Detailed Rationale

CRISIL Ratings’ rating on the bank facilities and debt instruments of Edelweiss Asset Reconstruction Company Limited (EARC) continue on ‘Rating watch with Negative Implications’. 

 

The rating was placed on Watch following material supervisory concerns raised by the Reserve Bank of India (RBI) via its press release on May 29, 2024, on EARC.

 

The RBI had ordered EARC to cease and desist from acquisition of financial assets including security receipts (SRs) and reorganising the existing SRs into senior and subordinate tranches.

 

CRISIL Ratings understands based on discussions with the management that EARC has submitted their remedial action plan to the RBI and is continuously engaging with the regulator. RBI’s response on the same is awaited.

 

Lately, the company has increased focus on retail acquisitions. Therefore, the embargo on new acquisitions would not translate into a significant impact on AUM in the short term given retail assets are not very AUM accretive. Revenues are also largely derived from recoveries from EARC’s existing book with new retail business contribution to overall profit after tax (PAT) at less than Rs 6 crore in fiscal 2024, of overall PAT of Rs 355 crore. Decline in AUM to Rs 29,905 crore as on June 30, 2024 from Rs 37,500 crore as on March 31, 2023 (31,590 crore as on March 31, 2024) is majorly on account of lower corporate NPA available in market as compared to past as well as limited stock of retail NPA available for sale and healthy recoveries from earlier acquisitions.

  

Nevertheless, a prolonged restriction on acquisitions would have a bearing on EARC’s business risk profile. The company reported a PAT of Rs 85 crore in quarter ended June 30, 2024 as against a PAT of Rs 80 crore in quarter ended June 30, 2023.

 

Aside from the direct business and financial impact for EARC, this development could have a second order impact on fund raising/ rollover of existing borrowings given the confidence sensitive nature of the funding environment. While so far, there are no concerns around these aspects, traction in fund raising will continue to be a key monitorable. Further, if the restrictions are not lifted for a prolonged period, there would be an impact on the business and financial risk profile of the company.

 

As on August 22, 2024, the EARC had liquidity of Rs 685 crore, which was in the form of bank balances and fixed deposits. This is expected to be sufficient to meet debt obligations and operating expenses for six months, even assuming nil business inflows and no incremental fund raising. While there is unpredictability in the stressed assets business, cashflows from recoveries should support the liquidity position of EARC. In fiscal 2024, total recoveries were healthy at Rs 9,416 crore, of which EARC’s share was Rs 2,841 crore. In first quarter of fiscal 2025, the total recoveries stood at Rs 1,332 crore of which EARC’s share was Rs 345 crore.

 

CRISIL Ratings will continue to closely monitor traction in fund raising, the company’s liquidity position, as well as await updates from the regulator on lifting of restrictions placed on the company. The watch will be resolved once greater clarity emerges on these aspects.

 

The ratings continue to reflect demonstrated sustainability in the standalone performance of EARC with comfortable market position, adequate capitalisation and an experienced management team. These strengths are partially offset by the moderate, albeit improving redemption record, and the volatility in earnings inherent in the distressed assets business

Analytical Approach

For arriving at the ratings, CRISIL Ratings has considered the standalone business and financial risk profiles of EARC.

Key Rating Drivers & Detailed Description

Strengths:

• Comfortable market position

EARC is the largest ARC in India, with outstanding security receipts (SRs) of Rs 29,950 crore as on June 30, 2024 (Rs 31,590 crore and Rs 37,100 crore as on March 31, 2024 and March 31, 2023 respectively). Previously, the company’s business was largely corporate focused, but now it has increased focus on acquiring retail assets and has put in place the requisite infrastructure for the same. Of the overall outstanding AUM as on March 31, 2024, 7% comprised retail security receipts.

 

EARC plans to focus on recoveries mainly through restructuring and rehabilitation of the portfolio companies acquired. Over the medium term, acquisitions will be done where the risk-reward equation is within a pre-decided range with a focus on fee-based business model.

 

The company’s growth was expected to be modest when compared to the past due to a retail focus, but this will be affected till the restriction is lifted by the regulator. A prolonged restriction on acquisitions would have a bearing on EARC’s business risk profile.

 

• Adequate Capitalisation 

EARC’s capitalisation remains adequate with networth of Rs 3,235 crore as on June 30, 2024 as against Rs 3,150 crore as on March 31, 2024.

 

EFSL is the promoter of EARC with 60% holding followed by Caisse de dépôt et placement du Québec (CDPQ), one of North America’s largest pension fund managers, holding ~20% stake.

 

The company’s leverage remains modest at 0.57 times as on June 30, 2024 and 0.63 times as on March 31, 2024.  EARC’s capitalisation is largely supported by internal accruals.

 

Going forward, leverage is expected to remain modest given the relatively lower predictability in cashflows.

 

• Experienced management

Mr Rajkumar Bansal, ceased to be the Managing Director (MD) and CEO effective June 2024 as RBI did not accede to EARC’s request for his reappointment. Subsequently, Ms Mythili Balasubramanian took over additional charge. In August 2024, the board has sought RBI approval for her appointment as MD & CEO.

