Bond Investors Shun State Government Firms, Make A Beeline For Central PSUs

State government firms have weaker standalone financial profiles than central PSUs, investors say. Also unlike central PSUs which rarely default due to the implications for the sovereign, some state government firms have delayed payments leading to nervousness.

Data from Bloomberg shows that the handful of state government firms, which are actively traded in the secondary markets, have seen yields jump. The spreads, or the additional interest rate charged over and above the benchmark government bonds of similar maturity, have also risen.

In particular, bonds of UP Power Corporation Ltd. have seen a surge in yields in the secondary market.

Late in 2019, it emerged that the the UP State Power Sector Employees Trust had faced losses due to investments in bonds of Dewan Housing Finance Corp. Ltd. The trust managed the retirement funds of the UP Power Corporation, which would have to make good for the loss. According to a November 2019 note from India Ratings & Research, this would be credit neutral for the company.

Further, in a note in March, the rating agency pointed out that UP Power Corporation has the backing of the state’s consolidated fund for the timely payment of debt servicing and the replenishment of the debt service reserve account (DSRA).

Still, investors have chosen to sell down these securities due to a combination of redemption pressure at mutual funds and nervousness around financial impact of the Covid-19 crisis on finances of the states and state government entities.

According to a senior debt banker, bonds issued by central government PSUs are preferred over state government owned entities in every cycle, even though both may have a quasi-sovereign status.

The central government PSUs have turned profit-making over time, improved their governance practices and completed projects on time, whereas state owned entities have a relatively poor track record in these aspects, this person said on the condition of anonymity.

The other entity that has seen a few secondary market trades at elevated levels are AP Capital Region Development Authority. The company is on “rating watch with negative implications”, according to CRISIL Ratings. This is due to the continued uncertainty regarding the status of the APCRDA Act given the ongoing discussion on its annulment, the rating agency said.

Even beyond company specific reasons, there are concerns over the finances of state governments themselves. This could restrict their ability to provide support to companies promoted by them.

“Given the halt to economic activity and the likely slowdown even after the easing of the lockdown, the states’ economic growth in 2020-21 would be lower than estimated at the time of preparation of the budget,” said Madan Sabnavis, chief economist, CARE Ratings. Since the state government revenues are also expected to be lower, only those states that budgeted a revenue surplus in FY21 are likely to weather the financial crunch due to higher spending requirements this year, he said in a May 4 report.

Central PSUs See Strong Interest

In contrast, bonds issued by central government PSUs have seen strong interest in the primary and secondary markets. While credit spreads of these securities have also widened, they remain modest in comparison to state-government peers.

Ajay Manglunia, managing director and head of institutional fixed income at JM Financial, said that investors like PSUs with strong balance sheets owned by the central government. These entities find it easier to raise money, he said. “In today’s environment the banks would have bought a large amount of these bonds through the funds raised via the targeted long-term repo operations,” Manglunia said.

Rating & Credibility Gap

The rating gap between central and state PSUs also impacts the yields and spreads on these bonds. Besides, despite state-government backing, the repayment track record of state PSUs has not been impeccable.

The debt banker cited earlier said there’s low appetite for state PSU bonds since some of these papers have credit rating below AA. With state government finances under pressure, mutual funds, banks and insurance companies would not want to hold these securities.

According to Manglunia, some state PSU bonds have delayed repayments and even defaulted on their bonds in the past, which means they have a heightened credit risk. “You cannot issue guarantees for all bonds when revenues continue to be under pressure and it’s harder to maintain credit discipline in this environment.”