Rating Rationale

Strengths:
* Strategic importance to GoI, given REC's key role in financing India's power sector
REC is strategically important to GoIas 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 itsrural electrification programme under the DeendayalUpadhyaya Gram JyotiYojana (formerly known as Rajiv Gandhi GrameenVidyutikaranYojana) and Pradhan MantriSahajBijliHarGharYojana (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 81% of its portfolio.

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 December 31, 2019. REC's outstanding loan book had exposure of 81%, 7%, and 12% to state sector, joint sector units, and private sector, respectively. 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 2.7 lakh crore as on December 31, 2019 (Rs2.5 lakh 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. Short-term commercial paper borrowings were Rs. 3500 crore as on December 31, 2019, constituting less than of 1.0% of total borrowings. 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 at7.47% (annualised) in the first nine months offiscal 2020 (7.16%in fiscal 2019).

For fiscal 2019, extra budgetary resources of Rs 18,827 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 networth was Rs 38,515 crore as on December 31, 2019 (Rs34,303 crore as on March 31, 2019). The Tier I capital adequacy ratio (CAR) and overall CAR stood at 15.44% and18.36%, respectively, as on December 31, 2019(14.44% and 17.77%, respectively, as on March 31, 2019).Gearing stood at 6.82times as on December 31, 2019 (6.98 times as on March 31, 2019). The net worth/net NPA ratio improved to around 4.0 times as on December 31, 2019 from 3.3 times as on December 31, 2018 (3.2 times as on March 31, 2019). Capitalisation is expected to remain adequate over the medium term, supported by a demonstrated ability to raise external capital .Accruals to networth will be supported by the company's ability to maintain good interest spreads and a low operating expense ratio. The return on assets ratio was 1.9% (annualised) in the first nine months of fiscal 2020 (2.3% in corresponding period of the previous fiscal). However, profitability will remain susceptible to increase in credit costs because of weakening in asset quality in the private sector exposures.

Weakness
* Exposure to risks relating to inherent vulnerability of asset quality, and significant customer and sectoral concentration
The company 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 81% of overall advances as on December 31, 2019. Further, top 10 borrowers constitute 39% of total loans as on December 31, 2019. 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 12% exposure to the private sector as on December 31, 2019, 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 December 31, 2019, the overall gross NPAs decreased to6.40% from 7.24% as on March 31, 2019 (7.57% as on December 31, 2018) led by recovery from delinquent accounts. Consequently, Net NPAs have reduced to 3.16% as on December 31, 2019 from 3.79% as on March 31, 2019 (3.96% as on December 31, 2018).As on December 31, 2019, 54 % of private sectors loans have been recognized as stage III assets on which the company has a provision coverage of 51%.

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.