With the latest mayhem on market , this needs to be re validated.
Do you think there is any issues with edelweiss too ?
BTW …He also recommended Diwan to his customers …only fyi.
So my mantra is never take any one on face value and do your own duedeligence before getting in to or out of anything.
After all every individual is human and hence can get influenced by bias,greed ,fear and other emotions so .
Edelweiss will face headwinds too –
Rising bond rates
Hit on MF distribution revenue from wealth management side
Souring of sentiment regarding MF inflows
Further weakness in Capital market revenues
Most of these are in common with other NBFCs but thankfully none of these are going to be permanent issues.
Edelweiss seem to be clean. Im a subscriber of his services and I must say he is among the most honest and passionate investors out there. Although I do not always agree with his approach.
Dewan is a very very small position of the pf. He had derisked the position at a 100% return sighting the various risks the company faced. He has further clarified to his customers today, the reasons behind the fall (he believes). Edelweiss are a high quality franchise and cos like edelweiss, bajaj finance and gruh have simply reacted to market panic. Please do not fault all his work just because of a black swan event in one company. He has been communicating all day with his clients via email.
Again I do not agree with his approach completely but it has given him returns and he is extremely passionate and super honest.
Everyone wanted to buy edelweiss when things were superb. Now that they have the chance they are sighting headwinds. Can the company’s bottom line hit 3000cr from current 1000cr in 4-5 years? Answer is yes imo. If not 3000cr maybe around ~2500cr. And if that is the case then these minor hiccups should not worry investors. Yes there will be the above headwinds and perhaps more. But in the long run we are looking huge macro tailwinds and potential financial powerhouse in the making…
I did’t say buy or sell because of the short term issues. Be careful for the next few months is my strategy. Amidst all this frenzy in the domestic market we have forgotten that US 10Y yield has crossed 3% again which is not a great sign for domestic bond yields. Could this bring down the growth machine to 25% from 35% that is perfectly possible.
Two days back company has conducted large event for their employees all across a very first one till day …where chairman conveyed some key messages it was a full day event and all employees were expected to attend over video conference / in person etc.
I will be meeting few of them on Monday and shall update what Rashesh shah and other top executive had conveyed to employees …after all they are adding 2000 odd employees this year to their current base of 10000 employee base of last year .
It’s imp and critical to keep communicating with all to keep them motivated and to give directions around area to focus.
I am happy to see such initiative happening at company in which I have 2nd highest holding with superb level of management integrity ( no negatives yet ) .
The following post is mainly to understand the impact of the events that have happened in the last week and the way it impact specifically related to the one of their subsidiary ECL finance limited and the short term (Stock in trade) of debentures that ECL carries.
There were two interesting developments that happened in the last few days:
- ILFS being downgraded from AA+ to BB on September 8 and then to D on September 17
- DSP selling DHFL debt at around 200 bps lower due to lack of liquidity or buying interest in DHFL.
Now why does these two event have anything to do with Edelweiss? Besides the generic issues like hardening interest rates which impact every financial Edelweiss carries a large amount of ‘Stock in trade’ of sub standard debt in its subsidiary ECL finance ltd.
How significant is ECL finance ltd?
Out of 890 crores PAT that Edelweiss had last year 462 crores came from ECL Finance. ECL Finance as per last year AR has a net worth of 2939 crores and Assets of 26755 cr.
What is Stock in Trade?
Stock in trade as per ECL finance annual report is:
How significant is Stock in Trade?
Out of the total assets that ECL Finance has i.e. 26755 cr , Stock in Trade is 9713 cr or 36% nearly.
So Stock in Trade is significant and is short term . One look at Stock in Trade and it is clear that it is dominated by sub standard debt. A rough break up is:
So a total of 7687 cr of Stock in Trade is in Corporate debentures. A brief look at this Corporate debt gives an impression that it is really a high yield debt of low quality. There are ofcourse some good names here and there like Shriram/Piramal/Edelwiss group companies/Indiabulls/DHFL/Yes but they are far and few. A crude analysis gives out that around 10% to 12% of corporate debt is in somewhat well know. From a business standpoint too it makes sense to have this kind of debt because short term borrowing would be costly (to acquire this debt) and this kind of debt if one can sell could give a 5% to 10% kind of spread.
The other interesting thing to look at is how much of Stock in Trade was carried over from last year FY17 and was not sold in FY18 in the corporate side. Holding which are present in both FY17 & FY18 can give an idea about that. Roughly this is how the nos. look:
So out of 4653 cr of Stock in Trade ECL Finance could not sell roughly 2053 cr nearly 44% of the corporate debt.
