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ORIX Corporation (IX)

Interim F2Q08 Earnings Call

November 08, 2007, 8:00 AM ET

Executives

Yui Takamatsu - IR Officer

Haruyuki Urata - Director, Corporate Sr. VP and Head of the Office of the President

Analysts

Presentation

Operator

Welcome to the ORIX Corporation Interim Results Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions].

I would now like to turn the call over to Mr. Yui Takamatsu. Sir, you may begin.

Yui Takamatsu - IR Officer

Thank you. Welcome everyone to ORIX's earnings conference call for the interim period for the fiscal year ended March 31, 2008. My name is Yui Takamatsu. I am joined here today by Mr. Haruyuki Urata, the Director, Corporate Senior Vice President, and Head of the Office of the President; and Tadao Tsuya who is the Executive Officer in charge of Accounting.

We will assume that everyone has a copy of the document entitled the ORIX Presentation 0709E dated November 8, 2007 that has been posted on our IR website. In today's conference call, we would like to first spend about 20 minutes and provide an overview of the presentation made at the interim results earnings announcement today in Tokyo by Mr. Urata and myself. We will then open up the lines to any questions that you may have.

Please turn to page four. I will now ask Mr. Urata to give an overview of interim results.

Haruyuki Urata - Director, Corporate Senior Vice President and Head of the Office of the President

Thank you Mr. Takamatsu. Hello, everyone. My name is Haruyuki Urata. I am in charge of corporate development, corporate planning, and corporate communications. Regarding our interim results, although interest expense, selling, general and administrative expenses, and provisions increased, net income increased 1% or 0.7 million yen year-on-year to 92 billion yen, which is the highest interim growth to date.

[inaudible] investment operations in companies and real estate, which ORIX sees as well its core businesses may on occasions will be reported under operating income or income before income taxes. While operating income and income before income taxes decrease, net income increased due mainly to the strong performance of our investment operations, which resulted in an increase in contributions as seen here.

Finally, there was no direct impact of the U.S. subprime loan program, the effect on ORIX of the turmoil in the credit and capital market has been limited.

Please turn to page five for an explanation of trends in our four major segments. First, starting with trends in the Corporate Financial Services business, while revenues increased, segment profit decreased to 17.3 billion yen. The main cause of the decrease in segment profit is the rising costs, and this can be explained by three factors. Firstly, we have seen an increase in provision. As can be seen from the increasing in SME bankruptcies, the SME markets have seen a polarization between competitive SMEs investing to achieve growth and those negatively impacted by the current environment.

In the previous fiscal year, provision levels were lower due to reversals being recorded reflecting an economic recovery. The absence of reversals in the first half of this fiscal year led to higher provision levels. As a whole, provisions have exceeded initial expectations.

Secondly, a rise in short-term interest rates and the flattening of the yield curve has led to a decrease in loan spreads due to an increase in our funding costs. It has taken us some time to pass on the rise in cost to our customers.

Finally, a one-off write-down of our intangible assets was recorded in the first quarter of this fiscal year. In response to these trends, we will further implement rigorous credit evaluation and measures to address the polarization of SMEs. Our credit exposure to the pachinko and consumer finance industries is on a downward trend. Going forward, we look to strengthening the ORIX franchise by taking advantage of the strength of our group-wide network.

Please turn to page six. The trend of polarization and diversification can also be seen in the Japanese real estate market. ORIX Real Estate segment profits have increased significantly by responding to these changes in the market, as shown on the table below. For rental purpose real estate, we are pursuing diversification from office buildings to logistics facilities and working to secure assets that meet the needs of real estate investors. That said, for the large-scale condominium development anywhere between their current fiscal year and the next can be expected to contribute to profit. The Real Estate segment, while achieving growth in profits, endeavor to build a stable revenue base through diversification.

Please turn to page seven. Regarding our US operations, ORIX has total assets of 507.6 billion yen in the United States and the break down is shown in the above table. However, I'd like to mention again that ORIX did not involve in subprime loan operations. Our investment in securities, including CMBS and high yield bonds, totaled 109.8 billion yen and our unrealized and realized gains and losses in CMBS and high yield bonds are shown in the table below. Although the subprime programs have impacted our US bond market on a whole, the effect on ORIX’s earnings is extremely limited.

