Detailed Rationale

CRISIL Ratings has revised its rating watch on the bank facilities and non-convertible debentures of IndoStar Capital Finance Ltd (IndoStar) to 'Rating Watch with Negative Implications' from 'Rating Watch with Developing Implications'. Further, CRISIL Ratings has placed its rating on the company’s commercial paper programme on ‘Rating Watch with Negative Implications’.

 

CRISIL Ratings has also withdrawn its rating on three non-convertible debentures aggregating Rs 525 crore in line with its withdrawal policy. CRISIL Ratings has received independent confirmation that these instruments are fully redeemed.

 

On May 17, 2022, CRISIL Ratings had placed its long-term rating on IndoStar on ‘Rating Watch with Developing Implications’. This followed the company’s disclosure on May 6, 2022 pertaining to certain observations and control deficiencies identified by the statutory auditors, primarily in the commercial vehicle (CV) loan portfolio of the company. As a result of this, it was estimated that the company may require an additional estimated credit loss (ECL) provisioning between Rs 557 crore to Rs 677 crore. The final impact of this was expected to be disclosed in the audited financial statements for fiscal 2022, and the impact of the same was to be seen.

 

The current rating action reflects the potential impact of the recently released fiscal 2022 results on the future fund raising and the business of the company emanating from three key aspects (a) Higher than earlier estimated impairment allowance at Rs 886 crores on the commercial vehicle portfolio with total impairment allowance of Rs 1117 crore as on March  31, 2022, and total gross non-performing assets of 15.5% (b) Qualified opinion issued by the statutory auditors Deloitte Haskins & Sells LLP on the audit report for the year ended March 31, 2022 (c) Material uncertainty related to Going Concern noted in the Audit Report. However, Auditor opinion on the Statement is not modified in respect of the uncertainty related to Going Concern.

 

CRISIL Ratings believes that the above aspects could impact lender and investor confidence and potentially make future fund raising challenging for Indostar, which could in turn impact business growth.

 

At the same time, the rating factors in the clear articulation and demonstration of support by the majority shareholder, Brookfield, which has been actively engaged in discussions with key stakeholders, and also arranged a sizeable funding line of Rs 770 crore through its global relationships- this has been instrumental in bolstering the liquidity position of the company. Steps have also been taken to strengthen the management team of IndoStar. Brookfield has articulated its intent to continue to support the company in raising debt and equity as needed.

 

The rating also factors in the comfortable capital position of the company, with an overall capital adequacy ratio of 25.8% and gearing of 2.1 times as on March 31, 2022 after factoring in the incremental provisioning requirement.

 

The liquidity position of IndoStar is currently adequate. As on August 10, 2022, the company had Rs 914 crore of cash and cash equivalents, and Rs 234 crore on undrawn working capital lines, totaling Rs 1148 crore (This is excludes term loans, a sizeable portion of which is earmarked to be used only for disbursements). The company is also in advanced stages of two securitization transactions totaling around Rs 630 crore. Regular collections should also support the company’s liquidity. Against this, the company has potential repayments of Rs 1284 of repayments in the current quarter, including Rs 700 crore of NCDs, where there is breach of asset quality covenants, and for which the management has already made a buyback offer.  Repayments in the second half of the year are at Rs 562 crore, almost equally split between the third and fourth quarters.  

 

CRISIL Ratings takes note of the updates by the management on the June quarter performance and guidance on the key business metrics. Basis the collections performance, and the measures taken by the management to bring down the gross NPAs, including settlement with borrowers, and sale of a part of the portfolio to an asset reconstruction company, management expects the gross NPA level as on June 30, 2020 to be under 10% with net NPA below 5%. In line with this, management expects a provisioning write-back, supporting the overall profitability of IndoStar, and consequently, capital adequacy ratio to reach around 30%.

 

CRISIL Ratings will continue to engage with the management for further clarity on portfolio performance, steps taken to strengthen incremental asset quality, likely ultimate losses from the identified portfolio, and also monitor progress on fund raising and return to business normalcy. The rating watch will be resolved once greater clarity emerges regarding the impact of recent developments.

 

Details of the Audit Report

The Audit Committee of IndoStar had appointed an independent external agency, Ernst & Young LLP (E&Y) to carry out a detailed review of the commercial vehicle (CV) and small and medium enterprises (SME) loan books. In IndoStar’s disclosure on May 6, 2022, based on the preliminary findings of the loan portfolio review, additional ECL provisioning was estimated to be in the range of Rs Rs 557 crore to Rs 677 crore. 

