CRISIL has revised its outlook on the long-term bank facilities, non-convertible debentures and long term principle protected market linked debentures of Edelweiss Asset Reconstruction Company Limited (EARC) to 'Negative' from 'Stable' and reaffirmed the 'CRISIL AA-/CRISIL PP-MLD AAr(SO)/CRISIL AA(SO)' rating. CRISIL has reaffirmed its 'CRISIL A1+' rating on the commercial paper programme.
 
The rating continues to centrally factor in the expectation of strong management, financial and, operational support for EARC from its ultimate parent, Edelweiss Financial Services Ltd (EFSL; rated, 'CRISIL A1+', holding company of the Edelweiss group), both on an ongoing basis and in the event of distress. Such expectation reflects the strategic importance of EARC to EFSL as well as the strong moral obligation of EFSL to support EARC, given the shared name and distressed assets resolution being a focus area of the group. 

CRISIL has revised its rating outlook on the long-term debt instruments of Edelweiss group entities to 'Negative' from 'Stable'. The outlook revision factors in the current challenging operating environment for non-banking financiers {non-banking financial companies (NBFCs) including housing finance companies, which has led to difficulty in funding access, especially for those with a wholesale lending book. Interest from investors in the debt capital market for non-banks has reduced in the recent past, and a material turnaround is not expected in the near term. Further, with rising borrowing cost and slowdown in disbursements by non-banks - mainly to wholesale borrowers, refinancing risks for real estate players has increased. This could strain the asset quality of the wholesale lending portfolio of non-banks, in the near to medium term.
 
From a funding perspective, the recent budgetary announcement of Government support to public sector banks through a partial credit enhancement mechanism for buying asset pools from NBFCs should bring some respite for the sector.
 
Given the current environment, with lenders exercising caution in increasing exposures, the Edelweiss group has witnessed a reduction in incremental funds raised in the past few months. Funds raised in the first quarter of fiscal 2020 are around half of the incremental funds raised in the quarter ended March 31, 2018. Consequently, the overnight on-balance sheet liquidity (including cash, liquidity investments and treasury assets) has reduced from the level of Rs 6,527 crore as on March 31, 2019. This is excluding other liquid assets (investments, securities-based lending book) which can be accessed if necessary- this stood at Rs 4,750 crore as on March 31, 2019.  Borrowing costs have also risen for the group as seen for many other non-banks as well. The group's ability to raise fresh funds from diverse sources over the near term will be a key monitorable.
 
Reported asset quality metrics of the group remains stable with overall gross non-performing assets (GNPA) at 1.9% as on March 31, 2019. However, the loan book remain chunky with around 50% of the overall portfolio towards wholesale lending (of which around 60% is towards real estate). Further, a sizeable proportion of the wholesale book is currently under moratorium with bullet or staggered repayments. While the group follows sound credit appraisal and risk management practices, has adequate collateral cover for its wholesale loans, and has also built strong recovery capabilities, asset quality in the past was also supported by an active refinance market, particularly for the real estate loans. The group also benefits from its diversified business ecosystem, and as part of its  account specific recovery/resolution strategy it has sold some of the stressed exposures in the lending business to the Edelweiss Asset Reconstruction Company Limited (on an arm's length basis) to benefit from the latter's better resolution capability and strong legal team. . With the slowdown in the real estate sector and incipient stress for developers, Edelweiss group's ability to get timely refinance/exits, recover from some of these exposures and maintain asset quality metrics will remain a key monitorable. 
 
Nevertheless, CRISIL has also taken in to account the group's ability to raise capital as has been proven even in the current market environment. It has entered into agreement to raise Rs 1800 crore from Caisse de depot et placement du Quebec (CDPQ) in the form of compulsory convertible debentures (CCDs) in ECL Finance (of which Rs 1040 crore has been already infused in the June 2019 quarter). This will bolster the group's networth, which is expected to increase to around Rs 10,000 crore by June end (Rs 8715 crore on March 31, 2019). The group is also considering raising capital in its wealth business by bringing in a strategic investor.
 
The ratings continue to reflect the group's diversified business and earnings profile with presence across credit, capital market, and insurance segments, and demonstrated ability to build significant presence in multiple lines of business. The ratings also factor in an established market position in capital market-related segments resulting in a regular stream of fee-based income.
 
These rating strengths are partially offset by vulnerability of asset quality to concentration in the wholesale lending segment, particularly in the current challenging environment, for some business lines such as the real estate developer segment.  Furthermore, the profitability ratios and gearing are relatively weaker than many other large predominantly wholesale players.
 
CRISIL will continue to monitor the group's ability to raise fresh funding, progress of the proposed  stake sale in the wealth business that would bolster the group's capital position, as well as any increase in build-up of stress in the wholesale book. Based on these factors, CRISIL will take appropriate rating action.

For arriving at the ratings, CRISIL has considered the standalone business and financial risk profiles of EARC. CRISIL has also factored in the support that EARC is expected to receive from its ultimate parent, EFSL. This is because EARC and EFSL have extensive business and operational linkages and a common brand.
 