Please turn to page eight where I would like to explain actions for global expansion to ensure ORIX’s medium and long-term growth. This slide introduces some of our investments in Asia and the Middle East. Going forward, we'd like to diversify the overseas businesses from leasing to investments in the same fashion as our Japanese operations. Teaming up with local business personnel with whom we have established strong relationships in joint operations such as leasing, we will expand the investments by obtaining local information and carefully scrutinizing risk and returns. We look to achieve the next stage of growth by the expansion of equity-type fields in addition to our established debt-type businesses in areas where high economic growth is expected.

In conclusion, I would like to explain three of ORIX’s strengths within the current operating environment. First, while global financial institutions have struggled in the recent turmoil and uncertainty in international markets, ORIX has been able to properly manage its operations, not only overseas, but in Japan as well.

Second, we feel that the decrease in profits in the Corporate Financial Services segment is manageable as we have experienced and overcome various obstacles in the past 40 years, including increased credit risk and fluctuations in industry. The Corporate Financial Services segment continues to be the core of our operations and we expect this segment to record stable growth going forward.

Third, in terms of our investment, our principal investments have established a solid track record, including the previous fiscal gain on the sale of our shares in Aozora Bank and the sale of our shares in Korea Life Insurance this fiscal year. Our other investments have also progressed favorably.

In terms of our growth strategy going forward, in our real estate investments, although the market is showing trends of prioritization and diversification, we feel we can take advantage by utilizing our unique strength of having capabilities for both real estate agreement and real estate finance, which will continue to be the key driver of earnings. Also, we believe that taking advantage of opportunities in regions such as Asia through our network developed through local business partners and Houlihan Lokey, we ensure ORIX’s medium and long-term growth.

Finally, I would like to mention that there is no change to the forecast for net income of 202.5 billion yen for the fiscal year ending March 31, 2008. Thank you very much.

Yui Takamatsu - IR Officer

Thank you, Mr. Hirotaka. Starting on page nine, I would like to give you an overview of segment results. Looking at segment profits, all segments recorded an increase in profits, while five segments were down year-on-year. The Rental Operations, Real Estate, Other, and Asia, Oceania and Europe segments recorded an increase in profits. On the other hand, the Corporate Financial Services, Automobile Operations, Real Estate-Related Finance, Life Insurance, and the Americas segment recorded a decrease in profits. Now, I would like to explain the year-on-year performance of each of our nine business segments. Please turn to page ten.

I will begin with the Corporate Financial Services segment. The following slides will explain each business segments in the same format. We have segment performance on the left hand side and trends in segment, assets, revenues, profits, and ROA on the right hand side. As Mr. Urata explained earlier, in this segment, in addition to increases in credit costs and a flattening of the yield curve, a one-off approximately 3 billion yen write-down of an intangible asset was recorded in the first quarter of this fiscal year. As a result, segment profit decreased 41% year-on-year to 17.3 billion yen.

Please turn to the next slide where you will find a graph explaining the trend in asset quality and provision for doubtful receivables and profitable loan losses in the Corporate Financial Services segment. Provisions for the Corporate Financial Services segment for the interim period was at 6.4 billion yen and the annualized ratio of provisions to segment assets is 0.66%, with credit costs rising slightly. With reversals of provisions recorded in the previous fiscal year as well as the fiscal year before that, the current rise can be seen as a rebound from previous low levels. Although provision levels did increase with the increase in assets, the ratio of provision is below the level of fiscal period ending March 2005, and while, uncertainty exists in individual industries, we do not feel that there has been a large change in our overall asset quality. However, we will continue to conduct strict risk management going forward.

With regards to our exposure to the pachinko industry to and the consumer finance industry, total leases and loans to the pachinko industry fee is approximately 350 billion yen, and for the consumer finance industry it is approximately 15 billion yen. A large majority of these has been collateralized and we feel that our portfolio to these industries has been properly managed. For more information regarding provision levels for our overall operations, please refer to page six of the interim results supplementary information, which can be downloaded by accessing our website, as shown on the very last page of this presentation.

Although competition in the market is increasing with the recovery of the so-called mega-banks and regional banks, we are closely managing revenue and asset growth as well as credit risk. As a result, we expect downside to be limited and still consider the Corporate Financial Services segment to be the core of our operations until we expect to record stable growth going forward.