 

As noted in the financial results published on August 5, 2022, basis the report provided by the external agency, IndoStar recorded an impairment allowance (net of recoveries) of Rs 1158 crore for the year ended March 31, 2022. Further, the Audit Committee had appointed an external law firm to review the transactions pertaining to the CV and SME loan portfolio to identify the root cause of control deficiencies, evaluate the business rationale and understand the transactions which were processed through deficient controls. The external law firm has not yet submitted the report. Further, IndoStar has indicated that it cannot determine the prior period effects as it is not practicable to apply the same judgement without hindsight for the prior period(s). As a result, the Statutory Auditor, Deloitte Haskins & Sells LLP, has been unable to determine whether any adjustments are required for prior period(s) relating to the impairment recorded for the quarter and year ended March 31, 2022 and whether any additional adjustments for this period and prior period(s) are required relating to the outcome of the review. Consequently, the auditor has issued a qualified audit opinion on the audit report for the year ended March 31, 2022.

 

The Auditor has also noted material uncertainty related to going concern, stating that total liabilities exceed the total assets maturing within 12 months by Rs 2206 crore, and for certain borrowings, the gross NPA and/or net NPA ratios have exceeded the threshold for triggering accelerated repayment on liabilities. The Auditor also notes that there can be no assurance of success of management’s plan to access additional sources of finance to the extent required, on terms acceptable to the company, and to raise these amounts in a timely manner.

 

CRISIL Ratings notes the management’s plan to address the going concern uncertainty. The company has been able to raise funds post March 31, 2022, including post disclosure of the control deficiencies. Management has made a buyback offer for Rs 700 crore of non-convertible debentures where the asset quality thresholds have been breached.  At this point, CRISIL Ratings understands that none of the bankers has recalled their loans - asset quality covenants impact Rs 1244 crore of the bank borrowings. CRISIL Ratings will continue to monitor developments on this front.

Analytical Approach

For arriving at the ratings, CRISIL Ratings has combined the business and financial risk profiles of IndoStar and its subsidiaries, together referred to herein as IndoStar. This is because they have significant operational, financial, and managerial integration and also operate under a common brand.

 

Please refer Annexure - List of entities consolidated, which captures the list of entities considered and their analytical treatment of consolidation.

Key Rating Drivers & Detailed Description

Strengths

Demonstrated support from majority shareholder, Brookfield

IndoStar’s majority ownership by Brookfield has helped enhance its capital base and provides it with added financial flexibility; post the infusion Rs 1,225 crore in May 2020, Brookfield now owns 56% of the company’s equity.

 

The rating factors in the clear articulation and demonstration of support by the majority shareholder, Brookfield, which has been actively engaged in discussions with key stakeholders, and also arranged a sizeable funding line of Rs 770 crore through its global relationships- this has been instrumental in bolstering the liquidity position of the company. Steps have also been taken to strengthen the management team of IndoStar with Brookfield bringing back Mr. Pankaj Thapar as Director – Finance, to oversee the finance function of the company post exit of the previous CFO, and also bringing in experienced people in key positions such as the Chief Risk Officer, Internal Audit Head and Head of CV Credit. Senior resources in the housing finance subsidiary are also expected to come on board shortly

 

Brookfield has articulated its intent to continue support the company in raising debt and equity as needed, and this is a key rating sensitivity factor.

 

Adequate capitalisation

IndoStar continues to have adequate capitalization, even post the impact of the additional provisioning taken in the financial statements pertaining to fiscal 2022. Consolidated networth stood at Rs 2,929 crore as on March 31, 2022 (down from Rs 3,698 crore as on March 31, 2021),  while gearing level remained low at 2.1 times as on the same date. Overall CAR stood well above the regulatory requirement at 25.8% as on March 31, 2022. Management has indicated an expectation of improvement in overall CAR to around 30% as on June 30, 2022, driven by staging improvement, resulting in ECL release and writebacks.   Over the medium term, with retailisation of the portfolio, gearing is expected to increase from current levels. However, CRISIL Ratings expects management to be prudent in managing the same.

 

Retailisation of portfolio, though successful scale up to be demonstrated

Consolidated AUM was Rs 9,266 crore as on March 31, 2022 compared to Rs 8,990 crore as on March 31, 2021. Out of this, retail book accounted for Rs 7,685 crore (83% of AUM) as on March 31, 2022, as compared with Rs 7,040 crore (78%) as on March 31, 2021. This is a significant change from earlier when IndoStar was a wholesale focused lender; the company has been running down the corporate loan portfolio in the last three years.

