Rating Rationale

CRISIL has downgraded its ratings on the long-term debt instruments and bank facilities of ECL Finance Ltd (ECL Finance; a part of the Edelweiss group) to 'CRISIL AA-/CRISIL PP-MLD AA-r/Stable' from 'CRISIL AA/CRISIL PP-MLD AAr/Negative'. The rating on the commercial paper issue and short-term debt programme has been reaffirmed at 'CRISIL A1+/CRISIL PP-MLD A1+r'.

CRISIL has also withdrawn its rating on Long-Term Principal-Protected Market-Linked Debentures of Rs 3.6 crore and Non Convertible debentures of Rs 50 crore (See Annexure 'Details of Rating Withdrawn' for details) in line with its withdrawal policy.

The rating revision factors in the current challenging operating environment for non-banking financial companies (NBFCs), especially those with a wholesale lending book. Interest from debt investors in the sector has reduced in the recent past, leading to issues in funding access for non-banks, including the Edelweiss group. Although the group has been raising resources on an ongoing basis since September 2018, the overall fund raising remains significantly below pre-September 2018 levels. Further, the ease of raising resources and the associated cost have been impacted. Nevertheless, bank borrowing and funds raised via securitisation were higher in the second quarter of fiscal 2020, as compared to the first quarter. Furthermore, with rising borrowing cost and slowdown in disbursements by non-banks - mainly to wholesale borrowers, refinancing risks for real estate players has increased. This could strain the asset quality of the wholesale lending portfolio in the near to medium term.

The 'Stable' outlook reflects the group's diversified presence across financial services, ability to raise capital even during challenging times, expected decline in share of wholesale book and adequate liquidity. From a funding perspective, budgetary announcement of the Government to support public sector banks through a partial credit enhancement mechanism for buying asset pools from non-banks should bring some respite for the sector. The Edelweiss group has recently received sanctions of around Rs 900 crore under this mechanism with a few other sanctions in pipeline as well.

Given the current environment, with lenders exercising caution, the Edelweiss group has witnessed a reduction in incremental funds raised post September 2018, and an increase in the borrowing cost. The group has raised around Rs 3,000 crore (excluding commercial paper) during the first six months of the current fiscal as compared to around Rs 7600 crore for the corresponding period of the previous fiscal. Within this, market borrowing fell sharply. Nevertheless, going forward, incremental fund raising is expected to improve with fresh bank sanctions in pipeline, increase in securitisation/assignment volumes and the group's plan to start tapping capital markets (including raising of retail NCDs). However, the group's ability to raise fresh funds from diverse sources over the near term will be a key monitorable.

Reported asset quality metrics witnessed an uptick with overall gross non-performing assets (GNPA) ratio at 2.3% as on June 30, 2019, compared to 1.9% as on March 31, 2019. The loan book remain chunky with around 50% of the overall portfolio towards wholesale lending (of which 67% is towards real estate). Further, a sizeable proportion of the wholesale book is currently under moratorium with bullet or staggered repayments. While the group follows sound credit appraisal and risk management practices, has adequate collateral cover for its wholesale loans, and has also built strong recovery capabilities, asset quality in the past was also supported by an active refinance market, particularly for the real estate loans. The group also benefits from its diversified business ecosystem, and as part of its account specific recovery/resolution strategy, it has sold some of the stressed exposures in the lending business to the Edelweiss Asset Reconstruction Co Ltd (EARC; on an arm's length basis) to benefit from the latter's better resolution capability and strong legal team.

The group is planning reduce its wholesale book through sell down over the next few months. With the slowdown in the real estate sector and incipient stress for developers coupled with exposure to few stressed corporates, the Edelweiss group's ability to get timely refinance/exits, recover from some of these exposures, maintain asset quality metrics and scale down the wholesale book will remain key monitorables.

