OREANDA-NEWS. Fitch Ratings has affirmed Rural Electrification Corporation Limited's (REC) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'BBB-'. A full list of rating actions is at the end of this commentary

REC's ratings are equalised with those of the Indian sovereign (BBB-/Stable). This reflects its public sector status, the government of India's ownership, and strong operational and strategic ties with the government that result in a strong likelihood of extraordinary government support if needed. REC is therefore classified as a credit linked entity under Fitch's criteria.

KEY RATING DRIVERS
REC is one of two public financial vehicles that provide funds exclusively to the Indian power sector and is also the second-largest lender to the sector. The government has appointed REC as the sole central agency in implementing two nationwide power reform projects aimed at increasing electricity coverage in rural areas and subsidising electricity distribution projects.

The Indian government owns 60.64% of REC and has provided it support by allowing REC to issue tax-free bonds and 54EC Capital Gains Tax Exemption Bonds, and raise foreign commercial borrowing of up to 75% of its net worth without prior government approvals. Fitch expects REC will continue to receive support from the government.

The government controls REC through its board and the Ministry of Power signs an annual memorandum of understanding with REC to set its annual operational and financial performance targets, which it reviews on a quarterly basis. The Comptroller and Auditor General of India appoints auditors for REC on an annual basis.

As at end-March 2015, 79% of REC's outstanding loan portfolio was extended to state power utilities, which inherently have weak credit profiles. Nevertheless, the financial performances of state power utilities have improved in the past two years because the government has raised electricity tariffs and launched a financial restructuring package for the utilities.

REC's capital adequacy ratio improved to 19.35% at end-March 2014 (end of the financial year 2014), from 17.71% at end-FY13, and remained above the regulatory requirement of 15%. REC's healthy profitability is underpinned by its comfortable interest spread and lean operating cost structure. Fitch expected REC's net profit will increase by 15%-20% a year during FY15-FY16, driven by Fitch's forecast of 17%-20% annual growth in outstanding loans and the company's ability to maintain its interest spread at the current level over the period.

Concentration risk arises from REC's exposure to the power sector. However, this risk is mitigated by the guarantees from state governments for part of the loans extended to state utilities, use of escrow accounts and the critical role that REC plays in providing infrastructure financing to its borrowers.

RATING SENSITIVITIES
Positive rating action would stem from a similar change in the ratings of the sovereign in conjunction with continued strong explicit and implicit support from the state.

Significant changes to REC's legal status that would lead to a dilution of control by the government or deterioration in the likelihood or timeliness of support by the sovereign may result in the ratings being notched down from the sovereign ratings. Further dilution in the state's shareholding to less than 51% would lead to Fitch to change its approach to the rating to a standalone basis (from the top down), which may result in a downgrade.

The full list of rating actions follows:

REC
Long-Term Foreign-Currency IDR affirmed at 'BBB-'; Outlook Stable
Long-Term Local-Currency IDR affirmed at 'BBB-'; Outlook Stable
CHF200m 3.5% senior unsecured notes due 2017 affirmed at 'BBB-'
USD500m 4.25% senior unsecured notes due 2016 affirmed at 'BBB-'