CRISIL has revised its outlook on the long-term bank facilities, non-convertible debentures and long term principle protected market linked debentures of Edelweiss Asset Reconstruction Company Limited (EARC) to 'Negative' from 'Stable' and reaffirmed the ratings at 'CRISIL A+/CRISIL PP-MLD AA-r(CE)/CRISIL AA-(CE)' rating.
 
CRISIL has withdrawn its rating on the commercial paper programnme at the company's request as there is no amount outstanding against the rated instrument. This is in line with CRISIL's withdrawal policy. CRISIL has also withdrawn its ratings on the long-term, principal-protected, market-linked debentures of Rs 5 crore and non-convertible debentures (NCDs) of Rs 565 crore (See annexure 'Details of Rating Withdrawn') in line with its withdrawal policy.
 
CRISIL has also revised its outlook on the long-term debt instruments of the other Edelweiss group entities to 'Negative' from 'Stable'. The outlook revision factors in the increased stress in the Edelweiss group's loan book, particularly the wholesale book, which has also impacted the group's overall earnings profile. Further, while the group is in the process of scaling down its wholesale portfolio, this could be delayed, given the challenging macro environment, including issues related to the Covid-19 pandemic. Furthermore, the group's fundraising, which had seen an improving trajectory in the preceding couple of quarters, was impacted in the fourth quarter of fiscal 2020.
 
Overall reported gross non-performing assets (GNPAs) in the lending business increased to 2.76% as on December 31, 2019, from 1.87% as on March 31, 2019. While GNPAs in the retail book increased to 2.0% as on December 31, 2019, from 0.7% as on March 31, 2019, the reported GNPAs in the wholesale book increased to 3.6% from 2.6% during the same period. The group has sold some of the stressed exposures in the lending business to asset reconstruction companies (ARCs), including Edelweiss Asset Reconstruction Co Ltd (EARC; on an arm's length basis) to benefit from better resolution capabilities and strong legal teams. Including assets sold to ARCs, a sizeable proportion of which continue on the books in the form of security receipts, the stressed assets of the lending book would be higher. The increased stress in the loan book and consequent higher provisions has significantly impacted the group's earnings with net profits (before minority interest) for the 9 months ended December 31, 2019, declining by 70% to Rs 238 crore from Rs 798 crore during the corresponding period of the previous year.
 
The Edelweiss group's collections and asset quality metrics may come under further pressure on account of the extended nationwide lockdown. The lockdown has been further extended, although there has been a partial lifting of restrictions based on classification of zones. CRISIL believes that further lifting of restrictions will continue in a phased manner. Any delay in return to normalcy will put pressure on collections and asset quality metrics. The group has offered moratorium to their borrowers and hence, the collections are expected to be low in the near-term. Thereafter, collections could witness challenges as the income streams of the group's borrowers are likely to be impacted given the current challenging macro environment.
 
The Edelweiss group witnessed a reduction in incremental fund raising in fourth quarter of fiscal 2020. The group raised around Rs 1,500 crore in the quarter, as compared to around Rs 3,750 crore in the third quarter and around Rs 2,700 crore in the second quarter.
 
Nevertheless, CRISIL understands that the management is engaging with lenders and has fresh bank sanctions in the pipeline [including those under Long Term Reverse Repo Operation (LTRO)] and is also in process of raising retail NCDs. The group's ability to raise fresh funds from diverse sources, over the near term, will be a key monitorable.
 
Further, CRISIL has also factored in the group's ability to raise capital as demonstrated in the last few quarters. Investments from Caisse de depot et placement du Quebec (CDPQ), Kora Management (Kora; a US-based investment firm), and Sanaka Growth SPV I Ltd (part of Sanaka Capital) between March and November in 2019, have bolstered the group's capital position with overall networth (including CDPQ investment of Rs 1,040 crore, Kora investment of Rs 177 crore, and Sanaka Capital investment of Rs 117 crore as part of networth) increasing to Rs 10,163 crore as on December 31, 2019, and gearing reducing to 3.7 times. The group plans to raise additional capital at the holding company level, as well as in the Edelweiss Global Investment Advisors (EGIA) business, which is expected to further improve the capital levels for the group.
 
The group also has adequate liquidity. On the liability side, the Reserve Bank of India (RBI) announced regulatory measures under the Covid-19 - Regulatory Package, whereby lenders were permitted to grant moratorium on bank loans. The Edelweiss group has, currently, not applied for moratorium and is repaying its liabilities as per schedule. The overnight on-balance sheet liquidity (including cash, liquid investments, and treasury assets) stood at around Rs 2,450 crore as on April 30, 2020, while unutilised bank lines stood at Rs 700 crore on same date. Over and above, the group has other liquid assets (investments, securities-based lending book), which can be accessed if necessary. This stood at around Rs 4,000 crore as on April 30, 2020.
 
