Detailed Rationale

CRISIL Ratings has reaffirmed its 'CRISIL AA/Stable/CRISIL A1+' rating on the debt instruments of Phoenix ARC Private Limited (Phoenix ARC). CRISIL Ratings has withdrawn its rating on Rs 100 crore non-convertible debentures since the outstanding against the same was nil.

 

The ratings continue to centrally factor in expectation of strong support from Phoenix ARC’s sponsor and largest shareholder, the Kotak group. The group consists of Kotak Mahindra Bank Ltd (KMBL; rated 'CRISIL AAA/CRISIL AA+[1]/FAAA/Stable/CRISIL A1+'), its subsidiaries and associates. The ratings also reflect Phoenix ARC’s comfortable capitalisation, and good recovery record. These strengths are partially offset by volatility in earnings because of asset quality challenges inherent in the distressed assets business.

[1] For Perpetual Non-Cumulative Preference Shares

Analytical Approach

For arriving at the ratings, CRISIL Ratings has considered the standalone business and financial risk profiles of Phoenix ARC. CRISIL Ratings has also factored in the support that Phoenix ARC is expected to receive from Kotak group. This is considering the strategic importance of the entity and the 49.9% ultimate shareholding by the bank, via its subsidiaries.

Key Rating Drivers & Detailed Description

Strengths:

• Strong support from sponsor and largest shareholder

KMBL, via its subsidiaries, holds 49.9% stake in Phoenix ARC as on March 31, 2022. Phoenix ARC, which has a strong focus on the distressed assets business, is a critical platform for the Kotak group’s overall strategy in this segment.

 

Phoenix ARC not only benefits from the franchise of being an associate of Kotak group, but also from management and governance philosophy of the Kotak group, which extends oversight to Phoenix ARC. The Kotak group has infused capital worth Rs 97.8 crore in Phoenix ARC till date, including participation in the rights issue in fiscal 2015. Phoenix ARC’s borrowing had also been from associate companies, although it started raising external funds from fiscal 2016, thereby reducing dependence on funds from the group companies. As on December 31, 2021, borrowings from within the group formed around 34.6% of the outstanding borrowings (Rs 184.1 crores though listed non-convertible debentures and term loan from an associate company). However, the flexibility to lend further remains.

 

Also, Phoenix ARC and KMBL have operational synergies, and have been co-investors in some deals. Furthermore, the group provides management expertise and strategic direction to Phoenix ARC. The group is also well represented on Phoenix ARC’s board. While Phoenix ARC does not carry Kotak’s name, it is widely recognised as a Kotak group-sponsored company. CRISIL Ratings believes that the Kotak group would continue providing financial support to Phoenix ARC through appropriate avenues—equity, loan, and preference shares -- given the strategic importance to the group and strong moral obligation on the group to support the company.

 

• Comfortable capitalisation

Phoenix ARC has comfortable capitalisation with adequate networth for its current and proposed scale of operations and a conservative gearing philosophy. Networth was Rs 530 crore as on December 31, 2021, with gearing at 1.0 times. Given the inherently volatile nature of cash inflow in the asset reconstruction business, Phoenix ARC has a philosophy of maintaining gearing below 3.0 times, which is more conservative than its peers. Phoenix ARC’s capital profile is also supported by granularity in its portfolio. Phoenix ARC is likely to maintain comfortable capitalisation with relatively low gearing over the medium term. The gearing philosophy will remain a key rating sensitivity factor.

