Detailed Rationale

CRISIL Ratings has assigned its ‘CRISIL A+/Stable’ rating to Rs.629 crore Non Convertible Debentures of Edelweiss Asset Reconstruction Company Ltd (EARC). The rating on the company’s existing debt instruments and bank facilities have been reaffirmed at ‘CRISIL A+/Stable/CRISIL AA-(CE)/CRISIL PPMLD AA-(CE)/Negative’.

 

CRISIL Ratings has also withdrawn its rating on the Non Convertible Debentures of Rs 1,250 crore as these have been redeemed (See - ‘Annexure - Details of Rating Withdrawn'). These withdrawals are in line with CRISIL Ratings’ withdrawal policy.

 

The ratings continue to reflect demonstrated sustainability in the standalone performance of EARC and the reaffirmation of ratings for the Edelweiss group. With significant scale up over time, EARC has become one of the key contributors to the overall business profile as well as profits of the Edelweiss group. EARC is the largest ARC in the country with securities receipts managed of Rs 39,150 crore as on June 30, 2023 (Rs 37,100 crore as on March 31, 2023). The company reported net profits of 80 crore for first quarter of fiscal 2024 and Rs 318 crore for fiscal 2023 (Rs 65 crore for first quarter of fiscal 2023 and Rs 252.7 crore for fiscal 2022).

 

The ratings on the debt instruments of EARC continue to centrally factor in the expectation of strong management, financial, and operational support from the ultimate parent, EFSL (rated ‘CRISIL AA-/Negative/CRISIL A1+’, holding company of the Edelweiss group), both on an ongoing basis and in the event of distress. Such expectation reflects the strategic importance of EARC to EFSL as well as the strong moral obligation on EFSL to support EARC, given the shared name and distressed assets resolution being a focus area of the group. 

 

The ratings on EFSL and Edelweiss group, continue to reflect the adequate capitalisation level of the group, supported by multiple rounds of capital raising; the diversified business profile with presence across lending, asset management, asset reconstruction and insurance segments; and demonstrated ability to build competitive presence in multiple lines of businesses, which should support improvement in earnings going ahead. The group also maintains adequate liquidity on an ongoing basis.

 

The continuation of the ‘Negative’ outlook reflects the challenges in profitability and asset quality, that the group has been facing largely on account its wholesale lending book. Although the group’s overall profitability has seen some improvement and the group is also taking concerted efforts to arrest asset quality stress, in CRISIL Rating’s view, sustained and substantial improvement in profitability and asset quality, over the medium term, will be key monitorable.

Analytical Approach

For arriving at the ratings, CRISIL Ratings has considered the standalone business and financial risk profiles of EARC. CRISIL Ratings has also factored in the support that EARC is likely to receive from its ultimate parent, EFSL. This is because EARC and EFSL have extensive business and operational linkages and a common brand.

For credit enhanced instruments, CRISIL Ratings has applied its criteria on rating instruments backed by guarantees. The (CE) suffix reflects the payment structure that is designed to ensure full and time-bound payment to lenders.

 

For arriving at the ratings of EFSL, CRISIL Ratings has combined the business and financial risk profiles of EFSL and its subsidiaries (excluding entities engaged in wealth business.). This is because all these entities have significant operational, financial, and managerial linkages and operate under a common Edelweiss brand.

Key Rating Drivers & Detailed Description

Strengths:

Strong market position

EARC is the largest ARC in India, with outstanding security receipts (SRs; includes both owned and managed) of Rs 39,150 crore as on June 30, 2023 (Rs 37,100 crore as on March 31, 2023). While the company initially acquired primarily corporate assets, it has also started acquiring retail and has set-up the requisite infrastructure for the same. 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 experienced management team at EARC is a key support factor in building up its strong market position and enhancing its recovery capabilities.

 

Benefits accruing from being part of Edelweiss group

EFSL is the promoter of, and the largest shareholder in, EARC. EFSL holds ~60% stake in EARC through its wholly owned subsidiary, Edelweiss Securities and Investment Private Limited and other subsidiaries. Caisse de dépôt et placement du Québec (CDPQ), one of North America’s largest pension fund managers, holds ~20% stake in EARC. The Edelweiss group will continue to hold minimum 60% stake in EARC. The company is strategically important to the group, which has identified distressed asset reconstruction as a growth area.