ECL Finance gives the carrying value and market value for quoted debentures and since the market value is higher than the carrying value there is no impact on balance sheet. Incase of unquoted debentures we need to take it on good faith.
Looking at some of the corporate debt ECL Finance has it is easy to see that some of it has had ratings downgrade and most of quoted debt doesn’t trade actively.
If we look at most of the debt matures in CY19/CY20/CY21. So any assumption that Stocks in Trade debt if it is not traded will mature does not hold.
Finally a few questions to those who understand debt markets and accounting:
- How can one mark to market the corporate debt that ECL Finance has when it does not trade in the market? Also incase of rating downgrade which has happened in some cases like the ones below what is the right course of action?
2.The major way in which this ‘Stock In trade’ seems to be financed on the liability side is Short term borrowings + Loans from related parties + CBLO + Other current liabilities (maturing term loan + maturing NCD + book overdraft). Now incase of a liquidity squeeze how does this scenario play out since there are no buyers for this kind of corporate debt? Will this not create an ALM scenario?
3. For those invested in Edelweiss the general answer to the quality of debt has been that there are multiple covenants and the underlying assets should be sufficient to address the debt. The argument is based on faith in management and an underlying assumption that they are doing the right thing. Assuming the argument holds good implying Edelweiss can do fine in the long term but isn’t there an underlying dangerous assumption on the short term liquidity not falling apart.
Discl: No holding. ECL Finance’s corporate debt has always been a concern.
ECL Finance Annual Report FY18: https://www.edelweissfin.com/documents/30595/206861/ECL%20Finance%20Ltd.pdf
Great post @Anant and thanks for sharing your findings! Will share my understanding on some of the items below:
Well, as it says below, “incase of debt instruments for which direct quotes are not available, fair value is the lowest of the quotes as on the valuation date as provided by market intermediaries”. If the lowest quote from intermediaries is below cost, they will write it down and run the difference through P&L since its “held for trading” and stock in trade is part of current assets.
I noticed your examples, ABT, Saha, Shree, and Parinee all are quoted corporate bonds. They would take their quotes from market on book closing date and then compare with previous value in the books. Would mark up or down the difference and enter the difference in the P&L (other income). To answer your question - rating downgrade would have pushed bond price down and they would have had to write them down (if quote is available or else go with intermediaries quote).
Just FYI - I noticed them marking down their holding in Nspira Management Services Pvt Lt bond. Below is the screenshot.
As you are aware of - exposure to such high yield bonds (if not Masala or Junk bonds) is not bad as long as they are paid appropriately for the risk involved in it. I hope they were purchased at significant discount to the par value and also hope that BMU (balancesheet management unit) did appropriate due diligence of underlying collateral and ability for the management to pay back the principal. Crucial thing to find out would be, if these corporates are paying coupon (if there is one) on time. I hope Indian debt debt market experts reading my comment would shares his/her insight with us on the corp bonds in question.
Excellent question. IMHO - no one except BMU would know how the ‘stock in trade’ is financed. Here an investor has to trust the management and its execution capability to ensure ALM is maintained all the time. Hence, as we know, conservative management is super critical in lending business.
Views/questions/comments invited. Thanks
Disc: invested and views may be biased.
Few observations here:
Most of the quoted debentures are listed on BSE (ABT, Saha etc) but have never traded there. There is no quote, no 52 wk H/L. In such cases how would ECL price them?
From what I understand the following things should impact the pricing of bonds:
– The G-Sec yield : In FY18 G-Sec yield moved from 6.87 in the beginning of FY18 dropping to 6.43 reaching a high of 7.6 and closing at 7.19. Most of the banks had MTM losses in the last 2 qtrs on their treasury. How did ECL finances’ carrying value of its corporate bonds change? Also despite yield hardening ECL finance had a 300 cr excess of market value compared to its carrying value. I guess they must be doing a real smart job here.
–Rating of the company : Haven’t gone through all the companies but it suffices to say that a good number of them have moved down and some also to D. Since ECL in its AR does not give the market rate of individual companies it would make sense to ask them for the carrying value of each line item. It is very difficult to imagine how carrying value has remained above the market value with yields hardening and rating downgrades.
–ALM, Current Assets & Current Liabilities: If one looks at the balance sheet in term of non-current liabilities vs long term assets and short term liabilities and short term assets it looks decent. It does not show much ALM concerns in short term (a year). The problem is when you look at the 7500 cr corporate debt Stock in Trade (which is in current assets) which is not maturing and the company can have difficulty selling off and is financed by short term borrowings one can see a problem building up.
