Moody's raises concern, places PFC, REC under review for downgrade

Acquisition will erode PFCs capital adequacy

Global rating agency Moody’s on Thursday said that State-owned Power Finance Corporation’s (PFC) move to acquire government holding (52.6 per cent) in REC Ltd is credit negative for PFC as it will weaken its capital adequacy ratios.

Agency has placed the Baa3 issuer ratings as well as standalone credit profile of both PFC and REC under review for downgrade.

On December 6, the government of India (Baa2 stable) gave an 'in principle' approval to PFC to acquire government's entire 52.6% stake in REC. Upon completion of the transaction REC will become a subsidiary of PFC.

PFC is headquartered in New Delhi and has total assets of Rs 2.86 trillion ($43 billion) at the end of March 2018. REC, also Delhi headquartered entity, has total assets of Rs 2.46 trillion ($37 billion) at the end of March 2018.

The transaction could create some operational synergies, as both PFC and REC operate in the same business segment. But, the negative impact from lower capital levels will outweigh any potential synergies, Moody’s said.

The review for downgrade of PFC's standalone credit profile will focus on the extent of decline in the post-transaction consolidated capital ratios of PFC. The agency will assess whether PFC will be required to make an open offer to minority investors in REC, and thus acquire a stake greater than just the 52.6% government stake.

It would also look at the price that PFC will have to pay to acquire this stake, including any premium that it would have to pay over and above REC's prevailing market valuations. Any action(s) by PFC to mitigate the negative impact on its capital ratios, for example by raising new equity would also be under scanner. Although Moody's deems such measures as unlikely.

Moody’s will also assess the impact of the transaction on the company's liquidity profile, particularly its ability to raise sufficient funding to finance the transaction.

The review for downgrade of REC's standalone credit profile will focus on the impact of the transaction on the company's liquidity profile. Of particular interest will be its ability to manage its liquidity profile when change of control clauses in some of its outstanding bonds trigger accelerated repayments.

As PFC's final ratings will continue to benefit from government support, REC's will ratings benefit from implicit government support in this rating architecture.

The review for both entities will also focus on any material and tangible evidence of operational synergies created by the transaction, Moody’s added.