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Special Report | June 2016

The Cash Crunch

Banks are riddled with colossal piles of bad debts, the major chunk of which comes from the power sector. As such, better-evolved finance models and focus on renewable projects could be the solution.

Public sector banks in India are staring at humongous piles of bad debts; delinquent loans are rising unabated. Ballooning bad debts have caused 10 Indian state-owned banks to report losses of a whopping Rs.153 billion for the March, 2016 quarter. India Ratings, a Fitch associate, estimates that 21 per cent of the total bank credit is stressed. Total bank credit at the end of March 2016 stands at Rs.70 lakh crore. Banks have waived Rs.1.14 lakh crore of bad debts in the last three fiscal years, more than the write-off in the previous nine. The numbers show the extent of non-performing assets (NPAs) rot in public sector banks.

A major chunk of the NPAs comes from the power sector; the gross bank credit to the power sector stands at over Rs.5.6 lakh crore according to data from Reserve Bank of India (RBI). This constitutes around 9 per cent of total advances and 22 per cent of Indian banks´ cumulative exposure to India Inc. In contrast, the banks´ exposure to the sector was only 9 per cent in 2005!

Just the power distribution companies (discoms) have an outstanding debt of around Rs.4 lakh crore, rendering projects worth around Rs.1.6 lakh crore as NPAs. About 25,000 MW of installed capacity is unable to find buyers. This makes the NPAs at banks approximately Rs.6.4 crore per MW!

The power sector woes of the country are baffling, to say the least. The thermal power sector is operating at a decadal low of 59 to 60 per cent plant load factor (PLF) due to the bad health of discoms and state utilities, which are unable to buy more power. In turn, this has resulted in frequent power outages in a vast part of India - one of the world´s fastest growing economic powers.

Moreover, many power projects are making losses because of overly aggressive or optimistic tariff bidding, a lack of long-term buyers, hereto absence of regulatory norms that mandated power purchase agreements (PPAs), infrastructure bottlenecks and inadequate fuel supply.

The situation has now morphed into a vicious cycle with denting effects on the overall state of things - the banks are themselves fraught with bad debt problems, thrashing the scope for funding; consequently, the generation and transmission segments remain largely underutilised, further worsening the sector´s predicament. As such, flexible financial models to fund power projects, and focus on the renewable energy segment are the need of the day.

Power Finance
Power finance involves financing of power projects from sources other than the capital of the developer. It is also referred to as limited-recourse financing or off-balance sheet financing, as it takes the risks off the balance sheet of the sponsor. This is achieved by using the credit of a third party to support the transaction, wherein the lender looks at the cash flows and earnings of the project as a source of repayment, and at the secured assets of the project as collateral security. This type of lending is no doubt an attractive alternative, since it allows the developer to spread its risk exposure to various parties like banks or capital debt markets. However, at a time when the sector is replete with projects that are experiencing unnecessary delays and cost overruns, while the public sector banks (PSBs) cannot afford to fund such projects, involving private lenders for project financing of independent power producers (IPPs) seems like the only way to get new capacity fast. Nevertheless, in India, public private partnerships (PPPs) in IPP ventures have been disappointingly lethargic, due to various challenges, including corruption, higher costs and lesser returns on investment.

In such a scenario, limited-recourse financing will have to evolve towards a structure with greater balance sheet support, as it would offer greater security to lenders, while providing easier and cheaper access to long-term debt, which is critical to power sector financing, since IPPs typically depend on debt for 60 to 75 per cent of their financing requirements. Moreover, a greater balance sheet support by IPP sponsors would open wider access to public equity markets which are deeper and generally cheaper. Demand uncertainty is a huge factor behind the problems plaguing the Indian power sector. Increased balance sheet support will also play a crucial role in sharing demand risks among key stakeholders.

Renewable Energy
Harnessing renewable energy will not only help clean the environment, but also contribute to clearing up India´s messy power sector. For one, they do not involve as bulky investments as required for conventional power projects. Secondly, the government´s emphatic thrust on the renewable energy sector, with its declared intent to meet 40 per cent of its electricity demand from non-fossil fuel sources by 2030, only spells a positive milieu for developers. Thirdly, it is easier on the lender´s end to continually monitor the progress of renewable projects, given their smaller size, thereby mitigating risks of landing on NPAs.

Given India´s huge renewable energy potential across solar, wind, hydropower and even waste-to-energy, it shouldn´t come as a surprise that encouraging the sector is the way to shed a huge burden off the country´s debt-ridden power sector. The recent fall in solar tariffs to Rs.4-5 per kWh indicate that achieving grid parity is no longer a herculean task, while also signalling that the sector might soon become mainstream. In a recent development, India´s rooftop solar power program received a major boost from the World Bank after it approved a huge sum of debt funding - about $750 million.