 

However, EARC has a strong management team and there are other senior members in EARC with extensive experience in reconstruction and resolution of stressed assets.

 

Management has also put in place an ecosystem to enable resolution of assets. The company has a dedicated legal team of over 40 lawyers and professionally qualified officers, who are specialised in dealing with stressed assets, stemming from their experience in the banking and financial services industry. The infrastructure for retail assets has also been set up.

 

Weaknesses:

• Moderate, albeit improving redemption ratio

EARC is exposed to challenges related to the timing and quantum of recovery given its business of stressed assets, despite its adequate asset acquisition and resolution policy framework. The company had put in place resolution strategies for stressed assets of more than Rs 72,767 crore till date through employment of various mechanisms. EARC has issued security receipts of Rs 73,948 crore till March 31, 2024, of which Rs 38,111 crore has been redeemed and Rs 29,801 crore is outstanding as on June 30, 2024. The overall cumulative SR redemption ratio till June 30, 2024 was 51.6% (50% till March 31, 2024 and 45.8% till March 31, 2023). This is in line with the industry average.

 

EARC’s ability to recover from its exposures in a timely manner will remain a key monitorable.

 

• Earnings remain exposed to inherent volatility in the business

EARC’s earnings profile is volatile because of unpredictable recoveries from acquired assets, owing to the nature of the business. The company focuses on fee-based income by managing large trust assets, wherein a significant proportion of the security receipts are held by external investors (selling entities or qualified buyers). This lends some stability to revenue as management fees are higher in the payment waterfall than payment to security receipt holders. For EARC, the five-year average of management fee as a percentage of total AUM was 1.8%. For industry players, this ratio ranges from 1-2%. However, with the management fees being linked to net asset value, the ability to recover impacts management fees as well.

 

EARC’s income levels also include recovery incentive and upside income on returns post redemption of security receipts. The company's overall profitability has been improving with reported PAT of Rs 355 crore in fiscal 2024 when compared to Rs 318 crore in fiscal 2023 and Rs 253 crore in fiscal 2022 (Rs 186 crore in fiscal 2021). Return on Average Assets (RoA) was 6.3% for fiscal 2024 as against 5.3% for fiscal 2023 as against 4.2% and 2.9% in fiscal 2022 and fiscal 2021. For quarter ended June 30, 2024, EARC reported a PAT of Rs 85 crore (RoA of 6.5% annualized) as against a PAT of Rs 80 crore (RoA of 5.4%) for corresponding period last fiscal. For the current fiscal, continued traction in recoveries and resolution will support the earning profile, offsetting some impact of the restriction on acquisitions.

Liquidity: Adequate

EARC had liquidity of Rs 685 crore, which was in the form of bank balances and fixed deposits as on August 22, 2024. This is expected to be sufficient to meet debt obligations and operating expenses for six months, even assuming nil business inflows and no incremental fund raising. Notwithstanding the unpredictable nature of the stressed assets business, cashflows from recoveries would support the liquidity position of EARC.

Rating sensitivity factors

Upward factors

• Substantial improvement in the market position with substantial increase in retail AUM share
• Sustained improvement in earnings profile

 

Downward factors

• Delay in lifting of restrictions by regulator, impacting business
• Significant decline in earnings profile with ROA of lower than 2.5% on a sustained basis
• Challenges faced in timely fund raise
• Weakening in recovery track record

About the Company

EARC was incorporated in October 2007 and registered with the RBI as a Securitization and ARC in October 2009. The Edelweiss group currently holds 60% stake in EARC, with high-networth individuals (16%) and two foreign institutional investor (24%) holding the remaining stake. As on March 31, 2024, the company was managing AUM of Rs 31,590 crore. 

 

EARC reported PAT of Rs 355 crore on total income of Rs 623 crore for fiscal 2024, as against Rs 318 crore on total income of Rs 553 crore for fiscal 2023.

 

For quarter ended June 30, 2024, it reported a PAT of Rs 85 crore on total income of Rs 145  crore as against a PAT of Rs 80 crore on total income of Rs  131 crore for corresponding period last fiscal. 

Key Financial Indicators

EARC Standalone

 

As on / for the year ended	Unit	Mar-24	Mar- 23	Mar-22
Total assets	Rs crore	5358	5,947	6,079
Total income*	Rs crore	623	553	444
Profit after tax (PAT)	Rs crore	355	318	253
GNPA	%	NA	NA	NA
Gearing	Times	0.6	1.0	1.3
Return on assets	%	6.3	5.3	4.2

*net of interest expense

 

As on / for the year ended	Unit	June-24	Jun-23
Total assets	Rs crore	5,199	5,375
Total income*	Rs crore	145	131
Profit after tax (PAT)	Rs crore	85	80
GNPA	%	NA	NA
Gearing	Times	0.6	0.8
Return on assets	%	6.5	5.6

 

Any other information: Not applicable