Strengths: * Strategic importance to GoI, given REC's key role in financing India's power sector REC is strategically important to GoI as it plays an important role in the Indian power sector, not only by providing finance but also by implementing GoI's power sector policies. It is the nodal agency for channelling finance towards its rural electrification programme under the Deendayal Upadhyaya Gram Jyoti Yojana (formerly known as Rajiv Gandhi Grameen Vidyutikaran Yojana) and Pradhan Mantri Sahaj Bijli Har Ghar Yojana (translated as the Prime Minister's Programme to provide easy electricity access to all households), or 'Saubhagya'. Furthermore, the company has been nominated as the sole nodal agency to operate the National Electricity Fund Scheme'an interest subsidy scheme introduced by GoI'to promote capital investment in the power distribution sector. REC is the second-largest lender to the sector. The company plays a developmental role in channelling finance to meet the power sector's large funding requirement, particularly of State Power Utilities (SPUs), which constitute 89% of its portfolio as on June 30, 2020. The government supports the company financially and operationally in various ways, including conferring special status to raise capital gains tax exemption bonds. Even after stake sale to PFC, GoI indirectly controls REC. CRISIL believes that GoI has strong strategic reasons and a moral obligation to support REC, both on an ongoing basis and in the event of distress, given the latter's role in implementing the government's power sector policies. * Dominant market position in the power financing segment REC plays an important role in the Indian power sector, not only by providing finance but also by implementing GoI's power sector policies. REC provides project-based long-term loans for generation, transmission and distribution activities and renewable energy. Besides, the company also offers short-term loans for working capital requirement, bridge loans, and debt refinancing which forms less than 1% of the overall advances as on June 30, 2020. REC's outstanding loan book had exposure of 82%, 7%, and 11% to state sector, joint sector units, and private sector, respectively, as on June 30, 2020. The importance of REC in channelling financing to the domestic power sector is underscored by the fact that REC, together with PFC, accounted for a significant portion of the aggregate debt raised by SPUs. To support this role, REC has also received exemption from single and group borrower exposure norms for exposures to state power utilities (SPUs) till March 2022. Clearly, REC will remain a key financier to SPUs and, therefore, play a crucial role in sustaining their operations. Loans outstanding to government sector stood at Rs 2,93,152 crore as on June 30, 2020 (Rs 2,84,644 lakh crore as on March 31, 2020; Rs 2,47,716 crore as on March 31, 2019). As on June 30, 2020, overall loan book stood at Rs 3,30,788 crore (Rs 3,22,425 crore as on March 31, 2020; Rs 2,81,210 crore as on March 31, 2019) * Strong resource profile REC's credit risk profile is supported by its sound resource profile, with competitive borrowing costs and a diversified, albeit wholesale, resource base. As on June 30, 2020, overall borrowings stood at Rs 2,97,420 crore with domestic bonds forming the largest share at 57%, foreign currency borrowings at 17%, and funding from banks/FIs at 12% and capital gains/tax free bonds at 11%. Short-term commercial paper borrowings were nil as on June 30, 2020 (Rs 2,925 crore as on March 31, 2020). On a steady state, CP borrowings are likely to remain within 5% of the total borrowings. REC's debt instruments have wide market acceptability and the company typically borrows at low spreads over government securities. Its cost of borrowing is lower than that of most of its peers, and stood at 7.19% in the first quarter of fiscal 2021 (7.31% in fiscal 2020; 7.16% in fiscal 2019). For fiscal 2020, extra budgetary resources of Rs 3782 crore were raised on behalf of the Ministry of Power, GoI. These bonds will be used to augment infrastructure funding, and be fully serviced by the government through the general budget; hence, a separate government guarantee was not required for issue of these bonds. In its analytical treatment, CRISIL has assumed that REC will ensure the bonds are serviced on time if need be. * Adequate capitalisation REC's capital profile provides a cushion against asset-side risks arising from high sectoral and customer concentration. The net worth was Rs 37,384 crore as on June 30, 2020 (Rs 35,077 crore as on March 31, 2020). The overall capital adequacy ratio (CAR) and Tier 1 CAR stood at 16.91% and 13.59%, respectively, as on June 30, 2020 (16.06% and 13.17%, respectively, as on March 31, 2020). Gearing stood at 7.96 times as on June 30, 2020 (8.0 times as on March 31, 2020). The net worth/net NPA ratio was around 3.9 times as on June 30, 2020 (3.3 times as on March 31, 2020). Capitalisation is expected to remain adequate over the medium term, supported by a demonstrated ability to raise capital through public issues (REC raised Rs 2000 crore of subordinated debt in Q1FY21). Accretion to net worth will be supported by the company's ability to maintain good interest spreads and a low operating expense ratio. The return on assets (RoA) ratio was 1.5% in fiscal 2020 as against 2.1% in fiscal 2019 (RoA (annualised) stood at 2.1% in the first quarter of fiscal 2021). Profitability was impacted in fiscal 2020 due to increase in credit costs and foreign exchange (forex) losses. Ability to contain credit costs and hence improve profitability and capitalisation will remain a key monitorable. Weakness: * Inherent vulnerability in asset quality, and significant sectoral and customer concentration REC's asset quality remains inherently vulnerable as it caters only to the power sector and faces inherent asset quality challenges because of the weak financial risk profiles of its main customers, SPUs, comprising around 89% of overall advances as on June 30, 2020. Further, top 10 borrowers constitute ~37% of total loan book. Effective execution of various reform measures is extremely critical for SPUs to produce the desired positive impact, and broad-based political consensus is necessary to implement the much-needed tariff hikes to ensure sustained improvement in the performance of SPUs. However, REC has been able to manage overall asset quality risks in this segment owing to its criticality to borrowers and through various asset protection mechanisms. REC also has around 11% exposure to the private sector as on June 30, 2020 (12% as on March 31, 2020), which has been vulnerable to asset quality risks owing to issues such as lack of fuel availability, inability to pass on fuel price increases, and absence of long-term power purchase agreements for assured power offtake. As on June 30, 2020, the overall gross NPAs and Net NPAs decreased to 6.1% and 2.9%, respectively, from 7.2% and 3.7%, respectively, a year ago (6.6% and 3.3%, respectively, as on March 31, 2020) led by recovery from large private delinquent accounts. As on June 30, 2020, 54% of private sectors loans have been recognized as stage III assets on which the company has a provision coverage of 53%. Overall, CRISIL believes that the asset quality will remain vulnerable over the medium term primarily because of the increased challenges likely to be faced with private sector borrowers. The ability to resolve stressed accounts will also be a key monitorable going ahead. |