–What happened in Q1 FY19: In Q1FY19 yields went up from 7.19 to 7.9 a 70 bps jump. Ideally there should be an MTM loss on the entire Stock in Trade portfolio unless some part was sold of. Going by last year’s rate it should be around 14% a quarter.
Finally in financials I understand trust is key since a lot of jugglery is possible in books, but I think these are pertinent questions and it would help if someone has asked/understood this aspect.
RBI norms: Prudential Norms for Classification, Valuation and Operation of Investment Portfolio by Bank
Dont understand much of valuation so any bond experts will be helpful.
So, ECL fin is almost half of Edelweiss profits. And stock in trade is 36% of ECL fin assets. So, 18% of Edelweiss assets are these stock in trade.
Out of this 80% is in corporate debt.
So, 15% of Edelweiss assets are in corporate debt.
Let us assume, 15% of this debt defaults completely and goes to zero.
That gives us a 2% net impact.
Edelweiss fell 10-15% yesterday in one go.
I think you need to work out a little more math (& finance here), if the entire corporate book defaults Edelweiss net worth will be completely eroded. If 15% defaults as you are saying 2.25% of net worth gets lost but also the underlying ability to borrow and it will have to sell more assets to manage debt equity since it is levered around 6/8 times.
I am sure the entire corporate book will not default and assuming the underwriting is good most of it will not be impacted in the long term, the issue is more of short term liquidity and the mark to market adjustments which I guess has not happened.
Fin cos are leveraged cos. And the entire debt defaulting is ZeroHedge prediction for 10 years now for big countries like China.
Even ILFS debt is backed by huge assets and is more of a cash flow mis-match and not the company going bankrupt. It is govt cos that owe huge payments to Ilfs.
Usually MTM accounting is done if the bonds are held in AFS (available for sale) category. If however, it is held in HTM (held to maturity), then MTM accounting need not be applied.
Not sure about edelwiess split, but the categorization is done at the time of investing in the debt and there are rules around moving them between categories. HTM to AFS is allowed, but vice versa is not usually.
For ALM - look at slide 44 of the investor presentation , they have a fairly matched book and often this done via derivative instruments too. finally slide 47 also shows a 5500 crs liquidity cushion which is close to 9% of the balance sheet.
There are three distinct issues here:
Long term viability of ECL Finance corporate debt: I am not suggesting any defaults here. I am just saying that I dont understand the quality of these but at the same time from the face of it most of the corporate debt looks low quality. At the same time I would assume there is significant underlying asset which can help recover incase of a default. The point of my most is not to any way suggest the long term outcome of this debt.
The points that I am trying to riase are:
ALM issues and other short term liquidity issues:
Mark to market adjustments in the bond values:
The points I have raised are related to Short Term Assets and specifically Stock-In-Trade which is not maturing in short term. If these were HTM assets going by their maturity they should be held in Long term assets. IMO these should have MTM accounting.
Why is all the “super detailed digging for pitfalls” and “hunting for negatives” happening only when there is price erosion? This thread has been around for a long time and nothing exceptional has happened in the past few weeks/months except the 25% price correction, but it seems all the negativity are coming out only after the price fall.
It would have been great if these negatives were listed when the price was at 310 levels then the people who were not comfortable with the fundamentals would have got a decent exit.
Unfortunately when the price was going up, only things being posted were the praises for Rashesh Shah and how great the company is fundamentally.
It was pointed before ofcourse not in so much detail. The post was on Feb 17.
I am not justifying what edelweiss is or is not doing. I am describing the account standard.
AFS and HTM classification of assets (Bonds, NCD are just a few example) is done at the time the asset is put on the books. It is based on the intent of the management and have to declared. The same asset can land in either buckets, but management has to make the decision at the time the asset is put on balance sheet. If an AFS asset has a change in value, the changes is passed through P&L. For HTM asset its a little more complicated where changes may be captured in OCI in some cases.
Management cannot change an asset from AFS to HTM on the fly if they suddenly start seeing losses in the portfolio. Banks were given special permission by RBI in the past to do this, to avoid them from showing losses.
The balance sheet classification which you mention is the duration of the asset. Both AFS and HTM assets can be short or long term based on the duration of the asset (or even the intent of the management).
On liquidity - it is usually defined as cash or equivalents/lines of credit. Atleast thats how it is defined. The same slide talks of liquidity as banking lines, FD and G-sec. I dont think they are considering corporate bonds