Fitch Ratings has affirmed REC Limited's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'BBB-'.

The Outlook is Stable, in line with that on the India sovereign (BBB-/Stable). Fitch has also affirmed REC's USD10 billion global medium-term note programme and senior unsecured notes at 'BBB-'.

The affirmation reflects Fitch's view that REC remains as an important government-related entity (GRE) due to its strategic role in supporting India's power sector.

KEY RATING DRIVERS

Support Score Assessment 'Virtually certain'

We believe extraordinary support from the government would be 'Virtually Certain' should REC need it, reflecting a support score of 50 out of a maximum 60 under Fitch's GRE criteria. This is based on our assessment of the government's responsibility and incentive to provide support.

Responsibility to Support

Decision Making and Oversight 'Strong'

We believe the government has strong decision-making influence over REC, despite its indirect shareholding through Power Finance Corporation Limited (PFC, BBB-/Stable). The government exerts its control by appointing REC's board of directors; all members are appointed by the president of India through the Ministry of Power (MoP). The board also approves the company's key policies. The government defines the company's scope of business and sets its operational and financial performance targets through an annual memorandum of understanding with PFC.

However, our assessment is moderated by REC's status as a Maharatna company, which grants REC with greater operational and financial autonomy compared with other public sector enterprises.

Precedents of Support 'Strong'

REC is financially self-sufficient and we consider government support to be indirect via supportive policies; government-sector borrowers accounted for 90% of REC's standalone loan assets as of the financial year ending March 2023 (FY23), which supports its financial viability and loan quality. Government sector borrowers have no non-performing assets; 40% of REC's loan book is guaranteed by a bank or the government and unsecured loans accounted for less than 5% of its total loan balance.

REC is also allowed to issue long-tenor low interest-rate bonds for extra liquidity. We view this as way to ease the company's debt financing by the government. These include infrastructure, tax-free and capital gains tax exemption bonds and accounted for 13% of REC's standalone borrowings at FY23. The government has also directly provided a term loan to REC of INR100 billion.

Incentives to Support

Preservation of Government Policy Role 'Very Strong'

We believe REC is strategically important in implementing power-sector reform to boost India's economic growth and development, while its funding prevents the dislocation of liquidity in the power-sector value chain, particularly to weak distribution companies.

REC's default is likely to disrupt funding and thus impact the power sector. There are also few substitutes, considering the company's significant market share in the power-lending sector. The market also considers REC as one of the highest-profile GREs in India. We think REC's default would trigger a deep political crisis, particularly given its 'Maharatna' status.

Contagion Risk 'Very Strong'

We consider REC to be a reference issuer and singled out as a core government entity as a Maharatna company. REC has diverse funding channels, including access to cheap bond and offshore funding; it cost of funds is close to that of the government. REC has high visibility of borrowings, as one of India's three public sector undertaking that can issue capital gain bonds. We believe its default would almost certainly disrupt access to and the cost of financing for the government or other GREs.

Operating Performance

REC's operating performance continues to improve. Its standalone loan asset size reached INR4.4 trillion in FY23, to be up by 13% yoy, 90% of which was loaned to government-sector borrowers. However, standalone net interest income fell by 7.21% to INR146.2 billion on higher finance costs. This saw the net interest margin on earning assets fall to 3.38%, from 4.01% in FY22. The interest spread on earning assets, measured by yield on earning assets less cost of funds, decreased to 2.45%, from 3.23%, although profit after tax still rose by 10.0% to INR110.5 billion.

Asset quality is improving as REC resolves stressed assets, with its net non-performing assets ratio falling to 1.01% in FY23 (FY22: 1.45%). The capital/risk-weighted assets ratio remained resilient at 25.8%, with a 22.8% Tier-1 ratio, up from 23.6% with 19.6% Tier-1 in FY22.

Derivation Summary

We rate REC under our Government-Related Entities Rating Criteria. The rating reflects our assessment of the government's responsibility and incentive to provide support. We believe the government is 'Virtually Certain' to step in and provide support should REC default.

Debt Ratings

REC has a USD10 billion global medium-term note programme. The programme and bond rating are aligned with REC's IDR, as the bonds constitute its direct, unconditional, unsubordinated and unsecured obligation and rank pari passu with all of its other present and future outstanding unsecured and unsubordinated obligations.

Issuer Profile

REC was established in 1969 as a non-deposit taking non-banking financial company registered with the Reserve Bank of India (RBI). It is under the administrative control of the MoP and is responsible for extending financial support to various entities within India's power sector. It has also expanded its business to logistics and the infrastructure sector. REC's borrowers are primarily from government sectors. REC is also the nodal agency for the implementation and operation of power-sector government schemes.

Liquidity and Debt Structure

REC's standalone total debt increased by 14% in FY23 to INR3.8 trillion, with the net debt/equity ratio reaching 6.5x, from 6.4x in FY22. We believe REC has adequate asset and liability management to meet the RBI's guidelines. REC has diverse funding sources, including domestic bonds (41% of total debt), foreign-currency borrowings (20%), term loans from banks and financial institutions (16%), capital gain bonds (10%), infrastructure and tax-free bonds (3%), subordinated bonds (2%) and a term loan from the government (3%).

Its overall cost of funds stood at 7.28% in FY23 and has remained consistent throughout the years. Floating interest-rate borrowings accounted for 30% of total borrowings, with 14% hedged. Undrawn bank facilities totaled INR147.6 billion at FY23, which offers liquidity when needed.

Rating Sensitivities

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

Negative rating action on India's sovereign rating.

A deterioration in Fitch's perception of the government's responsibility or incentive to provide support.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Positive rating action on India's sovereign rating.

ESG Considerations

Fitch does not assign ESG scores for REC, as the ratings and ESG profile are derived from the parent. ESG relevance scores and commentary for the parent entity, India, can be found at Fitch Affirms India at 'BBB-'; Outlook Stable

Public Ratings with Credit Linkage to other ratings

REC's rating is linked to India sovereign.

References for Substantially Material Source Cited as Key Driver Rating

The principal sources of information used in the analysis are described in the Applicable Criteria.

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