The group continues to strategically focus on reducing its wholesale book through sale of assets to investors and shifting these assets to a fund platform, which will provide completion finance to the projects. In this regard, the group has already announced one transaction of $425 million between Edelweiss Alternative Asset Advisors (EAAA) and Meritz Financial Group (a South Korean financial services conglomerate) of which one tranche has already been concluded. The group is in advanced stages of discussion with various global investors for more such transactions.
 
The ratings also continue to reflect the group's diversified business 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 economic environment.  Furthermore, the profitability ratios are relatively weaker than some other large, predominantly wholesale players.
 
CRISIL will continue to closely monitor the progress in sell-down of wholesale assets, group's ability to raise fresh funding, proposed capital raising plans as well as any increase in build-up of stress in loan book. Based on these factors, CRISIL will take appropriate rating action.
 
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, Edelweiss Financial Services Ltd (EFSL; '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 rating on EARC's Rs 150 crore non-convertible debentures and Rs 350 crore long-term principal-protected, market-linked debentures continues to be driven by the corporate guarantee extended by the parent, EFSL, the structured payment mechanism, and the expected strong oversight by the guarantor. The rating also factors the company's strategic importance to the parent. Any adverse movement in the credit risk profile of the guarantor or non-adherence to the payment mechanism and guarantee fall-off are key rating sensitivity factors.

For arriving at the ratings, CRISIL has considered the standalone business and financial risk profiles of EARC. CRISIL 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. CRISIL 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 on EFSL, CRISIL has combined the business and financial risk profiles of EFSL and its subsidiaries. That's because all the entities, collectively referred to as the Edelweiss group, have significant operational, financial, and managerial integration and also operate under the common Edelweiss brand.

Strengths
* Strong support from the parent: EFSL is the promoter of, and the largest shareholder in, EARC. EFSL holds 74.81% stake in EARC through its wholly owned subsidiary, Edelweiss Custodial Services Ltd and other subsidiaries. CDPQ (Caisse de Depot et Placement du Quebec), one of North America's largest pension fund managers, has invested in EARC through CCPSs (compulsorily convertible preference shares) and upon conversion of the CCPSs it will hold 20% stake in EARC, with Edelweiss holding 60% on a fully diluted basis. The Edelweiss group has articulated that it will continue to hold a minimum 60% stake in EARC. The company is strategically important to the Edelweiss 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, and benefits from financial, operational, and management linkages with the Edelweiss group, which has infused Rs 281 crore as equity in EARC till date. Also, EARC borrows from the group companies as and when required; 10% of EARC's borrowings were from the group as on December 31, 2019 (28% as on March 31, 2019). The group's senior management is actively involved in EARC's strategic decision-making. CRISIL believes the Edelweiss group will continue to support EARC due to its majority shareholding in the company and shared brand.
 
* Comfortable market position: EARC remains the largest asset reconstruction company (ARC) in India, with outstanding security receipts (SRs; includes both owned and managed) of Rs 43,100 crore as on December 31, 2019 (around Rs 45,000 crore as on March 31, 2019). While the company initially acquired primarily corporate assets, it has also started acquiring retail and SME assets 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.
 
Weaknesses
* 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. Till December 31, 2019, EARC has put in place resolution strategies for assets of Rs 36,560 crore through employment of various strategies. Also, recoveries improved significantly in last few quarters supported by resolution of couple of large assets. However, in the current economic scenario, with significant pressure on the cash flow of borrowers, EARC's ability to recover money will remain a key monitorable. At the same time, developments such as IBC (Insolvency and Bankruptcy Court) and NCLT (National Company Law Tribunal) are expected to support recoveries from, or resolution of, stressed accounts with banks and ARCs.
 
* Volatile earnings profile: EARC's earnings profile is volatile because of unpredictable recoveries from acquired assets, given the nature of its business. The company's strategy is to focus on fee-based income by managing large trust assets, wherein a significant proportion of SRs will be held by external investors (banks or qualified buyers). This lends some stability to revenue, as management fees are higher in payment waterfall than in payment to SR holders. However, with management fees being linked to net asset value, ability to recover impacts management fees as well. At the same time, the increasing trend of an early recovery incentive under the 15:85 and subsequent regime provides a potential additional income stream if EARC is able to effect recoveries swiftly. The resolution strategy is mainly turnaround and recovery rather than asset stripping. Given the regulatory construct of investing a minimum of 15% of SRs of each trust, EARC's earnings profile is more strongly linked to the extent of recoveries from acquired assets compared to the previous minimum 5% regime.