CRISIL has combined the business and financial risk profiles of Edelweiss Financial Services Limited (EFSL) and its subsidiaries to arrive rating of EFSL. That's because all these entities, collectively referred to as the Edelweiss group, have significant operational, financial, and managerial integration and also operate under the common Edelweiss brand.

EARC has adequate cash and cash equivalent to meet the debt repayment over the next 3 months ending September 30, 2019. The Edelweiss group also maintains comfortable liquidity. As a policy, the group maintains liquidity cushion of ~9-10% of balance sheet size. Even in the current market conditions, there was a liquidity cushion (Including treasury assets) of around Rs 5,315 crore in the form of liquid investments (around Rs 3,615 crore) and unutilised bank lines (around Rs 1,700 crore) as on June 24, 2019. The group also continues to tap debt capital markets for fresh issuances.

CRISIL believes EARC will continue to receive strong support from the Edelweiss group and will maintain robust market position over the medium term. The rating, however, will be downgraded, if the group's stake in, or support extended to, EARC declines, or if the group's (including EFSL's) credit risk profile weakens. Ratings will also be downgraded if pace of recoveries by EARC is below expectation or earnings profile weakens. The outlook may be revised to 'Stable' in case of a material improvement in the group's (including EFSL's) credit risk profile by improved funding access on a sustained basis and reduced asset quality challenges in the lending business or there is significant increase in EARC's recovery from stressed assets while maintaining comfortable financial profile.

EARC was incorporated in October 2007 and registered with the Reserve Bank of India as a securitisation and asset reconstruction company in October 2009. The Edelweiss group currently holds 74.80% stake in EARC, with high-net-worth individuals and one FII holding the remaining stake. Edelweiss group on a fully diluted basis holds 60% stake in EARC. As on March 31, 2019, the company had managed SRs of Rs ~45,000 crore. 
 
On October 3, 2016, Edelweiss Group announced an agreement to enter into a long-term partnership with CDPQ (Caisse de Depot et Placement du Quebec), one of North America's largest pension fund managers, which includes target investment by CDPQ of Rs 5000 crore over the next four years in Indian distressed assets and specialised corporate credit space including a 20% equity stake in EARC. The 20% stake sale has resulted in an infusion of Rs 500 crore equity capital in EARC upto September 30, 2018 from CDPQ in the form of CCPSs. Further, as a part of the Agreement, CDPQ has representation on the Board and Executive Committee (Investment) of EARC.  
 
EARC reported a profit after tax (PAT) of Rs 435.0 crore on total income of Rs 1366.9 crore for fiscal 2019, against a PAT of Rs 180.2 crore on total income of Rs 769.4 crore for fiscal 2018.

Any other information:
The rating on EARC's PPMLDs reflects the strength of an unconditional and irrevocable guarantee extended by EFSL, and payment mechanism for the issue. The guarantee covers EARC's entire obligations on the PPMLD issue. The rating thus reflects the credit strength of the guarantor, EFSL. CRISIL believes EFSL's guarantee and the structured payment mechanism will ensure entire debt obligations under the debt instruments are met on time. The guarantee will remain unaffected even if EARC faces bankruptcy or in case of dissolution, insolvency, liquidation, or winding up proceedings initiated by or against the issuer.
 
As per the payment mechanism, if EARC doesn't deposit the requisite amount in the designated account by T¹-1 date, the guarantor (EFSL) would be obligated to deposit the shortfall amount in the designated account latest by 12.00 p.m on the T date. If the guarantor (EFSL) fails to deposit such funds in the designated account on T date, it would constitute default on the part of the guarantor.
 
Payment structure for the Rs 150 crore NCD, Rs 150 crore and Rs 200 crore PPMLD programme guaranteed by EFSL

Day*	Action
T-1	EARC shall deposit the requisite funds in the designated account
T	If EARC does not deposit the requisite funds in the designated account on any T-1 date (as mentioned above), EFSL would be obligated to deposit the shortfall amount in the designated account latest by 12.00 p.m on the T date. If EFSL fails to deposit such funds in the designated account on T date it would constitute default on part of EFSL.

* T being the coupon payment date, scheduled principal redemption date, Put/Call option settlement date
or redemption date under an early redemption/ acceleration event  

1. RBI has changed the regulations for investment by banks in SRs backed by assets sold by them. Effective April 01, 2018, where the investment by banks in SRs backed by stressed assets sold by them is more than 10%, the provisions held in respect to these SRs is higher of:

• Provisioning rate required in terms of net asset value (NAV) declared by the ARCs
• Provisioning rate applicable to the underlying loans, assuming that loans notionally continued in the books of banks

The impact of this change on the business volume and change in business model by the company will remain monitorables.

¹T being the coupon payment date, scheduled principal redemption date, Put/Call option settlement date or redemption date under an early redemption/ acceleration event