September 04, 2020 Reliance Securities Limited: Ratings reaffirmed; removed from watch with negative implications Summary of rating action Previous Rated Amount Current Rated Amount Instrument Rating Action (Rs. crore) (Rs. crore) [ICRA]A4; reaffirmed, removed Commercial Paper Programme 200.00 200.00 from rating watch with negative implications [ICRA]A4; reaffirmed, removed Short term non-fund based bank 50.00 50.00 from rating watch with negative lines implications [ICRA]A4; reaffirmed and Short term non-fund based bank 350.00 - withdrawn, removed from rating lines watch with negative implications Total 600.00 250.00 Rationale ICRA has reaffirmed the short term ratings of Reliance Securities Limited (RSL) at [ICRA]A4. The rating has been removed from watch with negative implications following the company's demonstrated ability to service its debt obligations in a timely manner in the past year despite the liquidity issues being faced by the Group. In addition, there was an improvement in the gearing levels (1.21x as on March 31, 2020 from 1.50x as on March 31, 2019). The rating is constrained by RSL’s low diversification of business revenues, weak profitability due to lower yields, high cost structure and provisioning. In addition, the parent entity has a solvency constraint and capital infusion will remain a challenge with the current ownership. ICRA notes that the management buyout of RSL which was announced by Reliance Capital Limited in 2019 is still under approval stage with government authorities. While reaffirming the rating, ICRA has taken note of the inherent volatility in the capital markets which can have a bearing on RSL’s financial profile. The outstanding rating on the bank facilities of Reliance Securities Limited has been withdrawn at the request of the company and based on the no objection certificates provided by its bankers, and in accordance with ICRA’s Policy on Withdrawal and Suspension of Credit Rating. Key rating drivers and their description Credit strengths Focus on Retail segment and growing client base - RSL is focused on the retail segment forming 97% of total broking volumes in FY2020. It operated from 103 branches, with 1,552 active franchisees and a client base of 942,470 as on March 31, 2020 (897,607 as on March 31, 2019). Further, it has assets under management (AUM) of Rs. 961 crore as on March 31, 2020 (Rs. 778 crore as on March 31, 2019) under its retail distribution business. RSL’s broking volumes grew at moderate rate of 5% to Rs. 15.95 lakh crore in FY2020 from Rs. 15.21 lakh crore in FY2019. RSL’s volumes in cash segment (forming 3% of total broking volume) de-grew by 15%, while volumes in F&O segment (forming 97% of total 1 broking volume) grew by 6% in FY2020. With the overall volume growth of RSL being lower than industry volume growth of 44% in FY2020, the RSL’s market shared contracted to 0.45% in FY2020 from 0.62% in FY2019. Credit challenges Parent entity in default: RSL’s existing parent (Reliance Capital Limited), has defaulted in its debts obligations in 2019 and 2020. The default by the parent not only limits any additional capital raising for RSL but also severely restricts its funding ability for the current scale of operations. The change of ownership with a management buyout has been delayed due to the debenture holder resolution at Reliance Capital Limited which will need an approval of the creditors. This will remain a key rating monitorable. Low diversification of revenues with high dependence on broking income – RSL’s revenue profile is dominated by broking income which accounted for 70% of the net operating income (NOI) in FY2020 compared to 61% in FY2017. Any downturn in the capital markets could significantly affect the company’s financial profile. Although the company is augmenting its retail distribution business, the revenues remain negligible. Going forward, the revenue stream is expected to remain concentrated on the broking segment (~70-80% of NOI) as RSL does not have any plans to diversify into any other capital markets business. Weak profitability due to lower yields, high cost structure and higher provisions – RSL has posted net losses in six out of last ten years. RSL reported net loss of Rs. 39 crore in FY2020 compared to net profit of Rs. 23 crore in FY2019 due to de- growth in brokerage income and higher provisions. Brokerage income declined by 27% to Rs. 121 crore in FY2020 from Rs. 166 crore in FY2019 due to lower brokerage yield (blended yield of 0.55 bps in FY2020 against 0.67 bps in FY 2019) in FY 2020. RSL’s cost structure remains elevated when compared to many other ICRA-rated brokerage houses, with the cost to income ratio of the company being reported at 125% during FY2020 (106% in FY2019). During FY2020, increase in the total provisions to Rs. 19 crore from Rs. 5 crore in FY2019 was attributed to reversal of the brokerage income for its investment distribution segment. However, ICRA notes that the company has rationalized its investment distribution segment which is expected to improve cost structure and overall profitability going ahead. Liquidity position: Stretched RSL funding from the financial institutions for its margin and operational requirement is severely restricted. The margin placements are critical for a broker to do business, and ICRA notes liquidity as being stretched for the broking operations through funding by the lending institutions. However, for its debt repayment, ICRA notes that the company has an adequate liquidity with free cash and cash equivalents of Rs. 24 crore (August 10, 2020) compared to its annual debt servicing of Rs. 10-15 crore till September 2021 (primarily interest on inter-corporate deposits). Further, the proprietary arbitrage trading book is liquid in nature, wherein the company has the flexibility to square-off its position in a short time frame to meet any liquidity requirement. Rating sensitivities Positive Trigger: The ratings could be upgraded under the following scenarios: » Change in ownership AND » Improvement in scale of operations and client acquisitions resulting in higher revenues and sustained profitability. Negative Trigger: The ratings could be downgraded in case the company faces severe stress in liquidity resulting in a delay in servicing of its debt obligations. 2 Analytical approach Analytical Approach Comments Rating Methodology for Entities in the Brokerage Industry Applicable Rating Methodologies ICRA Policy on Withdrawal and Suspension of Credit Rating Parent/Group Support Not Applicable Consolidation/Standalone Standalone About the company Reliance Securities Limited (RSL) is a wholly owned subsidiary of Reliance Capital Limited (RCL) and is engaged in retail and institutional securities broking. As on March 31, 2020, the company had a net worth of Rs. 92.70 crore, including redeemable preference shares of Rs. 25 crore from the parent. During FY2020, the company reported a net loss of Rs. 38.77 crore on a net operating income of Rs. 153.32 crore as compared with a net profit of Rs. 22.79 crore on a net operating income of Rs. 199.07 crore during FY2019. Key financial indicators (standalone; audited) FY2018 FY2019 FY2020 Brokerage Income (net) 149.81 165.64 120.69 Trading income 23.31 38.72 17.86 Net Interest Income 37.63 33.27 32.57 Other Non-interest income 0.06 0.16 0.06 Net Operating income 187.50 199.07 153.32 Total Operating expenses 186.22 211.48 191.36 Profit before tax 7.80 21.56 (38.89) Profit after tax 7.10 22.79 (38.77) Net Worth 109.23 132.00 92.70 Cost-to-income ratio 99.32% 106.23% 124.81% Return on Net Worth 6.50% 17.27% -41.82% PAT/NOI (%) 4.16% 10.83% -25.37% Total debt / Net worth (times) 2.67 1.50 1.21 Amount in Rs. crore Source: Company data, ICRA research Status of non-cooperation with previous CRA: Not applicable Any other information: None 3 Rating history for last three years Rating History for the Past 3 Years Current Rating (FY2021) Instrument FY2020 FY2019 FY2018 Amount Amount Type 04-Sep-20 26-April- 04-Sep- Rated Outstanding 29-Mar-19 05-Mar-19 31-Jan-18 19 17 Commercial Short [ICRA]A4; 1 Paper 200 - [ICRA]A4@ [ICRA]A2@ [ICRA]A1@ [ICRA]A1+ [ICRA]A1+ Term reaffirmed Programme Short-term non fund Short [ICRA]A4; 2 50 - [ICRA]A4@ [ICRA]A2@ [ICRA]A1@ [ICRA]A1+ [ICRA]A1+ based bank Term reaffirmed facilities Short-term [ICRA]A4; non fund Short reaffirmed 3 350 - [ICRA]A4@ [ICRA]A2@ [ICRA]A1@ [ICRA]A1+ [ICRA]A1+ based bank Term and facilities withdrawn Amount in Rs. crore Complexity level of the rated instrument ICRA has classified various instruments based on their complexity as "Simple", "Complex" and "Highly Complex". The classification of instruments according to their complexity levels is available on the website www.icra.in 4 Annexure-1: Instrument details Date of Amount Coupon Maturity Current Rating and ISIN Instrument Name Issuance / Rated Rate Date Outlook Sanction (Rs. crore) Commercial Paper NA NA NA 7-365 days 200 [ICRA]A4 Programme Short-term non fund bank NA NA NA <1 year 50 [ICRA]A4 facilities [ICRA]A4; Short-term non fund bank NA NA NA <1 year 350 reaffirmed and facilities withdrawn Source: Company data 5 Analyst Contacts Karthik Srinivasan Sahil Udani +91 22 6114 3444 +91 22 6114 3429 [email protected] [email protected] Mayank Chheda Neha Parikh +91 22 6114 3413 +91 22 6114 3426 [email protected] [email protected] Relationship Contact L. Shivakumar +91 22 6114 3406 [email protected] MEDIA AND PUBLIC RELATIONS CONTACT Ms.