Power Sector                                            Lenders                                            Will the credit...
Insights         A knowledge sharing endeavour from CRISIL                                                                ...
Insights         A knowledge sharing endeavour from CRISIL                                                                ...
Analytical contacts                                                                                                       ...
Analytical contacts                                                                                                       ...
Insights         A knowledge sharing endeavour from CRISIL                                                      Meaningful...
Insights         A knowledge sharing endeavour from CRISIL                                                      Meaningful...
Meaningful action on reforms critical                                                                                     ...
Meaningful action on reforms critical                                                                                     ...
Insights         A knowledge sharing endeavour from CRISIL                                                      Credit qua...
Insights         A knowledge sharing endeavour from CRISIL                                                      Credit qua...
Credit quality of power sector lenders -                                                                                  ...
Credit quality of power sector lenders -                                                                                  ...
Credit quality of power sector lenders -                                                                                  ...
Credit quality of power sector lenders -                                                                                  ...
Credit quality of power sector lenders -                                                                                  ...
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  1. 1. Power Sector Lenders Will the credit quality trip? October 2011 InsightsA knowledge sharing endeavour from CRISIL
  2. 2. Insights A knowledge sharing endeavour from CRISIL Foreword As a part of our knowledge sharing endeavour, I am delighted to present this compendium of articles on Indias power sector and power sector lenders. Given the criticality of the sector and rising risks, there is a keen desire from investors to understand the sectors outlook and its implications for the lenders. The various articles in this compendium highlight insights gained from our analysis of state power utilities (SPUs), distribution entities, generation companies, and lenders to the sector. In preparing this outlook, we have been constrained by lack of updated and aggregated financial information for SPUs - which distribute nearly 95 per cent of Indias power, account for nearly two-thirds of the sectors total debt, and nearly its entire losses - this, in our opinion, significantly adds to the risks for investors. We have gathered information from various industry participants, leveraged our domain understanding (arising from having rated nearly 200 entities in the power industry), and used qualitative estimates, to build and project a landscape for the sector. After a series of reforms over the past decade, risks in the Indian power sector are again rising - primarily from a weak financial risk profile of state distribution companies (discoms) - CRISIL estimates that the losses of discoms increased to Rs.350-400 billion in 2010-11. These losses can be still higher if the large receivables of SPUs need to be written-off. As a result, the outstanding debt of discoms has risen to Rs.2.1 trillion at the end of March 2011, and can further grow to Rs.3.3 trillion over the next two years. Further, power generation companies face a structural threat in the form of fuel unavailability and pricing. CRISIL estimates that nearly one-third of capacity under implementation (nearly 20,000 MW) has no- or limited-pass-through of costs, which can impact their viability. This weakening performance of power sector, unless reversed, can impact the financial system. The total exposure of banks and About CRISIL Insights infrastructure finance companies to the power sector stood at a significant Rs.4.8 trillion, at the end of March 2011, and will grow at a rate of 23 per cent annually till March 2013. For over two decades, CRISIL has helped shape the evolution of the debt markets in India, and has added value to market participants in a variety of ways. Even though the asset quality of lenders to power sector has remained comfortable so far, it is vulnerable to the heightened risks in the sector. As per a CRISIL study, nearly 45 per cent of the lenders power sector exposure is to higher-risk SPUs. Despite this ‘CRISIL Insights’ is a knowledge sharing endeavour from CRISIL to vulnerability, the credit risk profiles of specialised power sector lenders are underpinned by two key factors - first, an l Share our analytical insights and thought leadership perspectives expectation of policy and funding support from the Government of India (GoI), given their strategic importance; and second, an m CRISIL continues