Ind-Ra: Partial Credit Enhancement for Corporate Bonds a Positive Step; Product Design by Banks Key to Next Step

The Reserve Bank of India's (RBI) guidelines on partial credit enhancement (PCE) for corporate bonds will allow banks to reduce their elevated exposure to infrastructure projects, says India Ratings and Research (Ind-Ra). The guidelines will also allow project companies to reduce their borrowing costs based on improved ratings.

By allowing only those projects with a credit rating of at least 'BBB-' and PCE of not more than 20%, RBI has ensured that only projects with a robust standalone credit profile would benefit from the guidelines at the same time not diverging significantly from the 'standalone' profile.

Ind-Ra believes that the requirement to have an inter-creditor agreement among the issuer, PCE provider and other lenders will provide the agency greater comfort in concluding that the benefits of PCE cannot be encumbered upon by other creditors in times of stress. However, the capital provisioning norms are quite stringent such that the initial capital provisioning by the PCE provider is not allowed to reduce even if the 'standalone' rating of the issuer improves resulting in a similar improvement in the rating of the credit enhanced bond.

Non-amortising PCEs would, if not drawn down in the initial years, result in a greater level of support to bond holders in the later years and this is considered credit positive by the agency. Also, the agency appreciates that the PCE will be fully subordinated to bond holders.

The RBI guidelines require banks to have a board approved policy covering issues such as quantum of PCE, pricing of such facilities and setting of limits. Ind-Ra believes that the key mandate of a PCE is to provide credit support in times of distress and also provide project companies time to turnaround if they reach a situation of distress. The agency believes that the benefit of PCEs will accrue to corporate bonds conditionality is limited. Also, a PCE that is allowed to accelerate and enforce security interest when it becomes an NPA will not allow the project to have a chance of revival, which is critical for such credit enhanced ratings.

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