DHFL exposure may dent UPPCL bonds, but impact credit neutral: Ind-Ra

Kolkata: Fitch group firm, India Ratings and Research (Ind-Ra) believes the likely loss to the UP State Power Sector Employees Trust, which manages retirement funds of employees of U.P. Power Corporation (UPPCL) and its subsidiaries, due to its investment in Dewan Housing Finance Corporation will have an impact on UPPCL’s financial performance but will be credit neutral for Ind-Ra rated UPPCL bonds.

DHFL is now rated under the default category. UP State Power Sector Employees Trust has investments of about Rs 4300 crore, of which Rs 2600 crore were in DHFL and of these Rs 1000 crore have been realised.

As per Employees' Provident Funds Act, 1952, the employer, in this case UPPCL and its subsidiaries are responsible and will have to make good for the loss that may be caused to the provident fund due to theft, burglary, defalcation, misappropriation or any other reason.

Therefore, Ind-Ra believes, unless the government of Uttar Pradesh (GoUP) steps in to bail out UPPCL, this loss will have to be borne by the UPPCL and will have an impact on its bottom line. However, servicing of UPPCL’s bonds will not be impacted, since these bonds are serviced from the top line and have strong structure/external credit enhancements in place.

Ind-Ra has rated bonds of UPPCL totalling to Rs 19,989 crore, which were raised during FY17-FY18 under two different series and in two separate tranches of each series. Both the series are top-line (revenue) funded/serviced bonds. Starting from the first day of each quarter of the interest/repayment schedule of the bonds, UPPCL has been remitting daily an amount on a pro-rata basis to the respective bond servicing accounts. While bonds under both series are guaranteed by the government of UP, they are also supported by bond specific internal and external credit enhancers. The bond specific credit enhancers define the credit quality of the series, leading to the agency’s differential credit view on the two series.

For the Series 1 of Rs 9999.5 crore bonds, UPPCL used the credit enhancement mechanism which the power ministry had suggested. Under this mechanism, the credit enhanced structure is layered in such a manner that in case of a shortfall in the UPPCL bond servicing account the trustees will send a notice to the state government to cover the shortfall.

In case the state government fails to cover the shortfall within five days, the trustee will trigger the direct payment mechanism, which means asking the Reserve Bank of India (RBI) to tap the principal account of the state government and fund the debt servicing account’s shortfall within the next four days.

In case the debt servicing account is still in shortfall, then the trustees will make up the shortfall from the debt service reserve account (DSRA).

Under this payment mechanism, the state government of Uttar Pradesh has given an unconditional and irrevocable mandate to the RBI to make a direct deduction from its account upon the receipt of the request from the trustee to cover the shortfall in the UPPCL bond service account. This arrangement has been accepted and acknowledged by the RBI.

The Series 2 of Rs 9989 crore, raised in FY18, is supported by a subsidy receivables by the distribution companies from the government of Uttar Pradesh and a daily flow of at least Rs10 crore to the designated receipt accounts opened specifically for this series, which is then used to meet the daily flow towards debt servicing accounts of Series 2.

As per the structured payment mechanism, if the fund required for servicing the quarterly debt obligations is not enough 15 days before the quarterly debt servicing date, the debenture trustee would inform the state and ask it to cover up the shortfall within the next five days.

If the state fails to cover up the shortfall, the trustee will call upon the GoUP guarantee on the next day to the extent of the shortfall. Thereafter, the state will have to make good the shortfall within the next six days.

In case of DSRA impairment, power subsidy received by UPPCL and its subsidiaries will become available to the trustees for recouping the DSRA. This power subsidy is being routed into a specified subsidy account with a default escrow mechanism which gets triggered in case of DSRA impairment or shortfall.

Further, to ensure sufficiency of the power subsidy to meet DSRA impairment, the structure ensures that in case the flow into subsidy account is less than Rs 600 crore per quarter for any two consecutive quarters, the revenue flow from urban domestic divisions will be hypothecated in favour of the debenture trustee until the flow into the subsidy account is restored to INR8 billion per quarter.

Both the series are further supported by the liquidity buffer available in the form of a rolling DSRAs, which were created one working day prior to the deemed date of allotment. In line with the transaction documents, DSRA accounts are being maintained at an amount equivalent to the total debt servicing obligation -- principal and interest, for the next one quarter for bonds of Series 1 and two quarters for bonds of Series 2. Since it is a rolling DSRA, UPPCL has been stepping it up to meet the enhanced principal repayment obligation, as and when required.

UPPCL has been maintaining comfortable coverages, both in debt service accounts (DSA) and DSRAs. For the NCD Series 1, until October 2019, average quarterly DSA cover was 1.05x and DSRA was 1.03x. Similarly for Series 2, the DSA cover was 1.05x and DSRA was 2.90x as the DSRA requirement is of two quarters.

UPPCL is allowed to park the unutilised funds in the escrow accounts and the DSRA in fixed deposits of scheduled commercial banks with a minimum credit rating of ‘AA’ and or in liquid mutual funds having the highest possible investment-grade rating. While some amounts are invested in the bonds of central public sector entities which are rated at par with the sovereign, the balance is in fixed deposits of scheduled commercial banks.