 

Among retail product offerings, the company operates in CV finance (AUM Rs 4,892 crore), and SME finance (mainly comprised secured loans against property, AUM Rs 1,570 crore) through IndoStar Capital and affordable home finance (AUM Rs 1,223 crore) through its wholly-owned subsidiary – IndoStar Home Finance.

 

While there have been challenges in the CV portfolio, CRISIL notes the better performance of the recently originated portfolio (post November 2020), where the gross NPAs stood at 1.9%. Further, the company is reorienting its underwriting policies and shifting focus on the customer side to small fleet owners, resulting in greater granularity, and on the product side to used CVs, especially medium CVs and small CVs, from  heavy CVs. Future growth is expected to be driven by these segments and affordable housing. Performance of the housing finance business remains better than the other businesses.

 

Having said this, on-ground execution will be key and CRISIL will continue to monitor the same.

 

Weaknesses

Weak asset quality, impacting earnings profile

Overall asset quality weakened as gross stage 3 and net stage 3 assets increased sharply to 15.5% and 8.3%, respectively, as on March 31, 2022, from 4.3% and 2.3%, respectively, as on December 31, 2021. The increase in GS3 was the result of the staging policy adopted by the company in the light of control deficiencies identified primarily in the CV loan book and to some extent in the SME loan book.

 

As a result of the increase in provisioning requirement, with credit costs of Rs 1158 crore in fiscal 2022, as against Rs 487 crore previous fiscal, the company reported a net loss of Rs 736 crore in fiscal 2022 as compared with a loss of Rs 214 crore in fiscal 2021. Pre-provision profits remained stable at Rs 262 crore in fiscal 2022, as against Rs 268 crore in previous fiscal.

 

As on June 30, 2022, Stage 3 assets are expected to reduce on account of (a) Sale of Rs 516 crore to an asset reconstruction company, (b) Write-offs of Rs 369 crore, and (c) run down/ resolution of Rs 94 crore. This, coupled with regular collections, is expected to lead to provision write-backs and hence, improved profitability in the first quarter of fiscal 2023.

 

Nevertheless, it will be important for the company to demonstrate improved asset quality metrics on a sustained basis, which should support profitability over the medium and long term.

Liquidity: Adequate

The liquidity position of IndoStar is currently adequate. As on August 10, 2022, the company had Rs 914 crore of cash and cash equivalents, and Rs 234 crore of undrawn working capital lines, totaling Rs 1148 crore (This is excludes term loans, a sizeable portion of which is earmarked for disbursements). The company is also in advanced stages of two securitization transactions totaling around Rs 630 crore. Regular collections should also support the company’s liquidity. Against this, the company has potential repayments of Rs 1284 crore in the current quarter, including Rs 700 crore of NCDs, where there is breach of asset quality covenants, and for which the management has already made a buyback offer.  Repayments in the second half of the year are at Rs 562 crore, almost equally split between the third and fourth quarters.

Rating Sensitivity Factors

Upward Factors

• Substantial improvement in fund raising on a steady state, and successful execution of planned business strategy
• Significant improvement in profitability, with return on assets (RoA) beyond 3.0% on a sustained basis
• Material and sustained improvement in asset quality

 

Downward Factors

• Reduction in stake by Brookfield below 51% and/or any reduction in expectation of support by Brookfield
• Delay in fund raising other than through the securitisation route, impacting business growth
• Further deterioration in capital adequacy levels
• Continued stress in asset quality and profitability

About the Company

IndoStar Capital Finance Limited, incorporated in November 2011, is registered with the Reserve Bank of India as a systemically important, non-deposit taking NBFC. The company was founded and incorporated by private equity players (Everstone, Goldman Sachs Baer Capital Partners, ACPI Investment managers, and CDIB International) with an initial capital of around Rs 900 crore. In May 2020, Brookfield invested Rs 1,225 crore and became the largest shareholder and co-promoter. As on June 30, 2022, Brookfield held 56.20% stake, followed by IndoStar Capital Mauritius (owned by the Everstone group and other marquee private equity investors) at 30.47%.

 

The company started its business as a wholesale financier in fiscal 2011, and then entered the SME finance (loan against property) segment in fiscal 2015. In fiscal 2018, the company started offering vehicle finance and housing finance (through its wholly owned subsidiary, IndoStar Home Finance Private Limited). In fiscal 2019, the company acquired the CV finance business of IIFL Finance Limited. Going ahead, the company plans to focus on used commercial vehicle financing and housing finance.

Any other information: Not applicable