Nevertheless, CRISIL has factored in the group's ability to raise capital as demonstrated even in the current market environment. In August 2019, the Edelweiss group announced that Kora Management (Kora; a US-based investment firm) will be investing around Rs 525 crore (USD 75 million) in the advisory business, Edelweiss Global Investment Advisors (EGIA). EGIA includes the businesses of asset reconstruction, wealth and asset management and the institutional client group. In addition to this investment, Kora also plans to invest an additional Rs 350 crore (USD 50 million) into the group, the timing and structuring of which is being finalised. The group also announced that it plans to raise additional capital in EGIA of up to Rs 525 crore (USD 75 million) excluding the investment by Kora and is in talks with investors for the same. Earlier, the group had entered into an agreement to raise Rs 1,800 crore from Caisse de depot et placement du Quebec (CDPQ) in the form of compulsory convertible debentures (CCDs) in ECL Finance (of which Rs 1,040 crore has been already infused in the June 2019 quarter). These investments shall further bolster the group's networth (Rs 9,844 crore as on June 30, 2019, treating CDPQ investment as part of networth), and reduce the consolidated gearing which stood at 4.5 times as June 30, 2019.

The group also has adequate liquidity. The overnight on-balance sheet liquidity (including cash, liquid investments and treasury assets) stood at around Rs 4,200 crore as on September 26, 2019. This excludes other liquid assets (investments, securities-based lending book), which can be accessed if necessary- this stood at around Rs 4,600 crore as on same date.

The ratings continue to reflect the group's diversified business and earnings profile with presence across credit, capital market, and insurance segments, and demonstrated ability to build significant presence in multiple lines of business. The ratings also factor in an established market position in capital market-related segments resulting in a regular stream of fee-based income.

These strengths are partially offset by vulnerability of asset quality to concentration in the wholesale lending segment, particularly in the current challenging environment. Furthermore, the profitability ratios and gearing (while declining) are relatively weaker than many other large predominantly wholesale players.

CRISIL will continue to monitor the group's ability to raise fresh funding, progress of additional capital raising in the wealth business, any increase in build-up of stress in the wholesale book, as well as proposed scale down of wholesale lending book.

Strengths:
* Diversified business profile
The group has been diversifying within each of its key businesses, as well as entering new businesses, over the past few years. It is now present in the retail and wholesale lending segments, securities broking, wealth management, asset management, insurance, stressed-asset management, and alternate assets. Many of these have now attained sizeable scale, and likely to lend greater stability to earnings. Within the capital market, retail broking volume now constitutes around half of the overall broking volume. In terms of new business lines, the life insurance business has grown significantly and may break even over the next 3-4 years. In the lending business (book size of Rs 33,968 crore as on June 30, 2019, excluding capital deployed in distressed assets credit), the group will continue to focus on increasing the granularity of the loan book. As a part of this strategy, it will focus on growing the retail book (comprising mortgage, small and medium enterprise [SME], agriculture loans and retail loans against shares) from around 50% as on June 30, 2019 (45% as on March 31, 2018) to about 70% by March 2021. Within wholesale lending, focus will be on a new segment of mid-market corporate lending, with lower ticket size of Rs 50-100 crore as against large ticket size in the existing structured collateralised credit. Growth in the wholesale credit book will be through funds structure. However, given the current evolving liquidity situation for non-banks since September 2018, and the slowdown seen in the sector, the group has reduced its disbursements in the wholesale segment.

* Demonstrated ability to build significant competitive positions across businesses
While the group remains a large player in the traditional broking business, it also has one of the largest wholesale lending book among non-banks; this portfolio stood at Rs 16,987 crore as on June 30, 2019 (Rs 18,055 crore as on March 31, 2019; excluding capital deployed in distressed assets credit). In the distressed assets segment, EARC remains the largest asset reconstruction company in India with total securities receipts managed at around Rs 47,400 crore as on June 30, 2019 (Rs 46,600 crore as on March 31, 2019). In the commodities business, the group has exited its agricultural commodities and precious metals trading businesses and is focusing on the agricultural credit and value chain services business.

* Established position in capital market businesses
Earnings and accretion to capital should provide a regular stream of fee-based income over the medium term, given the established market position in capital market-related businesses. Profit from the fee-based capital markets and asset management has increased in the past few years, and may record healthy growth over the medium term. The group has an established franchise in institutional broking and investment banking, and an expanding presence in retail broking, wealth management, and asset management segments. It is also one of the largest Indian institutional brokerage houses, with over 700 foreign and domestic institutional clients. The retail broking franchise is also expanding, with more than 5.55 lakh unique clients as on March 31, 2019. The group operates across the corporate finance and advisory domains-equity markets, private equity, mergers and acquisitions, advisory structured financial syndication, and debt issues. The wealth business and alternate assets business have also witnessed significant growth. Assets under advice in the global wealth management business were Rs 106,000 crore, and the assets under management in the asset management business stood at Rs 36,300 crore, as on June 30, 2019.

