Wednesday, June 20, 2012

What if PA becomes NPA

Even this is about Power sector in India.

  1. Let's say CompanyXYZ intends to setup power plant. Total Project Cost is Rs1,000 Cr. 
  2. They managed Rs300 cr and they got a debt of Rs 700 cr since they got all the clearances including Coal Linkage, PPA, EC etc.
  3. They went ahead and placed the BTG order and BoP order.
  4. Activity worth ~Rs 500 cr is executed.

Suddenly one day the Coal Linkage is cancelled. And due to forex fluctuations the BTG cost increased by 20% leading to an overall cost increase of 15% for the project. Since the RoE from a power plant in itself is around 15%, the plant is no longer viable. 
Now a Performing Asset (PA) has become an NPA. Now what are the options for lender? While Technically NPA happens only after a default, for the sake of discussion let's assume that any project which is no longer happening is an NPA.
If the borrower is a Govt. entity, every lender has the support and cushion that Govt. body will pay back. But what if the borrower is a private entity. 
Moreover typically for power projects, funding happens based on cash flows but not necessarily based on balance sheet. So, only the successful completion and operation of the project will provide returns to the lender.
The answer may be as simple as saying, since the land and other equipment are a mortgage, the banks can sell the asset and recover the money. What are the things that Banks can sell?

  1. Machinery: While it may fetch some money, it will not be of the same value at which it is purchased. Once the power plant is no longer viable, the equipment isn't as valuable as it'd be had it been utilized. Since Machinery is customized in many cases, lot of investment further would be required to make it useful for any other project.That being the case, banks may not be able to recover good amount of money.
  2. Land: This is the only cushion that a lender might have assuming that the land prices might have appreciated. But this also doesn't provide enough buffer.

Lenders may force the Borrower to shell out some more equity to compensate for their loss. Since it is a cash flow based funding, the borrower is not liable more than the assets of the project. So, the overall risk exposure of the banks increase multifold. All that they can probably think about is converting the asset into NPA. But does that address the issue? The ideal way would be if the lenders can take the project forward my financial restructuring or by re-negotiating the contracts.
But Lenders do not have the capacity to operate the plant. So, what do they do?
I was asking this question to a friend of mine, who is working in a State funding agency with focus on Power sector. While earlier these instances were rare, with the increased volatility and the uncertainties in the sector, it is apparent that there are going to be power plants who may have to be shut mid-way during Construction. Considering that banks have tremendous exposure to Power sector and have very limited exit options, unless there is a drastic turn-around in some of the areas impacting the sector, lenders have tough days ahead.Contrary to the belief that developers are facing the wrath, it is the lenders who are at the risk of going bankrupt. 
Do I sense another business opportunity for Consulting? :)