Rating Rationale

Strengths:
* Extensive experience of the promoters and leadership team that backs the group's established brand name in the capital market business
Anand Rathi, an established brand with over 25 years of track record, is a diversified financial services conglomerate which is present in various segments of the financial services sector, including non-banking financial services, wealth management, equity, commodity and currency broking, investment banking and insurance broking. ARGFL is the non-banking financial company (NBFC) of the Anand Rathi group engaged in the business of loan against securities (shares, mutual funds and bonds), construction finance, small and medium enterprise (SME) loans and loan against property.

Extensive experience of the founders of the group, Mr Anand Rathi along with the support of other members of the board, has enabled the group to develop and implement strong risk management systems and practices across all entities.

Similarly, ARGFL - spearheaded by Mr Jugal Mantri as its Chief Executive Officer, benefits immensely from the rich experience of its leadership team. Each business vertical is headed by a seasoned professional who ensures quality growth across the asset segment which is being looked into by them.

The credit committee of ARGFL comprising the senior members along with Mr. Anand Rathi himself, have significant experience in the financial services industry.

* Adequate risk management practices in the lending segments
The risk management practices that have been implemented are adequate in relation to the current scale of operations across the major product segments. The loans against securities are extended only against approved list of securities, at a loan to value of 50%. In case of depletion in margin, the square off happens at T+7 days. In construction finance, a lot of emphasis is levied on regular site visits and periodic monitoring of the projects; necessary corrective actions are taken if a developer fails to meet the interim milestones set for construction, sales, or realisation. More so, a minimum collateral cover of 2 times is maintained against all exposures. Additionally, the company endeavours to take additional security ' typically of a ready property not linked to the project being financed ' so that enforceability of security is easier in the event of any delinquencies. In small and medium enterprise financing, a detailed assessment of free cash flows available for debt servicing is carried out for all the cases. Moreover, loans are backed by residential or commercial property as collateral. On the resources side, exposure to risks arising from market-linked debentures is hedged by investing in index futures and options. The risk management practices are adequate.

* Improving scale of operations supported by diversity in product mix
Loan assets have grown to Rs 1,322 crore as of March 2019, registering a 29% growth over fiscal 2019. During this period, the company has scaled up its construction finance and SME (including loan against property) portfolio ' which together formed 64% of the loan assets as of March 2019. Loan against securities, which is among the core competencies of the group, accounted for 36% of the loan book. Additionally, the company has a large investment portfolio which is largely comprised of investments in government securities. Other investments are in the form of equity, CBLO and investments in group companies.

ARGFL is expected to sustain the growth in its loan portfolio over the next few years with the mix between its business segments remaining equitable. The investment portfolio would continue to form almost 50% of the total asset base however, as lending operations scale up - this mix would evolve in favour of loan book. During the course of increase in scale of operations, the ability of the company to upgrade its systems and practices suitably remains a key monitorable.

Weaknesses
* Modest capital position, further constrained by investments in equity
Capital position, in relation to the scale and nature of business, is modest. Tier I and overall capital adequacy ratio are also modest at 13.99% and 17.97%. Additionally, the company has exposure to equity, equity mutual funds and real estate. Hence, capital position remains susceptible to fluctuations in market value of these investments. However, the company intends to strengthen its capital position significantly by raising additional capital over the near to medium term. Ability to maintain adequate capital position while increasing scale, nevertheless, remains critical, and is a rating sensitivity factor.

* Limited track record of operations in non-capital market lending business with spike in delinquencies,
Although risk management systems are adequate, track record in non-capital market lending segments is limited. The company had ventured into construction finance and small and medium enterprise loans a few years ago, and has been growing this portfolio since then. Within the LAS segment, gross non-performing assets (GNPAs) have been flat at 2.0% as on year beginning and closing. In the non-capital-market business, in the SME (including LAP) segment the one-year lagged GNPA stood at 4.9% (2.2% on a non-lagged basis) as on March 31, 2019 compared to nil a year ago. In the construction finance book, one-year lagged GNPA spiked to10.8% (9.4% on a non-lagged basis) as of March 31, 2019 from nil GNPA a year ago. This spike was attributed to slippage of a few accounts with a cumulative exposure of Rs 41.5 crore; however, the company has the project as collateral along with additional tangible collateral cover against each of these and expects to make adequate recovery from each exposure. Overall GNPA for the lending book stood at 4.5% as on March 31, 2019. Given the limited vintage in non-capital market businesses, its asset quality performance across credit cycles is yet to be tested. Ability to manage asset quality and profitability across cycles while scaling up the portfolio in newer segments, therefore, remains a rating sensitivity factor.

* Mono line resource profile
The Assets under Management (AUM) are presently funded through secured market-linked debentures which are completely hedged. Although the company has access to a large number of high networth individuals, raising funds at regular intervals through market-linked debentures may be a challenge when equity markets are going through a downturn. Diversity in funding profile is, therefore, critical for long-term scalability and sustainability of the disbursements. Ability to build a diversified resource profile and borrow from banks, financial institutions, and capital markets at competitive costs is yet to be established, and will continue to be monitored.

* Risks associated with investments in equity and real estate
The company had nearly Rs 225 crore of investment in listed equities and another Rs 28 crore in unlisted equity shares. Additionally, ARGFL also had exposure to equity mutual funds and real estate alternate investment fund. The book value of these investments as of March 2019 was Rs 488 crore with majority of it being in the form of equity investments. These investments are subject to price fluctuations owing to volatility in markets. Company's strategy towards such future investments will remain a key rating sensitivity factor.

Liquidity: Strong
Almost 23% of the asset base as of March 31, 2019 comprised investments in G-Secs. Over and above, the company had a cash and bank balance of Rs 385 crore and CBLO of Rs 350 crore as on March 31, 2019. Additionally, the gearing level as on March 31, 2019 ' when adjusted for cash and bank balance, CBLO lending and investments in G-Secs, was comfortable at 4 times (3.8 times as on March 31, 2018). Availability of this amount of liquidity cushion, in addition to the prudent liquidity management philosophy of the company, makes its liquidity profile strong. On a steady state basis, the management intends to sustain its investments in G-Secs so as to ensure adequate liquidity for repayments and business growth. Asset liability maturity position is also comfortable as merely 13% of the debentures outstanding as on March 31, 2019 have repayments due over fiscal 2020.

Rating Sensitivity Factors
Upward Factors
* Substantial scale-up in lending business and,
* Maintaining overall GNPA levels at less than 2.5%

Downward Factors
* Inability to reduce GNPA in construction finance segment to below 5%
* Moderation in liquidity profile due to reduction in G-sec investments to below Rs 400 crore.