Investors are flocking to buy bonds formed from the restructuring of loans to Indian state power distribution companies, or discoms, handing a windfall to creditors at the expense of state governments.
These bonds were carved out of distressed bank loans to power distribution companies under a Financial Restructuring Plan approved in October 2012 by the Indian government and seven states.
Under the plan, 50 percent of the outstanding short-term debt of the power discoms up to March 31, 2012, was to be converted into roughly 600 billion rupees ($9.4 billion) of 15-year bonds in stages. Thereafter, these bonds were to be taken over by the respective state governments in a phased manner up to March 2017. In turn, the state governments were to issue fresh bonds.
According to DCM bankers, state governments have started issuing these bonds with staggered maturities of between four and 15 years to state-owned banks and institutions such as the Power Finance Corp and Rural Electrification Corp, which were lenders to the discoms before the restructuring.
Even though the bonds were born out of bad loans and the financial health of power discoms remains fragile, investor interest is high.
“Earlier, no one understood these bonds. But, gradually investors saw a great opportunity,” said a trader. “These bonds are being viewed as sovereign debt and hence very safe.”
Bondholders are already said to be sitting on big mark-to-market gains.
Last year, these bonds were auctioned in the secondary market at spread of 50bp to 60bp over the respective state government bonds. This spread has now narrowed to just 2bp to 4bp, according to DCM sources.
The bonds do not count towards regulatory liquidity ratios, but their higher yield versus state bonds still makes them attractive to banks, along with the prospect of further gains.
REC and PFC have seen good demand as they offload their holdings in the secondary market.
“Mostly banks and traders are buying these bonds in the secondary auctions. Later, they get sold to provident and pension funds,” said a source.
However, analysts and the Reserve Bank of India have raised concerns over the deteriorating health of discoms. The fear is that further losses at the discoms could harm the finances of state governments and hinder their ability to service their own bonds.
“The states have not been able to strengthen the financial health of discoms under their financial restructuring plans,” the RBI said in its June report, noting that the gap between supply costs and revenues remained unsolved.
Separately, Indian banks have restructured around 530 billion rupees of their exposure to the seven discoms. The moratorium period for repayment of the principal amounting to 430 billion rupees ended in March 2015, according to the RBI.
“Probability of slippage of this exposure into NPAs is very high considering the implementation of new regulatory norms on restructuring of loans and advances effective April 1, 2015,” the central bank said.
Considering that power discoms continue to face long-standing challenges of fixed tariffs, high power purchasing costs and high distribution losses, analysts fear there could be another round of restructuring soon.
But bond investors remain undaunted.
“There cannot be any default on these bonds. The RBI is responsible for the servicing of interest on these bonds. These are also ultimately state liabilities and no Indian state government will ever default,” said a DCM banker.