Please turn to page 12 for the Automobile Operations segment. Segment revenue increased due to the increase in revenues from operating leases and maintenance services in the automobile leasing operation. If securitization is taken into consideration, assets have been… steadily been expanding. On the other hand, segment profits decreased 7% to 12.4 billion yen year-on-year due to the increase in expenses accompanying an increase in revenues from operating leases, as upfront costs are recorded earlier for operating leases than for direct financing leases. This is in addition to the increases in interest expense and advertising cost.

Although competition is intensifying in the auto leasing market with the consolidation of major leasing companies, with our industry leading added value services and number of vehicles under management, we look to maintain our vantage within the market. We would also like to promote new ideas for vehicle utilization including the development of a non-sweep market, a retail market, as well as car sharing and rental and sales.

In terms of our Rent-A-Car operations, following the opening of a Rent-A-Car station in Hokkaido in April, we've opened the largest Rent-A-Car office in Okinawa. We look to expand the number of Rent-A-Car offices and improve the quality of services offered.

Please turn to page 13 for the Rental Operations segment. Demand for rental has been on a recovery trend due to the increase in both capital investments and need to improve information security measures by the company. Segment revenues increased due to an increase in revenue from operating leases, including precision measuring and other equipments. Segment profits also increased 51% year-on-year to 5.9 billion yen as there are no losses on the sale of investments securities, which were recorded in the same period of the previous fiscal year and due to the increase in revenue from operating leases. For further growth, we look to improve operating rates while striving to expand our product offering into the fields of environmental analysis and medical related fields.

Please turn to page 14 for the Real Estate Related Finance segment. Segment profits decreased 3% year-on-year to 20.4 billion yen. This segment comprises largely of our operations in non-recourse loans, loan servicing, and housing loans. Non-recourse loans continued to expand and have contributed strongly to the increase in segment assets and revenues as well as largely increase in profits. For our loan-servicing operations, although new purchases have seemed to reach a peak, loan recovery continues to be steady. However, due to the lack of large gains from sales of real estate acquired through our loan servicing operations, profits decreased. For housing loans, while assets and revenues steadily grew, securitization of housing loans is scheduled for the second half of the fiscal year. As a result, profits were down for the interim period. Although there are concerns regarding the effect on real estate related transactions in Japan stemming from the US subprime loan problems, demand for funding for goods properties is still strong and non-recourse loan operations continue to be extremely favorable, which is still the case in the second half of the fiscal year. Furthermore, there is no major turmoil in the CMBS market in Japan and we issued in September 37.8 billion yen in CMBS with terms in line with initial expectations.

Please turn to page 15 for the Real Estate segment. Segment profits for the Real Estate segment increased 32% year-on-year to 41 billion yen due mainly to the large contribution made by gains on sales of rental purpose real estate. Condominium sales including joint ventures accounted for, under the equity method, decreased year-on-year by full 227 [ph] units to 1545 units. While gains from condominium sales were slightly down year-on-year, sales are of condominium for a large project is scheduled for the fourth quarter of the fiscal year and we expect profit contributions to be above the previous fiscal year.

As Mr. Urata explained earlier, ORIX's Real Estate operations followed business model where in addition to ensuring a diversified portfolio, we actively make new investments and turn over these properties after improving their value. We expect the Real Estate segment to continue to be a growth driver for the ORIX group going forward.

Please turn to page 16 for the Life Insurance segment. Segment assets and revenues were generally flat year-on-year. Segment profits were down 12% to 3 billion yen year-on-year due to an increase in provisions, where some reversals were recognized in the same period of the previous fiscal year as well as a decrease in investment income in the second quarter due to the downturn of the Japanese stock market. Segment profits for the second quarter was only 0.1 billion yen. Sales for our CURE medical insurance product continues to be favorable. We look to continue to expand the sale of the guarantee-type insurance products going forward.

Please turn to page 17 for the Other segment. Due to the varied results produced by the diverse businesses in this segment, segment profits increased overall by 16% to 21.4 billion yen. In the principal investment operations, profits from equity method affiliates in Japan including DIJO [ph] and Fuji Fire & Marine increased.

