Rating Rationale

Key Rating Drivers & Detailed Description

Strengths:

Strategic importance to, and support from, Encore Capital Group

Encore ARC is strategically important to Encore Capital Group as it is in the same business and in line with the parent’s strategy. Also, it provides geographic diversification to the overall operations of the parent.

Encore ARC benefits from operational, financial, and managerial support from Encore Capital Group. The company's board comprises senior functional executives from Encore Capital group, ensuring strong support of its performance. Further, the investment committee of Encore ARC has the members from the parent. Encore Capital Group is committed to support the Indian entity with required capital support. It has infused Rs 142.5 crore of capital in Encore ARC, out of which Rs 52.5 crore has been infused in January 2021. After the capital infusion, the shareholding of Encore Capital Group had increased to 55% as on January 2021 (from 50% as on December 31, 2020). Encore Capital Group further purchased stake from International Finance Corporation (IFC) in fiscal 2023 which resulted in increase of shareholding to 70% as on March 31, 2023.

CRISIL Ratings believes close operational, managerial and financial linkages and shared brand, imply that Encore Capital Group will support Encore ARC.

Comfortable capitalisation, supported by regular capital infusion by the shareholders.

The Company had a networth of Rs 238.5 crore as on June 30, 2023 (Rs 238.4 crore as on March 31, 2023). The shareholders (Encore Capital Group and ADV Partners) have infused Rs 256 crore in the company till date, out of which Rs 75 crore was infused in January 2021. As on June 30, 2023, Encore ARC had nil gearing (nil as on March 31, 2023). The gearing is expected to remain comfortable and in the range of 1.5-1.6 times over the medium term. Furthermore, the company operates in the granular asset classes of small and medium enterprises (SME) and retail, which will reduce asset-side risks.

Weaknesses

Early and small scale of operations

Encore ARC started operations in March 2017, and the overall size remains small. It has taken a measured approach in terms of growing its business, especially in the last couple of years on account of uncertainties around the covid-19 pandemic and challenges related to recoveries as well as fewer assets brought to market and restriction impacting the due diligence process on the assets. This, along with the cautious approach by the management of Encore ARC, resulted in a significant slowdown in acquisition of assets to Rs 110 crore in fiscal 2023, as against Rs 313 crore in fiscal 2020. Nevertheless, despite the challenges in the external environment, Encore ARC was able to redeem SRs worth Rs 192 crore in fiscal 2023, Rs 172 crore in fiscal 2022 and Rs 50 crore in fiscal 2021 (Rs 78 crore in fiscal 2020), with a cumulative redemption ratio of 52.7% as on March 31, 2023 (38.0% as on March 31, 2022). Slowdown in acquisitions, coupled with the redemption in SRs, has resulted in decrease in assets under management (AUM) of the company to Rs 475 crore as on June 30, 2023 (Rs 484 crore as on March 31, 2023, Rs 562 crore as on March 31, 2022, Rs 675 crore as on March 31, 2021, and Rs 696 crore as on March 31, 2020). Nevertheless, the acquisition of assets is expected to pick-up from the current fiscal and the company has also tied up with a foreign portfolio investor for a USD 100 million (around Rs 780 Crore) fund to scale up the AUM.

The company operates mainly in the SME and retail segments. Of its total AUM as on June 30 2023, around ~ 90% is in SME and the rest in the retail segment. This makes the assets granular. However, the company’s ability to scale up operations while managing recovery will remain a key monitorable.

Modest, albeit improving earnings

Given the high operating expenditure during the initial years of establishing the business, Encore ARC’s earnings remain subdued. Furthermore, in line with the regulations, the waterfall approach for distribution of monies recovered is followed. Basis this, the trust, which issues the SRs, first pays for the expenses related to its operations and resolution of assets, then management fees, followed by redemption of SRs to security receipt holders. Only post this, Encore ARC would earn any upside income or yield from the amount recovered. Hence, earnings remained muted as it reported a loss of Rs 5.3 crore in fiscal 2020.

However, profitability improved gradually with an improvement in revenues and recoveries. The company reported a profit of Rs 7.5 crore with a return of assets of 3.0% for fiscal 2023 as against a PAT of Rs 6.0 crore with an Return on Assets (RoA) of 2.5% for fiscal 2022. The improvement is driven by improvement in revenues and operating expenses. While its cost-to-income ratio remains elevated, it has marginally moderated to 70.3% for fiscal 2023 as against 74.8% for fiscal 2022, it is better than 99.0% of fiscal 2020 and is expected to improve with the pick-up in pace of acquisitions. Nevertheless, Encore ARC’s ability to sustain the recent improvement in profitability will remain a key monitorable over the medium term.