Provisioning issues hit REC, PFC

Flat loan growth and net interest income drag down profits at the two power sector lenders, with the outlook a bit sombre

The problem of stressed assets and bad loans do not appear to be restricted to banks. Power sectors lenders such as Rural Electrification Corporation (REC) and Power Finance Corporation (PFC) also seem to have been hit by the need for higher provisioning on these in the December ’15 quarter.

To begin with, if REC saw it’s provisioning double to Rs 373 crore, PFC’s provisioning for non-performing assets (NPA) more than trebled to Rs 483 crore in Q3’FY16. Interestingly, much of the stress came from Essar’s power project, which impacted REC’s provisioning by Rs 134 crore, while that of PFC by about Rs 160 crore. Consequently, profits too closed on a flat note for both the companies (see table).

Asset quality pressures remain, given the spike in gross NPA ratios for both. REC’s rose from 0.82 per cent in the same quarter of FY15 to 1.7 per cent in this one; PFC's from 0.96 per cent to 1.89 per cent.

Analysts at Religare Institutional Research, in a note on REC last week, said: “The gross NPA ratio increased by 64 basis points (bps) sequentially to 1.7 per cent as two loan accounts, Essar Power MP (Rs 1,350 crore) and Starwire Vidyut (Rs 40 crore) slipped into NPAs. The restructured pool increased by four per cent sequentially to Rs 20,000 crore (10 per cent of loans), very high in our view.”

For PFC, Edelweiss analysts noted, “The restructured portfolio rose to Rs 24,100 crore (from Rs 22,300 crore in the earlier quarter), this being over 90 per cent of its private sector exposure. Progress on these projects warrant a closer look.”

Satisfying operational performance, given the tough industry outlook, was the silver lining in the quarter. Net interest income grew 13 per cent and 8.6 per cent year-on-year, respectively, for PFC and REC. However, net interest margin (NIM) shrunk 48 bps over a year to 4.59 per cent for REC, while it was flat for PFC at five per cent. Tax-free bonds issued at 7.21 per cent spiked the cost of funds to 8.46 per cent for the quarter (8.36 per cent in the same quarter a year before), impacting its NIMs.

Analysts feel NIMs could come under further pressure for these companies as more state electricity boards and distribution companies (discoms) opt for the UDAY (Ujwal Discom Assurance Yojana) scheme's restructuring package, to resolve the financial crunch at the latter entities. Analysts at Edelweiss explain that with state governments set to take over the debt of discoms (potentially at 8.2 per cent, much below the lending rates of PFC and REC at over 10 per cent), NIM compression is a logical corollary. This could hurt profitability in the near to medium term.

There is a secondary impact of the UDAY scheme, a fall in the loan book and in loan growth. Kotak Securities estimates a 30 per cent decline in the loan book of REC between this quarter gone by and FY18, due to the transfer of discom loans estimated at Rs 65,000 crore (32 per cent of loans, which will reflect under investments, if not sold by REC). On loan growth, Edelweiss is factoring in an eight per cent annual compounded rise from FY16 to FY18 for PFC. REC’s new loan growth is also expected to moderate from the current levels.

The challenge for REC and PFC is whether they can improve their loan disbursements from the current levels to offset for the possible shift in loans once UDAY is implemented. The disbursement revealed mixed trends this quarter, with PFC seeing only five per cent growth (Rs 10,755 crore) and REC a 23 per cent jump to Rs 11,919 crore, over a year. Despite all this, the companies are among the preferred investment bets in the financial institution space, mainly due to low valuations. The price to book ratio for FY17 is 0.6 for both, at par with leading public sector banks. Six of 13 analysts polled on Bloomberg after the December quarter results recommend a ‘buy’ on PFC; three recommend a ‘sell’, with a target price of Rs 228.71 (56 per cent upside from the current market price). Likewise, four of 10 analysts recommend a ‘buy’ on REC, while three suggest ‘sell’, with a target price of 238.86 (40 per cent upside).