Strengths: * Strategic importance to, and expectation of strong support from, L&T The LTFS group has demonstrated healthy growth and improved its return on equity (ROE) over the last few years. Due to L&T's focus on building a strong services portfolio including IT, technology and financial services, the LTFS group has been identified as a key focus area for the parent. As a result, L&T provides strategic oversight to the group and has personnel from its senior management, including the chief financial officer, on LTFH's board. L&T also has representation in some of the LTFS group's key committees, such as asset-liability, risk management and credit committees. The group also benefits from the synergies and expertise of L&T, especially in infrastructure and real estate lending. The shared name also supports the liabilities of the LTFS group. Furthermore, the parent provides capital support to the LTFS group and has infused around Rs 3,779 crore to date (including Rs 2,000 crore in fiscal 2018). It has also provided an ongoing line of credit of Rs 2,000 crore to the LTFS group, which could be used in times of contingency. Capital support from the parent, along with internal cash accrual, is expected to keep capitalisation of the LTFS group adequate, with gearing (debt/networth) expected at around 7.0 times - not exceeding 7.5 times - on a steady-state basis. The rating also factors in the strong support from the parent L&T, demonstrated by the articulation of its intention to (i) maintain strategic linkages and management oversight so that, among others, LTFS group conducts its business in a manner such that it honours its stakeholder obligations in a timely manner (ii) maintain majority shareholding in LTFH, and (iii) provide growth and risk capital, if and when required. Financial services is expected to remain one of the key focus areas for L&T, which should continue to support the LTFS group. * Strong and diversified presence across the financial services space LTFH is the holding company for the financial services business of L&T and holds a majority stake in various subsidiaries that operate in the wholesale lending (consisting of infrastructure finance, structured finance group, debt capital markets [DCM] and real estate finance), mortgage finance (home loans and loans against property [LAP]), rural lending (farm equipment, two-wheelers, and micro loans), asset management, and wealth management businesses. In the wholesale lending segment, structured finance loans and DCM have been classified as defocused by LTFS starting from the quarter ended June 30, 2019. In the lending space, the LTFS group has built a strong market position, with assets under management (AUM) of Rs 1,00,257 crore as on September 30, 2019. The portfolio has had a compound annual growth rate of 20% over the five fiscals through March 31, 2019. However, the growth has slowed down to 10% year-on-year as on September 30, 2019 and is expected to remain moderate in the near term. Furthermore, the portfolio is diversified, with presence across various asset classes, such as infrastructure finance (31% of AUM as on September 30, 2019), Infra Debt Fund (IDF, 8%), real estate finance (16%), home loans (7%), LAP (4%), micro loans (13%), two-wheeler financing (6%), and farm equipment financing (8%). The group is also planning to foray into personal loans and SME business loans and has been running pilots. The remaining 7% is the defocused portfolio (consisting of products where the book is being run down), comprising the small retail portfolio (identified earlier), structured finance group, and DCM portfolio (classified since June 30, 2019). Under the non-lending businesses, the LTFS group had sizeable average (quarterly) AUM of Rs 69,213 crore in the asset management business and closing assets under service of Rs 26,309 crore in the wealth management businesses as on September 30, 2019. In August 2019, LTFH entered into an agreement to sell its entire stake in L&T Capital Markets Ltd (LTCM; carrying out the wealth management business of the group) to IIFL Wealth Finance Ltd (rated 'CRISIL A1+') for a consideration amount of Rs 230 crore, plus the cash and cash equivalents balance of LTCM. The transaction is subject to regulatory approvals. Going forward, the LTFS group intends to focus on growing its retail business and concentrate to grow its fee-based income to supplement the net interest margins (NIMs). Consequently, it expects higher growth in the rural and home loan portfolios. The share of the wholesale portfolio (excluding the IDF loan portfolio) has been declining steadily, from 62% as on March 31, 2016, to 54% as on September 30, 2019; the management intends to reduce the share further in the coming quarters. This shift in proportion is supported by a higher sell-down strategy in the infrastructure financing book (which also supports higher fee income) as well as through growth in the retail and housing finance portfolios. While the group continues to use its (and L&T's) expertise in the infrastructure finance segment to underwrite loans, a majority of the disbursements are now sold down. Moreover, the focus will continue to be on operational infrastructure projects in L&T Infra Debt Fund Ltd, the share of which has increased from 4% to 8% over the three fiscals through March 31, 2019. The IDF portfolio comprises projects with an average of five years of satisfactory operations and around 70% of the portfolio is either backed by a tripartite agreement or guaranteed/ supported by a government/ state authority. Furthermore, with the classification of structured finance group and the DCM book as defocused products, no additional disbursements are being done in these portfolios, and hence, their rundown should also support an increase in the share of the retail book. * Well- diversified resource profile The resource profile is diversified across capital markets and bank funding. The group is a large and frequent issuer in capital markets and has strong banking relationships. Of the total borrowing of Rs 90,050 crore as on September 30, 2019, non-convertible debentures (NCDs; including retail), commercial paper, external commercial borrowings (ECB) and bank borrowings formed 42%, 10%, 3%, and 42%, respectively. The group has raised retail NCDs of Rs 2,500 crore and ECB of around Rs 2588 crore recently. The diversified resource profile is also reflected in the competitive average borrowing cost of 8.45% in fiscal 2019 (8.57% annualised for the first half of fiscal 2020), which is lower than most peers. L&T's parentage also supports the resource profile. Weakness: * Moderate, albeit improving, asset quality The asset quality of the lending portfolio remains moderate. On a consolidated basis, gross stage 3 and net stage 3 assets stood at 5.98% and 2.83%, respectively, as on September 30, 2019. This is primarily contributed by higher gross stage 3 assets in the infrastructure portfolio due to legacy delinquent accounts. In the wholesale portfolio, the ticket size remains chunky given the nature of these asset segments. Also, most of the segments in the retail portfolio have witnessed high growth in the last three years. However, with the management bringing in change in its strategy in terms of focusing on renewables and roads (for infrastructure finance), higher focus on retail loans, stronger underwriting and collection practices, better early warning systems, and focus on digitisation, the asset quality has improved over the past few quarters. The group has formed a specialised team to oversee recovery from stressed assets. The management's ability to keep the portfolio quality in check while scaling it up will remain a monitorable. Moreover, performance of the wholesale lending portfolios will be closely monitored given the chunkiness in ticket size and sensitivity of borrowers in these segments to an environment of prolonged stretch in liquidity. Also, any deterioration in the asset quality leading to a significant decline in profitability from current levels, will be closely monitored. |