In our card loan operations, while problems such as overpaid interests are mounting for the surrounding market, revenues from this operation have maintained previous fiscal year's level due to our consistent business expansion within the interest rate limits. Revenues from our venture capital operations decreased due to the downturn of emerging markets in Japan.

In our investment banking operations, we are looking to achieve business expansion by utilizing the sales and marketing base of our Corporate Financial Services segment as well as combining the expertise of Houlihan Lokey, who opened their first Japan office in September, and the know-how of Internet Research Institute, who joined the ORIX group in November.

Please turn to page 18 for the Americas segment. As Mr. Urata explained earlier regarding the impact of US subprime problems on our investment securities operations in the Americas segment, the effect on earnings is extremely limited. This is primarily due to our team of professionals in our US operations who continue to properly manage risk in the same fashion that have helped weather past crisis including 9/11 and the GM crisis in the market.

Corporate loans increased and segment assets and revenues also increased. However, while gains from the sale of real estate under operating leases increased, segment profits decreased 38% year-on-year to 11.1 billion yen due to one-off contributions made by gains on investment securities and interest on investment securities in the second quarter of the previous fiscal year, which were not recorded in the second quarter of this fiscal year. Segment profits for the second quarter was above the first quarter’s 5.4billion yen figure at 5.7 billion yen. With the exception of the aforementioned one-off contributions, business for the Americas segment is trending smoothly. While the extent of the subprime loans’ influence on the actual US economy must be carefully watched, we currently have not seen any deteriorating trends in our loan portfolio in the US.

Regarding investment-banking operations, while large-scale M&A deals have decreased due to the subprime loan problems, by having always concentrated on the middle market Houlihan Lokey fee income has maintained results level with the previous fiscal year, which was steady.

Finally, please turn to page 19 for the Asia, Oceania, and Europe segment. Segment profits increased 47% to 26.4 billion yen year-on-year. Our leasing operations in various countries, in particular automobile leasing in Australia and South Korea, performed favorably overall. Also, contributions form real estate, airplane, ship-related profits, and equity method all expanded. As many of you are aware, ORIX's shareholding in Korea Life Insurance were sold to the Hanwha Group in September of this year. Since acquiring the shares in December 2002, it has steadily recognized profits and has made a considerable contribution to ORIX’s earnings. And finally, as Mr. Urata explained earlier, we're aiming for investments in real estate infrastructure and businesses in the Asia and the Middle East region to become one of the bases for ORIX's growth going forward.

That ends the presentation portion of this conference call. And now, I would like to open up the floor to any questions that you may have.

Question and Answer

Operator

Okay. Thank you, sir. [Operator Instructions]. [Inaudible]. Please state your company name. Go ahead and state your question, sir.

Unidentified Analyst

Yes, regarding your aircraft-related business, I was wondering, what if any, effect delays in shipments by the two main aircraft manufacturers has on your business, one way or the other. Thank you.

Haruyuki Urata - Director, Corporate Senior Vice President and Head of the Office of the President

Thank you very much for joining. Regarding your questions, our aircraft related operations… or related business is mainly in the area of the used aircraft businesses. For example, we own or use aircrafts and are leasing to various aircraft companies in the southeast areas. So, our investments, we don't have any problems from the point you expressed.

Unidentified Analyst

Thank you very much.

Operator

And our next question comes from Julian Wesley [ph]. Please state your company name and proceed with asking your question.

Unidentified Analyst – Putnam Investments

Putnam Investments. I understand that you not changing your full-year forecast, but can you give us any more commentary about your expectations for the second half and your comfort around your guidance?

Haruyuki Urata - Director, Corporate Senior Vice President and Head of the Office of the President

You listened to my previous presentation, right now, say, I want to explain a little bit about our principal investments, for example, although we don't have any fixed idea about the sale of our big investment in, for example, DIJO Alzera [ph], but we have various investments in very different types of corporations. Most probably, from those investments to Japanese companies, we think we'll be able to realize some ideas of sales to the third party. So, through those operations, we think we can enjoy additional profits in addition to our normal operations. Of course, we don't have any schedules above the same level of that big investment, let’s say, like Alzera in the previous year, we think we can find out different areas like real estate development areas or others. So, we've another five months to achieve our sales forecast. So, at this moment, our top management doesn't have an idea to change our forecast.