 

EARC has operational synergies with other group businesses such as asset management, investment banking and corporate lending. It benefits from the financial, operational and management linkages with the Edelweiss group, which has infused Rs 281 crore as equity till date. Also, EARC borrows from the group companies when required. It derives benefits of association with the group in raising debt. The group’s senior management is actively involved in EARC’s strategic decision-making. The group will continue to support EARC owing to its majority shareholding in the company and shared brand.

 

Weakness:

Asset quality challenges inherent in the industry

EARC faces asset quality-related challenges given exposure to only stressed assets, despite its adequate asset acquisition and resolution policy framework. EARC had put in place resolution strategies for stressed assets of more than Rs 54,415.2 crore till date through employment of various mechanisms. The cumulative SR redemption ratio till June 30, 2023 was 45.4% (45.8% till March 31, 2023). This is in line with industry average. EARC’s ability to timely recover from its exposures will remain a key monitorable.

 

Volatile earnings profile

EARC’s earnings profile is volatile because of unpredictable recoveries from acquired assets, owing to the nature of 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 (banks or qualified buyers). This lends some stability to revenue as management fees are higher in payment waterfall than payment to security receipt holders. 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 early recovery incentive on a case-to-case basis and upside income on returns post redemption of security receipts, wherein a significant proportion of the security receipts are held by external investors (banks or qualified buyers). The Return on Average Assets was 5.3% for fiscal 2023 as against 4.2% in fiscal 2022. However, increasing focus on retail acquisition and resolution will bring stability to earning profile.

Liquidity: Adequate

EARC had liquidity of Rs 573 crore as on August 31, 2023, this is sufficient to meet repayments til March 2024. The group maintains adequate liquidity. As of the end of July 2023, the group had overnight liquidable assets of Rs 2085 crore, undrawn bank lines of Rs 346 crore and other liquidable assets (includes short term loans and treasury assets) of Rs 636 crore.  This is adequate to cover upcoming debt repayments of upto December 23.

Outlook: Stable

CRISIL Ratings believes EARC will maintain its robust market position over the medium term and continue to receive strong support from the Edelweiss group.

 

Outlook on instruments guaranteed by EFSL: Negative

The outlook on the debt instruments guaranteed by EFSL reflects CRISIL Ratings’ outlook on the credit profile of EFSL.

Rating Sensitivity Factors

Upward Factors

• Upward change in the credit risk profile of EFSL could have a similar rating change on EARC
• Substantial improvement in the market position and profitability levels at EARC
• Significant improvement in the group's asset quality with GNPA less than 3% on a sustained basis, coupled with reduction in level of stressed assets
• Improvement in earning profile across businesses for the group

Downward Factors

• Downward change in the credit risk profile of EFSL could have a similar rating change on EARC
• Significant decline in earnings profile and capital position EARC.
• Continued pressure on profitability of the group, with losses continuing on a sustained basis (Negative PAT excluding one-off gains)
• Deterioration in asset quality of the group
• Continued funding access challenges with limited fund-raising by the group

Adequacy of credit enhancement structure

The credit enhancement reflects the strength of an unconditional, irrevocable and legally enforceable guarantee extended by EFSL, and the payment mechanism for the issue. CRISIL Ratings believes EFSL's guarantee, and the structured payment mechanism will support the timely repayment of the debt instruments in full. CRISIL Ratings has fully consolidated the business and financial risk profiles of the borrower and the guarantor. The financials of the borrower, including the guaranteed debt, are adequately factored in the consolidated financials of the guarantor. The rating agency has also considered multiple scenarios to test the adequacy of the credit enhancement structure. It believes the instrument has a high degree of safety regarding timely servicing of financial obligations even in the most unlikely stress scenario.

Unsupported ratings  - CRISIL A+/CRISIL PPMLD A+

CRISIL Ratings has introduced the suffix CE for instruments having explicit credit enhancement feature, in compliance with the circular of Securities and Exchange Board of India dated June 13, 2019.

