Unlocking Value

Financiers’ perspective on the resolution of stressed assets

The high level of stress in the power sector has been an issue of concern for some time now. At a recent India Infrastructure conference, industry experts shared their views on the measures that have been taken to address the problem of stressed assets and the way forward for the banking and power sectors.

The progress with regard to the  resolution of stressed assets through the non-National Company Law Tribunal (NCLT) route has been quite grim and the process has been extremely slow. This could be attributed to a number of reasons such as banks concealing their non-performing assets (NPAs), stakeholders being reluctant to face the NCLT, and corruption seeping into the NCLT and insolvency process. Moreover, the interest during construction accumulated till date, which should be around 15 per cent for thermal power plants, is north of 35-40 per cent.

While it has been said time and again that the Insolvency and Bankruptcy Code (IBC) route is the way forward for stressed power asset resolution, the entire system needs to realise this rather than resist it. The code takes away control from the banks as well as the promoters, both of which are unwilling to relinquish control. For price discovery through the market, the IBC is the right solution. Unfortunately, the resolution process is not working as per the scheduled timelines. There are instances in the steel sector where the IBC has worked. However, there are cases from the Reserve Bank of India’s first list of defaulters, which have been languishing for almost a year in either the appellate tribunal or the Supreme Court. There are lacunae in the judicial system due to which a time-bound resolution has not fructified on the ground. Thus, to make IBC a success, there is a need to enforce the resolution timelines.

All the stressed asset cases cannot be salvaged. Initially, there were 30 cases that could be salvaged. Of these, 10 were resolved primarily through better administration of power purchase agreements (PPAs) and fuel supply agreements (FSAs). Another 10 cases required financial intervention, of which two have been resolved outside the NCLT and five (spread across Tamil Nadu, Chhattisgarh, Maharashtra and Madhya Pradesh) are at various stages of resolution. The remaining 10 cases have very slim chances of resolution. On an average, lenders expect a haircut of 50-60 per cent on the resolution of these 30 stressed assets. However, these assets can be divided into two groups – one, where there have been 10-15 per cent haircuts (these were salvageable cases) and the other comprises assets that have to be completely written off, resulting in a haircut of 100 per cent.

There is a glut of NPAs in the banking system. There are three criteria that need to be met to solve the problem – banks should be willing to take haircuts, the promoter/new investor should pump in money for meeting working capital requirements and for completion of projects, and there should be some correction in the regulatory policy. Asset reconstruction companies (ARCs) are looking at operational power plants with PPAs for 50-60 per cent of their capacity. ARCs are also exploring assets that are being restructured. Phoenix ARC, for instance, has minority stakes in Korba West Power Company Limited, SKS Power and KSK Energy Ventures Limited. However, assets that are still under construction require a strategic investor rather than an ARC. ARCs also refrain from acquiring large stakes in power companies and are trying to influence the recovery process through the joint lenders’ forum or the IBC route. Separately, a dedicated ARC for the power sector can work if it is well capitalised. At present, the total capital available to ARCs is between Rs 50 billion and Rs 60 billion, which is leveraged on a 2:1 debt-equity ratio. This is far below what is required for the power sector.

The warehousing mechanism (called the Pariwartan scheme), under which the government plans to warehouse stressed power projects under an asset management firm, works in cases where the asset is valuable and well built. Due to a temporary demand-supply mismatch for power and fear of large haircuts, warehousing sounds reasonable to prevent the loss of value of the asset, provided lenders have the requisite staying power. With a shift in the demand-supply scenario (situation of power shortage due to rising demand) expected over the next two years, assets being held at present will become relevant. In a situation of a power shortage, it will be relatively easy to secure PPAs. Once PPAs are in place, the value of stressed assets will be unlocked over the long term.

India has an installed capacity of 330 GW and a peak demand of around 170 GW. Assuming a growth rate of 6 per cent, there will be 10 GW of incremental demand. Also, assuming that NTPC Limited and solar players absorb 5 GW of this incremental demand, there will be 5 GW of demand that will absorb the stressed power. Over the next five years, once 25 GW of salvageable cases are absorbed by the increased demand, a power shortage scenario could arise. The warehousing mechanism is looking at this 5 GW demand that is not being met by NTPC Limited and renewable energy companies. Thus, of this 5 GW, well-built projects that were not able to secure complete power offtake and fuel intake should be warehoused. For others, lenders will have to take haircuts and write them off.

However, the warehousing concept has been adopted from power-surplus countries where interest rates are not more than 3-4 per cent. In the Indian context, warehousing for, say, three years, at a minimum interest rate of 10 per cent will result in a jump in the cost by at least 25 per cent. The viability of the project at that cost, three years hence, is not certain. There has been a 15-20 per cent decline in the cost of setting up a new plant owing to a surplus in the power generating equipment market. Thus, the asset could be outpriced by the new plants that are currently under construction.

In a nutshell, haircuts should be taken if need be. If the asset is well built and the lenders have the wherewithal to hold assets for two to three years, they should opt for warehousing rather than selling of assets at distressed valuations. Therefore, the warehousing mechanism can work if healthy assets are parked.

Meanwhile, discoms too have impacted the cost and size of haircuts. Investors have become discerning with respect to the counterparty in the project/asset. PPAs with discoms that do not honour their obligations are heavily discounted, leading to higher losses for bankers and investors. Recently, agreements were signed for 1,900 MW of capacity under the Aggregated Power Procurement Scheme on Medium Term Basis, with PFC Consulting Limited as the nodal agency. Investors evinced interest in those projects that were able to secure PPAs under this scheme. Revival of investor interest implies a better price for lenders. However, the tariff rate in the PPAs is a cause for concern as it is against independent power producers and favours discoms. These PPAs can result in even greater losses if coal prices move in an unfavourable direction. However, mostly low-cost projects, those located near mines in Chhattisgarh, Odisha and Jharkhand, comprise a major part of the PPA scheme.

In sum

Banks are currently saddled with loans worth Rs 4 trillion pertaining to the power sector, most of which are likely to turn bad. Their balance sheets are not strong enough to make 30 per cent provisioning (setting aside or providing funds to a prescribed percentage of their bad assets) on these. Through the IBC, banks are forced to have 50 per cent provisioning for their NPAs. In such a scenario, banks will act rationally and decide whether to sell the asset or restructure the loan to a more sustainable level on a case-by-case basis.

Implementing the Ujwal Discom Assurance Yojana (UDAY) in the right spirit will solve the stressed assets problem. Rather than laying emphasis on stressed assets, the focus should be on sustaining the $80 billion revenues of power distribution companies. The government is on the right track of fixing discom finances through UDAY. Also, there is no dearth of foreign capital for assets. However, investors are reluctant to invest due to the mess in the power sector. Further, listed utilities such as NTPC have phenomenal value. Investors should consider parking funds in such utilities to earn high returns.

Based on a panel discussion among Bharat Parekh, Executive Director, CLSA India; Jatin Pal Singh, Vice-President, NDRO, SBI Capital Markets; and Sanjay Tibrewala, Chief Operating Officer, Phoenix ARC, at a recent Power Line conference

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