Recent news about the merger of PFC and REC has given rise to many questions in the minds of investors. Here’s an explainer attempting to address a few of them.
What is the recent announcement regarding the PFC and REC merger?
On February 6, the boards of power finance PSUs – PFC and REC – accorded in-principle approval for the merger of REC with PFC, eventually liquidating REC post the merger. This follows a proposal by the Finance Minister in her Budget speech that the two NBFCs be restructured for scale and efficiency improvements.
Why is the Centre doing the merger? What are the synergies between the two companies?
Both PFC and REC are identical in many respects. Both are Maharatna PSUs managing a loan book of about ₹6 lakh crore each. Loans to the distribution segment remain the mainstay of their loan books at about 40 per cent each. Both have 12-15 per cent exposure to the fast-growing renewable energy generation segment, and both have forayed into non-power finance such as financing infrastructure projects (ports, roads, etc.).
They are largely identical in the way they operate as well. They raise funds from the market (via bonds and term loans) and lend them to the power ecosystem – generation, transmission and distribution. Their borrowing profile is also similar – about 55 per cent from domestic bonds, 15-20 per cent from bank loans, and 20-25 per cent from external commercial borrowings.
It is this similarity that appears to be behind the government’s decision. When two of your own companies are in identical businesses, sometimes competing for the same market, it does make sense to merge them. Once consummated, the merger could bring additional bargaining power to the combined entity owing to its scale, though there may not be any meaningful saving in operating costs. Currently, for both PFC and REC, operating costs as a percentage of total income are just a few basis points under 1 per cent.
Further, in respect of schemes such as the revamped distribution sector scheme (RDSS), both PFC and REC are the nodal agencies, though with distributed responsibilities. The merger could streamline such responsibilities under one entity and bring about process efficiencies.
How will the merger impact the business?
The merger could spawn a power financing behemoth with a loan book of ₹11.5 lakh crore – as large as Canara Bank, which is the seventh largest bank in India. When broken down, the book would have 40 per cent exposure to distribution, 29 per cent to conventional generation, 14 per cent to renewables, 8 per cent to transmission, 6 per cent to infrastructure and logistics and 3 per cent to miscellaneous loans. Categorising the book based on the borrower, loans to state-owned entities and the private sector would make up 80 per cent and 20 per cent of the portfolio, respectively. The GNPA ratio of the combined entity would be 1.3 per cent. These numbers are based on Q3 FY26 financials. Return on assets on a trailing 12-month basis (up to H1 FY26 where balance sheets are disclosed) could work out to about 3 per cent.
What does it mean for the existing shareholders of PFC and REC?
The government is the largest shareholder in PFC, with a controlling stake of 56 per cent. PFC, in turn, has controlling stake in REC. This, after it bought 52.6 per cent of REC’s shares from the Government for ₹14,500 crore in 2019. Since PFC controls REC, it consolidates REC’s books in its consolidated financials. This is the current structure.
The in-principle approval of the boards clearly states that post the merger, PFC would remain a government company. A government company, by definition, is one where at least 51 per cent of the paid-up capital is held by the government (centre/ state(s)/ jointly by centre and state(s)). However, with a swap ratio of 6 shares of PFC for every 7 shares of REC – worked out based on prices as of February 10, the government’s stake in PFC post-merger would drop to around 42 per cent.
To avoid this situation, there are two options for the government. One, direct PFC to carry out a buyback wherein the government does not participate, ensuring minimum public shareholding of 25 per cent. Two, infuse such capital into PFC that its stake remains at least 51 per cent post the transaction. The possibility for the former is remote, as reduction in capital would mean an adverse impact on the capital adequacy ratio, which in turn can strangle growth. If the government were to opt to infuse capital, it would have to infuse at least ₹32,000 crore to maintain 51 per cent of stake in PFC post the transaction. A third path where the government relaxes the definition of government company – to a minimum stake of 26 per cent, for instance – cannot be ruled out.
At the above swap ratio, outstanding shares of PFC will rise by about 33 per cent without the government’s capital infusion and will rise by about 56 per cent after such infusion.
Readers need to keep in mind that the above are just indicative numbers and that the final swap ratio can be different. The transaction is likely to take months to consummate as steps such as independent valuation, drafting the terms of the scheme, including the swap ratio, approval from shareholders, regulators and the NCLT are yet to go through.
Do the stocks of PFC or REC become attractive buys after the announcement?
As of February 10, the stocks of PFC and REC trade at attractive price-to-book value multiples of about 1.1x each.
While there is no denying that valuation should factor in the high concentration to the power sector/ state discoms and the lower loan growth in 9M FY26 versus FY25, the stocks still trade at unreasonably low multiples, considering their profitability.
PFC and REC have delivered RoA of 3 per cent and 2.8 per cent in the 12-month period ending September 2026 (when balance sheets are disclosed). Net NPAs, too, are contained at about 0.2 per cent. For context, SBI trades at 1.8x trailing book value for an RoA of 1.1 per cent (9M FY26 annualised).
Of the two, considering buying PFC could be advantageous. This is because, post the merger, it will come to fully own REC’s assets and non-controlling interests will be eliminated. As a result, the current holding company discount of about 15 per cent with which it trades, is expected to disappear. Shareholders of REC need to watch out for the actual swap ratio to take advantage of arbitrage opportunities, if any.
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