Key drivers for unsupported ratings

Refer 'Key rating drivers & detailed description' above

About the Company

EARC was incorporated in October 2007 and registered with the Reserve Bank of India as a securitisation 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 June 30, 2023, the company was managing security receipts of Rs 39,150 crore. 

 

EARC reported PAT of Rs 318.4 crore on total income of Rs 553 crore for fiscal 2023, against PAT of Rs 253 crore on total income of Rs 444 crore in fiscal 2022.The company reported PAT of Rs 80 crore on total income of Rs 236 crore for first quarter of fiscal 2024, against PAT of Rs 65 crore on total income of Rs 230 crore for corresponding period in previous fiscal.

About the Group

The Edelweiss group comprised 30 subsidiaries and associates as on March 31, 2022. The number of companies has come down from 74 as on March 31, 2016, because of multiple factors such as sale, windup and merger among others. The group had 293 offices (including 10 international offices in 6 locations) in around 136 cities as on March 31, 2022. Furthermore, as part of streamlining its operating structure, the group has restructured the businesses into four verticals namely credit, insurance, asset management and asset reconstruction.

 

The group is present across various financial services businesses, including loans to corporates and individuals, mortgage finance - loans against property and small-ticket housing loans, MSME finance, alternative and domestic asset management, and life and general insurance. In addition, the Balance sheet Management Unit (BMU) focuses on liquidity and asset-liability management.

 

On a consolidated basis, the group reported PAT of Rs 405 crore on a total income of Rs 6,058 crore for fiscal 2023, as against PAT of Rs 212 crore on a total income of Rs 4,320 crore for fiscal 2022. 

 

For the quarter ended June 30, 2023, the group reported PAT of Rs 78 crore on a total income of Rs 1,316 crore as against PAT of Rs 35.4 crore on a total income of Rs 651 crore during similar period in previous fiscal.

List of covenants

The material covenants of the instruments are as follows:  

• The company shall during the currency of the debentures maintain a security cover equal to the principal and interest payable throughout the tenure of the debentures.
• The company shall provide additional security to meet shortfall if the trustee and/or the debenture holder(s) are of the opinion that any time during which the debentures are outstanding the security provided by the company has become inadequate, the company shall provide and furnish to the trustee to its satisfaction such additional security for maintaining the security cover as provided in the financial covenants and conditions as may be accepted to the trustee to cover such deficiency
• The company shall not permit any transfer of the controlling interest or make any drastic change in the management setup.

Comply with all regulatory and other requirements/covenants as mentioned in the debenture trust deed as may be applicable

Any other information: For Credit Enhanced NCDs and LT-PPMLDs

The rating on EARC's credit enhanced NCDs and PPMLDs reflects the strength of an unconditional, irrevocable and legally enforceable guarantee extended by EFSL, and payment mechanism for the issue. The guarantee covers EARC’s entire obligations on the said issue. The rating thus reflects the credit strength of the guarantor, EFSL. CRISIL Ratings believes EFSL’s guarantee and the structured payment mechanism will ensure entire debt obligations under the debt instruments are met on time. The guarantee will remain unaffected even if EARC faces bankruptcy or in case of dissolution, insolvency, liquidation, or winding up proceedings initiated by or against the issuer.

 

As per the payment mechanism, if EARC doesn’t deposit the requisite amount in the designated account by T*-1 date, the guarantor (EFSL) would be obligated to deposit the shortfall amount in the designated account latest by 12.00 pm on the T date. If the guarantor (EFSL) fails to deposit such funds in the designated account on T date, it would constitute default on the part of the guarantor.

 

Payment structure for the NCDs and PPMLDs guaranteed by EFSL

Day*	Action
T-1	EARC shall deposit the requisite funds in the designated account
T	If EARC does not deposit the requisite funds in the designated account on any T-1 date (as mentioned above), EFSL would be obligated to deposit the shortfall amount in the designated account latest by 12.00 pm on the T date. If EFSL fails to deposit such funds in the designated account on T date, it would constitute default on part of EFSL.

*T being the coupon payment date, scheduled principal redemption date, put/call option settlement date or redemption date under an early redemption/ acceleration event