Weaknesses:
* Asset quality exposed to risks related to concentration in wholesale lending
Asset quality will remain vulnerable to concentration risks inherent in the wholesale loan book, despite the strong focus on collateral. As on June 30, 2019, wholesale lending constituted almost 50% of the total loan portfolio (excluding distressed assets credit), with the 10 largest loans constituting 18% of the wholesale portfolio. A sizeable proportion of this book is currently under moratorium with bullet or staggered repayments. The group has also sold a few stressed exposures to the ARC to leverage on the latter's better resolution capability and strong legal team.

Also, around 67% of the wholesale portfolio comprises real estate loans; this segment is vulnerable to cyclical downturns. Further, given the current evolving liquidity situation for non-banks since September 2018, asset quality on the group's exposures to loans against property (LAP) and loans to micro, SME (around 20% of the loan book as on June 30, 2019; excluding capital deployed in distressed assets credit), would also be a key monitorable. This stems from sensitivity of borrowers of such loans to an environment of prolonged liquidity tightness.

Any sharp deterioration in asset quality, specifically in the wholesale lending book, will also impact profitability and capital, and remains a key rating monitorable.

The group is also planning to reduce its wholesale through sell-down over the next few months. Its ability to refinance/exit and recover from some of the exposures as well as scale down the book will remain key a monitorable, considering the current challenging environment.

* Lower profitability than peers
Profitability has been lower than those of other large financial sector groups; return on assets (annualised) and return on equity (annualised) stood at 0.8% and 5.8%, respectively, for the first quarter of fiscal 2020 ( 1.6% and 12.6% for fiscal 2019).

Profitability in the first quarter of fiscal 2019 was also impacted by higher provisioning costs, which more than doubled to Rs 248 crore (Rs 110 crore during the quarter ended June 30, 2018).

The group's profitability, while on an improving trend over the past few fiscals, remains relatively lower as over 25%, of the capital (equity plus borrowings) is employed in businesses or investments that are either low yielding or loss making at this point. The group has a large investment portfolio under its balance sheet management unit (BMU), used for managing liquidity. This largely comprises government securities, fixed deposits, liquid mutual fund units and corporate bonds, which have a low return on capital employed. Furthermore, the life and general insurance businesses continue to be loss-making. The general insurance business started in February 2018, after requisite approvals were received from the Insurance Regulatory and Development Authority of India. This business is also expected to affect consolidated profitability in the initial years of operations, given its long gestation period. Expected improvement in profitability of the insurance business and reduction in the share of funds allocated to BMU will benefit profitability only in the long term. In the near term, profitability could be constrained by increase in credit costs, and higher borrowing costs coupled with limited ability to pass these on to borrowers.

* Relatively high gearing, though lower than earlier levels
Gearing is relatively high, though declining, in the context of the share of the wholesale portfolio in the Edelweiss group, which is around 50%. Other large, predominantly wholesale lenders operate at significantly lower levels. As on June 30, 2019, gearing was 5.1 times, while the net gearing (excluding the liquid assets of BMU) stood at 3.7 times. However, after factoring in the Rs 1,040 crore received from CDPQ in the June quarter and treating it as equity, the group's gearing stood at 4.5 times. With additional capital raising of Rs 525 crore from Kora coupled with plans of raising further capital in EGIA, the group's leverage ratio is expected to reduce further. Gearing, thereafter, is expected to gradually increase to 5-5.5 times over the medium term.

Liquidity: Adequate
Liquidity is adequate. As a policy, the group maintains a cushion of 9-10% of the balance sheet. Even in current market conditions, there was a liquidity cushion (including cash, liquid investments and treasury assets) of around Rs 2,900 crore and unutilised bank lines of around Rs 1,300 crore as on September 26, 2019. Collections of around Rs 2,400 crore, expected till December 31, 2019, also supports liquidity. The group also has other liquid assets (investments, securities-based lending book) which can be accessed if necessary- this stood at around Rs 4,600 crore as on same date. As on September 30, 2019, the overall liquidity was adequate to meet debt repayment of around Rs 4,500 crore due over the next three months ended December 31, 2019. The group has also reduced its dependence on commercial paper borrowing, which has dropped to less than 1% of overall borrowings as compared to 18% as on September 30, 2018. The assets and liabilities continue to be well-matched.