EARC has adequate cash and cash equivalents. The Edelweiss group also maintains adequate liquidity. As a policy, the group maintains a cushion of 9-10% of the balance sheet.  There was a liquidity cushion (including cash, liquid investments, and treasury assets) of around Rs 2,450 crore and unutilised bank lines of around Rs 700 crore as on April 30, 2020. The group also has other liquid assets (investments, securities-based lending book), which can be accessed if necessary; these stood at around Rs 4,000 crore. As on April 30, 2020, the overall liquidity was adequate to meet the debt obligation of around Rs 3,290 crore that was due over the next few months until September 30, 2020. The assets and liabilities continue to be well-matched. The group has also reduced its dependence on commercial paper borrowing, which dropped to less than 1% compared to 18% of total borrowings as on September 30, 2018.

CRISIL believes EARC will continue to receive strong support from the Edelweiss group and will maintain its robust market position over the medium term. The ratings may be downgraded if the group's stake in, or support extended to, EARC declines, or if the group's credit risk profile weakens.

Rating Sensitivity Factors
Upward Factors
* Significant increase in EARC's recovery from stressed assets while maintaining comfortable financial profile
* Significant improvement in the group's asset quality with GNPAs less than 1% on a sustained basis, and an improving earnings profile
* Increase in fund mobilisation on a steady-state basis for the group

Downward Factors
* Change in the extent of EFSL's ownership of EARC or diminution in the expected support from the parent
* Lack of progress on planned scale down of the wholesale portfolio
* Continued funding challenges with limited fundraising by the Edelweiss group
* Deterioration in asset quality of the Edelweiss group with GNPAs increasing to above 4%, thereby also impacting profitability.

The credit enhancement reflects the strength of an unconditional and irrevocable guarantee extended by EFSL, and the payment mechanism for the issue. CRISIL believes EFSL's guarantee and the structured payment mechanism will ensure entire debt obligations under the debt instruments are met on time. CRISIL has fully consolidated the business and financial risk profiles of the borrower and the guarantor. The financials of the borrower, including the entire guaranteed debt, are adequately factored in the consolidated financials of the guarantor. CRISIL has also considered multiple scenarios to test the adequacy of the credit enhancement structure. CRISIL believes the instrument will have high degree of safety regarding timely servicing of financial obligations even in the most likely stress scenario.

Unsupported ratings:  CRISIL A+/CRISIL PP-MLD A+r
CRISIL has introduced 'CE' suffix for instruments having explicit Credit Enhancement feature in compliance with SEBI's circular dated June 13, 2019.

Refer 'Key rating drivers & detailed description' aboveRefer 'Key rating drivers & detailed description' above.

About the Company and the Group
EARC was incorporated in October 2007 and registered with the Reserve Bank of India as a securitisation and asset reconstruction company in October 2009. The Edelweiss group currently holds 74.81% stake in EARC, with high-networth individuals and one foreign institutional investor holding the remaining stake. As on December 31, 2019, the company had managed SRs of Rs 43,100 crore. 

EARC reported a profit after tax (PAT) of Rs 435.0 crore on total income of Rs 1366.9 crore for fiscal 2019, against a PAT of Rs 180.2 crore on total income of Rs 769.4 crore for fiscal 2018. In the first 9 months of fiscal 2020, PAT was Rs 299 crore on total income of Rs 1,088 crore against Rs 327 crore and Rs 1,049 crore, respectively, in the corresponding period of the previous fiscal.

The Edelweiss group comprises 48 companies as on December 31, 2019. The number of companies has come down from 74 as on March 31, 2016, and is expected to come down further over the next few quarters (subject to requisite approvals). The group had 458 offices (including eight international offices in six locations) in around 190 cities as on December 31, 2019. Furthermore, as a part of streamlining its operating structure, the group has restructured the businesses into three verticals (credit, advisory and insurance).

The group has presence across various financial services businesses. These businesses include loans to corporates and individuals, mortgage finance, including LAPs and small-ticket housing loans, SME finance, agricultural credit including commodity sourcing and distribution, institutional and retail equity broking, corporate finance and advisory, wealth management, third-party financial products distribution, alternative and domestic asset management, and life and general insurance. In addition, the BMU focuses on liquidity and asset-liability management.

In fiscal 2019, the group's profit after tax (PAT) was Rs 1044 crore on total income of Rs 10,881 crore against Rs 890 crore and Rs 8,920 crore, respectively, in fiscal 2018. In the first 9 months of fiscal 2020, PAT was Rs 200 crore on total income of Rs 7,637 crore against Rs 763 crore and Rs 8,124 crore, respectively, in the corresponding period of the previous fiscal.

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
The rating on EARC's PPMLDs reflects the strength of an unconditional and irrevocable guarantee extended by EFSL, and payment mechanism for the issue. The guarantee covers EARC's entire obligations on the PPMLD issue. The rating thus reflects the credit strength of the guarantor, EFSL. CRISIL 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 Rs 150 crore NCDs, Rs 150 crore and Rs 200 crore PPMLD programme 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