Unidentified Analyst – Putnam Investments

Okay. Thank you.

Operator

[Operator Instructions] Okay. And we have a question from Julian Wesley [ph] and please state your company name and proceed with your question.

Unidentified Analyst – Putnam Investments

Putnam Investments. ORIX is a mixture of relatively stable businesses with a steady stable profit stream and then kind of one-off businesses with a one-off capital gain, where you have to have one-off capital gains on a fairly regular basis. Can you talk a little bit more about the stable businesses and how they are looking for the second half? So, for example, in the Autos business, you mentioned that profits were down in the first half, probably because of upfront costs for operating leases, but also because of rising interest expense, I mean how will this business do in the second half? To what extent is that kind of profitable due to kind of upfront costs that will reverse itself at the time? So, if you could just talk a little bit more in detail about the ongoing businesses, and how they are doing.

Haruyuki Urata - Director, Corporate Senior Vice President and Head of the Office of the President

Sure. Yes, as you say, business comprise of two different types of business, one is a very stable or asset-based businesses. Another one is very marketable business. Regarding with Corporate Finance businesses and the Automobile businesses and the Rental businesses, for those areas we think in the last… in the second half of fiscal year… for example. our Corporate Finance segment will show another steady growth in terms of the profits and the asset base because… of course, there are some trends in the Japanese economy… in the downtrend in the Japanese economy, but our main client or SMEs, some of them are very much active in funding the operations. That's why we think we can expand our operations in Corporate Finance segment.

And regarding our Automobile businesses, although the recent results cannot be shown in the same way with last couple of years, it is mainly because of the… for example, for the last couple of years Automobile business segment has shown a big profit expansion on… due to a mandate of the different rental businesses or leasing assets.

So, right now, in terms of the profit or income, we cannot show any big growth, but in the second half we think continuously this segment will expand. As Mr. Takamatsu mentioned, our competitive strength still works very well in this competitive market. So of course, we cannot show you probably the very weak increase of the profit, but at least steady growth can be expected.

In terms of the Rental businesses or Insurance businesses, those segments will also show a very steady growth in the second half of the fiscal year.

Unidentified Analyst – Putnam Investments

Okay. Thank you.

Operator

[Operator Instructions]. And our next question comes from Fred Barker. Please state your company name.

Unidentified Analyst

Mccanna Capital [ph]. Could you shed a little light on what to expect in terms of the Real Estate business in the second half in terms of delivery… or completions of condominiums, etcetera? And also, how the sales in the… I believe you have… in your discontinued operations you have sales from operating leases as opposed to your Real Estate segment. How are these assets different?

Yui Takamatsu - IR Officer

Can you give us the second half of your question, it kind of got cut off? Sorry, Fred.

Unidentified Analyst

Okay. Under the discontinued operations… profits from discontinued operations, I understand these come from the operating lease business. And so, I was wondering if you could explain to me how the assets are different between those in the operating lease and those in your real estate book?

Haruyuki Urata - Director, Corporate Senior Vice President and Head of the Office of the President

Okay. Regarding with your first question about the Real Estate businesses for the second half of the current fiscal year, for example, in the areas over the condominium businesses, as I said little bit, especially in the fourth quarter, we have a very big project, which would be completed and delivered to the client. So, in that sense for the first half year, we experienced the same level… almost the same level of the profit compared with previous fiscal year. But for the full year, we think in the area of condominium business project, we’ve regained more profits than the previous year.

And for the area of the… for example, the sale of the real estate [inaudible], we don't have any fixed figure for all types of the buildings. But for some areas, we have already started to prepare the sale of the existing offices, which we are now leasing. So, in that sense… at this moment we can't say any fixed figures about the profit from the sale of the office buildings others. But most probably, through the full year… you can most probably see at the end of the fiscal year the highest profit from this segment.

Regarding with the second question, in the case of the… for example, after the sale of the office buildings, still we have some relationship with the client, in this case, which is recorded as a--.

Yui Takamatsu - IR Officer

Gain on the sale of real estate and offerings.