Some innovative financing models for renewable projects, such as hybrid finance, OEMs equity finance, limited-recourse finance, and green bonds are discussed below.

Hybrid finance
Hybrid finance combines the characteristics of equity and debt, offering a more flexible and robust financing option. In hybrid financing, the lending agencies generally offer debt at around 12.5 per cent and take care of 100 per cent funding of the entire project. However, the funding period is limited to a period of 3-7 years, whereas banks offer funding at 11-12 per cent for a period of 15 years and non-banking financial companies (NBFCs) offer more than 13 per cent for the same period.

Moreover, 100 per cent funding involves the risk of ownership, since the lending firm will have complete ownership of the project till the debt period ends, implying that the developer must be able to arrange the requisite finance by the end of the debt period. Producers who can risk refinancing the project can benefit from the hybrid model. This is mainly because the hybrid model is taking more risk on a relatively new project by financing 100 per cent of the construction costs, than an under construction or completed one.

Additionally, a lot of private equity (PE) and institutional equity (IE) options are available for renewable projects, since the providers of such funds foresee a good growth area and asset class in renewable projects that give decent, risk-adjusted returns.

OEMs equity finance
In this funding model, original equipment manufacturers (OEMs) finance their own project on buyer´s credit, supplier´s credit or short-term trade finance in a structured way. Thereby, the project developer saves around 150-200 basis points from the senior loan providers for a period of 2-3 years. Again, like the hybrid model, a project developer can take this kind of structured funding for short-term and then refinance it with long-term project finance loans.

Alternatively, the OEMs and engineering, procurement & construction (EPC) companies can build the project at their cost as a developer with pre-agreed arrangements securitised for an end-buyer to acquire the asset. The buyer can then flip the asset for profit before it starts commercial operations.

Limited-recourse debt finance
In case of renewable projects, the limited-recourse debt finance can have an additional aspect - that of scrutinising the asset quality by lending institutes. These institutes can assess major components of a renewable project like modules, inverters, etc., through accredited labs, taking the help of consultants and EPC companies involved in the project.

Apart from assessing the promoter´s credentials and off-taker risk, such a detailed technical audit links the risk and consequently the debt interest rate to the quality of materials and services used, ensuring good asset quality. If poor quality products are used, the interest rates can see an increase and thus the incentive to investors. Such practices will ensure that debt institutes who lend a major chunk of the investment do not face dire consequences of sitting on NPAs, making the renewable power market viable.

Such a comprehensive limited-recourse financing model for renewable projects is definitely a welcome idea. Of course, as repayment will be from profit/earnings, regulatory steps will be needed to safeguard such finances, which may lead to critical due diligence of a project in terms of its ability to generate a promised level of electricity. This in turn, may lead to private PPAs with buyers having a better balance sheet and relatively better performance.

Green Bonds
Green bonds are similar to regular bonds, but for the fact that the bonds are issued for raising capital specifically to fund green projects, assets or business activities such as renewable energy, low-carbon transport, etc.

Globally, specific pools of capital are earmarked towards investment in green ventures; the source of capital primarily focuses on environmental, social and governance related aspects of the projects. Through green bonds, a project developer can get access to such investors which they otherwise may not be able to tap with a regular bond.

With India committed to harness 175 GW of green energy by 2022, requiring a massive funding of around $200 billion, green bonds can prove to be a major contributor in realising the vision. In December, 2015, the Securities and Exchange Board of India (SEBI) had emphasised on the need for green bonds while proposing new rules for issuance of such bonds. It said that given the huge investment requirements in infrastructure space, the existing project financing sources may not be sufficient for capacity addition, and that green bonds can be a sustainable solution. The Ministry of New and Renewable Energy (MNRE) had also launched an initiative in November 2015 to identify and develop innovative finance instruments that could unlock investment in building green infrastructure in India. However, full-fledged green finance models and platforms are yet to be evolved.

It is highly necessary that the power sector and PSBs remain in good health to realise the rapid economic growth envisaged by the government. Such high ambitions as Smart Cities and Power For All are commendable indeed. However, the possibilities look bleak in a scenario where the banking and the pwer sectors - two of the most important growth drivers - are going through dark times.

That said, the government certainly looks determined in promptly resolving these issues, as is evident from measures like Ujjwal DISCOM Assurance Yojana (UDAY), Integrated Power Development Scheme (IPDS), Bankruptcy Code, 5:25 scheme, etc. More such firm and effective measures from the government and RBI are the key to turn the tide in favour of both the sectors.

-Team Power Today

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