 

• Good recovery track record

Phoenix ARC has a good recovery track record from distressed assets. Given that it takes 2-3 years for significant recovery to commence, CRISIL Ratings has analysed redemption ratio (as on December 31, 2021) for Phoenix ARC’s security receipts (SRs) issued till March 31, 2020. At 44.8%, this is higher than peers. Furthermore, the overall SR redemption ratio till December 31, 2021, was 41.2%, which is also better than that of peers. In most of Phoenix ARC’s closed trusts, the gross internal rate of return has been well above the threshold. The company’s recovery record is supported by continued focus on relatively small accounts, primarily small and medium enterprises and retail accounts, where it has built expertise. While it has acquired large accounts in recent years, in line with market opportunity, the share of such assets in its portfolio is lower than that for peers. Also, given the regulatory changes, the share of cash deals has increased for Phoenix ARC in last couple of years as compared to earlier years. This has also kept the cumulative discount rate relatively high at 67% for acquisitions done till December 31, 2021. While the SR ratings of Phoenix ARC indicate reasonable expectation of recovery, there was downward movement in ratings of few trusts over last two years on account of expected impact on recoveries from Covid-19 pandemic. Nevertheless, Phoenix ARC may maintain better-than-industry-average recovery rate over the medium term.

 

Weakness:

• Volatile earnings profile

Phoenix ARC’s earnings are volatile given the uncertainty in recovery of acquired assets, both in terms of quantum and timing, as is inherent in the ARC industry.  Phoenix ARC used to traditionally acquire most of the assets in the form of cash deals; however, in between, the share of SR deals had increased manifold. But with the revised guidelines for provisioning by banks, the share of cash deals has picked up in last couple of years and is expected to increase further. Hence, the dependency on ultimate recoveries has in fact increased. Furthermore, the company’s ability to continue recovery traction in the large accounts acquired in the past few years is yet to be demonstrated.

 

Nevertheless, earnings profile is expected to remain volatile, being linked to both actual and expected recoveries. In line with the same, while profitability had improved in fiscal 2019, it substantially dipped in fiscal 2020, with Phoenix reporting a loss of Rs 5.5 crore. This was primarily on account of downward rating action on SR rating of a few trusts, leading to fair valuation loss and also reduction in management fees. However, in fiscal 2021, Phoenix ARC reported a profit after tax (PAT) of Rs 25.6 crore, supported by lower net loss on fair valuation. During nine months ended December 31, 2021, profitability picked up further, with PAT of Rs 60.6 crore, supported by recoveries in retail as well as corporate accounts. Since the recovery prospects may be impacted by macroeconomic factors, and consequent pressure expected on SR ratings, the performance of the entity will remain a monitorable.

Liquidity: Strong

Liquidity position of the company should remain strong, with cash, bank balance and liquid investments of Rs 108.4 crore as on February 28, 2022, with further cushion available through unutilised lines of Rs 458.4 crore. This is against Rs 126.1 crore borrowings coming up for repayments till August 31, 2022. The company also benefits from the support from the Kotak group franchisee.

Outlook Stable

CRISIL Ratings believes Phoenix ARC will continue to receive strong support from the KMBL and the Kotak group, and will maintain comfortable capitalisation and good recovery record, over the medium term

Rating Sensitivity factors

Upward factors

• Increase in shareholding to above 51% and increased branding support from KMBL
• Scaling-up of operations while maintaining healthy recovery track record, leading to sustained improvement in earnings profile

 

Downward factors

• Downward change in the credit risk profile of KMBL by 1 notch could have a similar rating change on Phoenix ARC
• Any material change in the shareholding or group support philosophy of KMBL
• More-than-expected increase in Phoenix’s gearing or the company’s inability to maintain traction in recoveries

About the Company

Phoenix ARC was incorporated in March 2007 by KMBL, which holds 49.9% stake in the company through its subsidiaries. The remaining stake is held by high-networth individuals. Phoenix ARC had acquired total dues worth Rs 46,572 crore till December 31, 2021, and had managed SRs (assets under management) of Rs 8,991 crore as on same date.

 

Phoenix ARC reported a PAT of Rs 25.6 crore on total income of Rs 154.6 crore for fiscal 2021, as against loss of Rs 5.5 crore on total income of Rs 182.6 crore for the previous fiscal. During the nine months ended December 31, 2021, it reported a PAT of Rs 60.6 crore on total income of Rs 153.8 crore (Rs 17.1 crore and Rs 111.0 crore, respectively, for the corresponding period last fiscal).

Any other information: Not applicable