India's pension and insurance funds are keen on investing in credit-enhanced bonds after National Bank for Financing Infrastructure and Development launched a partial credit-enhancement facility to help lower-rated infrastructure issuers access the domestic bond market.
The pension fund regulator is looking to revise its investment guidelines to open up investment into PCE-backed bonds.
Even though the current rules permit pension funds to invest in corporate bonds from infrastructure companies that have domestic ratings of A or higher, none have taken the plunge because they are looking for someone to help reduce the risk, Sivasubramanian Ramann, chairperson of the Pension Fund Regulatory and Development Authority, said on the sidelines of NaBFID's annual infrastructure conclave in Mumbai on Thursday.
NaBFID, which is rated AAA by Crisil, Icra and CareEdge, officially launched the PCE facility at the conclave. It can guarantee up to 50% of the principal of bonds. NaBFID will act as a PCE provider, providing a layer of protection which will fundamentally change the bonds' risk profile.
"The cashflow waterfall in a PCE-backed structure prioritises bondholder protection, beginning with project revenue, then tapping the reserve account, and finally drawing on the PCE credit enhancement facility, thereby significantly reducing the default risk, " said Crisil Intelligence in a note.
Rajkiran Rai, NaBFID's managing director, said that it is "working with a few companies and projects which are a fit" for a guarantee.
Infrastructure companies rated BBB to A could see a multiple-notch rating upgrade following a credit enhancement or first-loss guarantee of 20% to 50% of the deal size, making it palatable for insurance, pension and provident funds, which had assets under management of close to Rs230trn (US$2.6bn) as of March, he said.
This PCE facility by NaBFID is expected to bridge this gap in risk appetite with the help of "enhanced due diligence and also putting their [NaBFID's] money as first loss default," said Ramann of PFRDA. "Today we don't even talk about PCE in our regulations. We will have to make changes in our investment guidelines accordingly for investing in PCE products."
NaBFID is simultaneously working with rating agencies to assess the required credit enhancement and potential level of rating upgrade they are comfortable with. Rai did not disclose the timeline for the first issuance.
Insurance companies are attracted by diversification into PCE-backed infra bonds, given the reduced credit risk.
Dinesh Pant, managing director of Life Insurance Corporation of India, said LIC would be keen to invest in a PCE-backed bond depending on how it is structured and the risk and reward for its policyholders. A PCE-backed product will help the due diligence process, as "it will add another layer of comfort for us," he said.
Supporting infrastructure
India needs Rs90trn to Rs100trn for infrastructure development until March 2030, out of which close to Rs75trn will come from the central and state governments, and the remainder from the private sector through banks, nonbank lenders, bonds and external commercial borrowings. Corporate bonds and ECBs are estimated to make up Rs5trn to Rs8trn of the overall borrowings, according to a Crisil Intelligence report.
NaBFID can offer partial credit enhancement for up to Rs60bn, or 20% of its Rs300bn Tier 1 capital, under Reserve Bank of India rules.
"Assuming around 30% credit enhancement is given by us, Rs60bn exposure can lead to up to Rs180bn of PCE-driven bond issuance," said Samuel Joseph, deputy managing director of NaBFID.
NaBFID estimates there could be issuance of PCE-backed bonds worth Rs1.5trn over the next three to five years, provided banks, nonbank lenders and other stakeholders participate, after the RBI expanded the pool of PCE providers under its revised framework in August.
The PCE exposure limit has been increased to 50% of the issue size, which is higher than the 20% cap under an earlier framework. The capital required by the PCE provider will depend on the risk weights linked to the pre-enhanced credit rating.
Credit enhancement did not take off in the past because of the heavy burden on providers. Under RBI's earlier rules, a bank could provide a PCE of up to 20% of a bond's issue size but had to set aside capital for the balance.
IFR previously reported that NaBFID is in advanced talks with the World Bank for a US$1bn backstop facility, which would expand its capacity to provide guarantees and lower costs.
"Under the earlier guidelines the cost of providing a PCE was around 2.5%, which will come down to less than 1% following the revised rules, and may come down further to 0.5% to 0.6% if the World Bank backstop come in," said NaBFID's Rai.