Structuring Risk In Pse Bonds

A charge created on the assets of a PSE is no comfort to the investors. Due to labour and political compulsions it is almost impossible to realise the assets through liquidation. Asset sale of a running PSE is difficult unless the Government clearly spells out its policy on disinvestment and exit out of non-core areas. In this scenario, cash flows of PSEs, especially of those which are loss making, are the only asset which gives comfort to an investor. The general approach to credit enhancement has been to escrow the cash flows which are utilised on a priority basis for repayment of interest and principal.. It operates through a tripartite structured mechanism amongst the issuer, trustee and the banker through which the cash flows are routed. Additional comforts are added through State Government Guarantee or commitment from State Government to meet shortfall at the time of payment of interest/principal. The commitment from the State Government can be a simple commitment to meet shortfall in payment as in

 

the last bond issue of Sardar Sarovar Narmada Nigam Ltd. or it can be backed by budgetary support as in the case of the public issue of Maharashtra Krishna Valley Development Corporation.

No doubt cash flows which are directly escrowed in favour of a trustee representing investors are a good credit enhancement technique. However stability and quality of cash flows is a concern which investors need to address. For instance a road transport company which escrows cash flow from sale of bus ticket sales - the cash flows could dry up in case of strike leading to default. In case of SEBs, the nature of power sales is a qualitative factor affecting the credit worthiness of the escrow account. Retail sales of power are less risky and enhance quality and stability of escrow account. On the other hand, having a few high tension customers may not make a stable escrow mechanism since drawl of power could fall due to self-generation or temporary closure of operations of these customers.

Cash coverage is another crucial factor. There is no hard and fast rule on this and would necessarily depend on the nature of cash flows. For retail sale of power, a cash coverage of 1.33 may be sufficient but not so for HT consumers for which a higher coverage of 2 may be appropriate. The number of escrow accounts opened earlier is also significant as the credit rating would fall and risk would rise with creation of more and more escrows unless the growth in cash flows is commensurate with growth in borrowings. This rarely happens since cash flows take time to increase with time lag in implementation of projects which can be compounded by delays and cost overruns.The issuers need to improve disclosure levels.

Aggregate guarantee obligations of the state, state finances and ability to meet guarantee obligations and any earlier delays or defaults in meeting guarantee obligations need to be disclosed in the offer document. For investors, risk assessment is of crucial importance: all PSE structured obligation bonds are not the same and a higher rate should not be the only criteria for investment.

The author is Senior Vice President, Investment Banking Division, Apple Finance Ltd. The views expressed herein are the personal views of the author.