Haruyuki Urata - Director, Corporate Senior Vice President and Head of the Office of the President

And on the other hand, in the case of the no relationship after the sale of the buildings or offices, those profits is recorded in the area of the bottom line after the pre-tax profits. Can you understand?

Unidentified Analyst

Yes. Can you give us some color as to… in terms of your real estate business, what is the trend between third quarter and fourth quarter? Condominiums I know are… is a seasonal business that tends to concentrate in the fourth quarter, but in the third quarter what should we be the expecting? Is it going to be fairly consistent year-over-year with last third quarter, or more, or less, what can we expect?

Haruyuki Urata - Director, Corporate Senior Vice President and Head of the Office of the President

At this moment, we can't say any ideas, but most probably I think for the third quarter, you will be able to see a very big profit from this segment. For the fourth quarter, you can see more profit from this segment.

Unidentified Analyst

Okay. All right, thank you.

Haruyuki Urata - Director, Corporate Senior Vice President and Head of the Office of the President

Thank you.

Operator

[Operator Instructions]. And we have a question from Huzuki Suzuki [ph]. Please state your company name.

Unidentified Analyst

Kylin Management [ph]. Hi, thank you very much for having this opportunity. I have a question about your credit cost. I think you raised… increased the credit cost guideline to 30 billion yen from 20 billion yen this year. And I am wondering if there was any big borrowers who was in tough situations, or is generally SMEs’ credit costs is increasing. Could you explain in a little bit more detail, for example, any… was there any big borrowers for any specific products like a loan or finance lease or operating lease? I would like to know the details of this increase.

Haruyuki Urata - Director, Corporate Senior Vice President and Head of the Office of the President

Okay. Let me explain a little bit about our credit cost for the first half. We didn't realize any big losses for a certain company, but in general, as you probably know, in Japan, recently some of the SMEs have become a little bit difficult in funding the operations or continuing their businesses. So, as you know, our main clients are the SMEs, and as our assets increased our client base has expanded. And so, we have some new provisions for credit costs. And so, of course in general, the pachinko industry or consumer finance industries, we have experienced some losses and… or we have some difficulties. So, we have recorded some additional provisions compared to the same period over the last fiscal year. But as I said, as a whole, we think we can manage our credit risk properly. And although we will have another non-performing loan, but as you know, while full year mostly has been very well characterized rare assets or some securities. So, in that sense, at the final base, we don't think we will have some big losses from those areas. So, investments… in general, as you know Japanese economy right now is struggling from new figures and our client base or SMEs have some difficulties. But our main target is the upper level of our SMEs in Japan. In that sense, compared with other financial institutions we think we can limit or reduce our risk.

Unidentified Analyst

Do you think this 10 billion additional credit cost is mainly from loan business?

Haruyuki Urata - Director, Corporate Senior Vice President and Head of the Office of the President

Yes. In the area of the Corporate Finance segment, at this moment, we don't have any big differences between the loan businesses and the leasing businesses.

Unidentified Analyst

Yes, I am just wondering if your corporate loan balance is only 2.2 trillion yen, a 10 billion yen increase of credit cost is not small.

Haruyuki Urata - Director, Corporate Senior Vice President and Head of the Office of the President

You're saying about the increase of the full-year provisions?

Unidentified Analyst

Yes.

Haruyuki Urata - Director, Corporate Senior Vice President and Head of the Office of the President

Compared with our initial expectations about provisions for the full year, the economy and some limited industries, the season has changed we think. In that sense, we think we should more carefully monitor the market or industries.

Unidentified Analyst

I see. So, then, do you think your balance of this loan business is not growing so fast as before or do you think you can charge higher interest rate?

Haruyuki Urata - Director, Corporate Senior Vice President and Head of the Office of the President

Well, of course as the Japanese economy or market conditions have changed we think we should increase our spread to the client and judging from the past experience we think we can do that.

Unidentified Analyst

Thank you.

Haruyuki Urata - Director, Corporate Senior Vice President and Head of the Office of the President

And as a whole, this segment, as you know will not show any substantial increase in terms of the profit to our assets, but we believe this segment will show a steady growth in terms of the assets to our profit.

Unidentified Analyst

Okay. Thank you very much.

Haruyuki Urata - Director, Corporate Senior Vice President and Head of the Office of the President

Thank you, Suzanne.

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