driving up net interest margins in H109. However, higher provisions and lower margins resulted in a lower ROA of 2.5% in H110 (though still comparing well with the sector figure of 2.1% in H110). Provisions/pre-provision income increased to 22% in H110 (FY08:7.7%) and could increase further as NPLs increase in arrearage.

Despite falling deposit rates from March 2009 onwards, net interest margins (NIMs) in H110 improved only marginally to 9.8% (H209:9.7%) due to the negative effect of higher six month NPLs on interest yields, and a gradual reduction in lending rates in Q210. Fitch notes that interest yields could come under further pressure in H210 as more NPLs migrate into the over six month category where interest is suspended. However, following VFL's reduction in deposit rates in late-2009, NIMs could benefit from the consequent lower cost funds, which would partly offset the impact of lower yields.

Asset quality weakened in the period FY08-H110 driven by the effects of a weaker credit environment on VFL's largely SME customer segment, which is more susceptible to economic downturns. Although nominal NPLs fell significantly at FYE09, due to aggressive recoveries in the three to six month category prior to year-end, there was a slippage into the higher arrearage categories in the same period, followed by an overall increase in NPLs in H110. Three month and regulatory six month NPL ratios increased to 19.0% and 3.7% at end-H110 (FYE09:10.7% and 2.9%), respectively. Consequently, net NPLs/equity increased to 78.5% at H110 despite what appeared to be relatively good capital ratios (total CAR of 19.9% at end H110).

VFL is a registered finance company (RFC) accounting for 0.9% of Sri Lanka's total RFC sector assets and is 99.99% owned by Mr. K.D.D. Perera through his investment holding company Vallibel Investments Limited.

A credit analysis report will be available shortly on Fitch's websites www.fitchratings.com and www.fitchratings.lk

Applicable criteria available on Fitch's website www.fitchratings.com are: 'Master Global Financial Institutions Criteria', dated 31 December 2009, and 'Finance and Leasing Companies Criteria', dated 31 December 2009.