Rating Rationale

Strengths
* Diversified business profile: The Edelweiss group has been diversifying within each of its key businesses, as well as entering new businesses, over the past few years. Many of these have now attained reasonable scale and are expected to lend greater stability to the group's earnings profile. Within capital markets, retail broking volumes now constitute around half the group's overall broking volumes. In the commodities business, agricultural commodities became a focus area in fiscals 2015 and 2016 with the group rapidly scaling up the business. The current focus is on building the agri value chain business. In terms of new business lines, the group's life insurance business has grown significantly and is expected to break-even over the next five to six years. As the group's retail and SME businesses expand and life insurance business turns profitable, the revenue contribution from the retail segments is expected to increase.

* Demonstrated ability to build significant competitive positions across businesses: The Edelweiss group has built significant competitive positions in multiple business segments. While it remains a large player in the traditional broking business, it has one of the largest wholesale lending books among non-banks; this portfolio stood at Rs 15,398 crore as on September 30, 2017 (Rs 13,875 crore as on March 31, 2017; excluding capital deployed in distressed assets credit). In the distressed assets segment, Edelweiss Asset Reconstruction Company (EARC), remains the largest ARC in the country with total securities receipts managed of Rs 42,800 crore as on September 30, 2017 (Rs 38,278 crore as on March 31, 2017). EARC became a subsidiary of the Edelweiss Group in the second quarter of fiscal 2017 and the group holds 74.8% stake in this company as on date. However, the group has scaled down its agricultural commodities and precious metals trading business and is focusing on the agricultural commodities value chain business.

* Established position in the capital market businesses: The group's earnings and accrual to capital are expected to benefit from the buoyancy in the capital markets over the medium term, given the group's established market position in related businesses. Profit from the fee-based capital markets and asset management businesses increased in fiscal 2016 compared with fiscal 2015, and is expected to witness 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. It is also one of the largest Indian institutional brokerage houses, with over 300 foreign and domestic institutional clients. The retail broking franchise is also expanding, with more than 4,75,000 unique clients as on September 30, 2017. The Edelweiss group operates across the corporate finance and advisory domains-equity markets, private equity, mergers and acquisitions, advisory structured financial syndication, and debt issues. The group's wealth business and alternate assets business has also witnessed significant growth. The group's assets under advice in the global wealth management business were Rs 76,300 crores and the assets under management in the asset management business were Rs 22,100 crores.

* Comfortable liquidity: The Edelweiss group also has comfortable liquidity. The liquidity cushion, which was around Rs 1000 crores till March 31, 2014, and has been increased to Rs 4800 crore (10% of the balance sheet size) as on September 30, 2017, (Rs 4050 crore as on March 31, 2017). The liquidity cushion consists of unencumbered government securities and fixed deposits, unutilised bank lines, and liquid shares. To further manage liquidity requirements, the group has placed a limit on the quantum of debt coming up for repayment over a three-month period. The group's assets and liabilities continue to be well-matched as can be seen from the trend in cumulative mismatches in three-month and one-year buckets. CRISIL believes that the group's focus on liquidity will hold it in good stead as it grows its balance sheet.

Weakness
* Asset quality exposed to concentration risks inherent in wholesale lending: Edelweiss group's asset quality will remain vulnerable to the concentration risks inherent in its wholesale loan book, despite the strong focus on collateral. As on September 30, 2017, the group's wholesale lending constituted almost 47% of its total loan portfolio (excluding distressed assets credit), with the 10 largest loans constituting around 18 to 20% of the wholesale portfolio. Furthermore, around 51% of the wholesale portfolio comprises real estate loans; this segment is vulnerable to cyclical downturns. The group follows strong credit appraisal and risk management practices and has good collateral cover for its wholesale loans; the level of gross non-performing assets was comfortable, at 1.74% with net non-performing assets at 0.66% as on September 30, 2017. However, CRISIL believes that the inherent nature of the loan portfolio renders the group vulnerable to economic stress; any sharp deterioration in asset quality will also impact its profitability and capital. The proportion of wholesale lending in the overall credit book remains a key rating monitorable.

* High gearing: The group's gearing level remains higher than that of peers. As on September 30, 2017, the gearing increased to 7.7* times from 6.3 times as on March 31, 2017. At the same time, the net gearing excluding the liquid assets of Balance Sheet Management Unit (BMU), stood at 5.6 times as on September 30, 2017. This increase has been due to expansion in both the credit and commodities businesses, requirement for higher margins in the broking business, as well as increase in treasury/BMU assets. The group has raised around Rs 1527.75 crores through QIP issue which closed on November 20, 2017, which is expected to bring down the gearing levels. Over the medium term, the gearing is expected to remain within 7.5 times (net gearing of below 6.5 times). While the risks of a higher gearing are partially mitigated by the group's limits on short-term debt maturity and the liquidity cushion available, the pace of increase in gearing will remain a key rating monitorable.

* Lower profitability than peers: The Edelweiss group's profitability ratios are lower than that of other large financial sector groups; the group's return on assets was 1.8% and return on equity was 16.3% in Q1FY2018 (annualised). While profitability has been improving over the past few years, it remains lower than that of its peers. This is because a significant portion, over 25%, of the group's 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 balance sheet management portfolio, which is used for managing their liquidity. This portfolio comprises largely of government securities, fixed deposits, and corporate bonds, which have a low return on capital employed. Furthermore, the insurance business continues to be loss-making (net loss of Rs 83 crores in H1FY18, out of which Edelweiss group's share of loss was Rs. 42 crore). Expected improvement in the profitability of the insurance business and reduction in the share of funds allocated to BMU will benefit the group's profitability only over the long term.