to focus on developing a strong understanding of the Indian expectation of visible reforms in the sector. economy, corporate sector, and financial landscape CRISIL believes that strong policy measures are urgently needed to reform the distribution sector. These include timely m The knowledge and insights gained in this process are constantly shared with issuers availability of dependable financial information, meaningful and regular tariff hikes to enable recovery of economic costs of and investors on relevant topics that impact the credit markets power supply, and significant reduction in the distribution losses. Further, higher and timely provisions of subsidies by the state l Generate awareness about the rigour followed in our ratings process governments are critical to reduce their dependence on short-term borrowings. m As the country’s leading ratings agency, CRISIL has always set standards in analytical rigour, disclosures, and best practices in the industry The government has initiated steps to contain, and gradually improve, the performance of SPUs. These initial measures, however, need to be sustained over a period of time. In absence of any substantive progress over the next 12 to 18 months, the m CRISIL tries to generate familiarity of the market participants with the same asset quality of power sector lenders will weaken, and they will require additional capital to maintain adequate coverage for the l Enhance transparency of our analytical methodology and criteria increased delinquencies. m To develop confidence of the debt market participants, CRISIL constantly endeavours to highlight the analytical methodology and criteria used in its ratings process We hope you will find our insights and analysis useful. We welcome your feedback. CRISIL Ratings hopes that you find this research valuable, insightful, and useful. Your Warm Regards, comments and queries regarding the issues discussed here are welcome. Ramraj Pai Director - RatingsPower Sector Lenders: Will the credit quality trip?
  3. 3. Insights A knowledge sharing endeavour from CRISIL Foreword As a part of our knowledge sharing endeavour, I am delighted to present this compendium of articles on Indias power sector and power sector lenders. Given the criticality of the sector and rising risks, there is a keen desire from investors to understand the sectors outlook and its implications for the lenders. The various articles in this compendium highlight insights gained from our analysis of state power utilities (SPUs), distribution entities, generation companies, and lenders to the sector. In preparing this outlook, we have been constrained by lack of updated and aggregated financial information for SPUs - which distribute nearly 95 per cent of Indias power, account for nearly two-thirds of the sectors total debt, and nearly its entire losses - this, in our opinion, significantly adds to the risks for investors. We have gathered information from various industry participants, leveraged our domain understanding (arising from having rated nearly 200 entities in the power industry), and used qualitative estimates, to build and project a landscape for the sector. After a series of reforms over the past decade, risks in the Indian power sector are again rising - primarily from a weak financial risk profile of state distribution companies (discoms) - CRISIL estimates that the losses of discoms increased to Rs.350-400 billion in 2010-11. These losses can be still higher if the large receivables of SPUs need to be written-off. As a result, the outstanding debt of discoms has risen to Rs.2.1 trillion at the end of March 2011, and can further grow to Rs.3.3 trillion over the next two years. Further, power generation companies face a structural threat in the form of fuel unavailability and pricing. CRISIL estimates that nearly one-third of capacity under implementation (nearly 20,000 MW) has no- or limited-pass-through of costs, which can impact their viability. This weakening performance of power sector, unless reversed, can impact the financial system. The total exposure of banks and About CRISIL Insights infrastructure finance companies to the power sector stood at a significant Rs.4.8 trillion, at the end of March 2011, and will grow at a rate of 23 per cent annually till March 2013. For over two decades, CRISIL has helped shape the evolution of the debt markets in India, and has added value to market participants in a variety of ways. Even though the asset quality of lenders to power sector has remained comfortable so far, it is vulnerable to the heightened risks in the sector. As per a CRISIL study, nearly 45 per cent of the lenders power sector exposure is to higher-risk SPUs. Despite this ‘CRISIL Insights’ is a knowledge sharing endeavour from CRISIL to vulnerability, the credit risk profiles of specialised power sector lenders are underpinned by two key factors - first, an l Share our analytical insights and thought leadership perspectives expectation of policy and funding support from the Government of India (GoI), given their strategic importance; and second, an m CRISIL continues to focus on developing a strong understanding of the Indian expectation of visible reforms in the sector. economy, corporate sector, and financial landscape CRISIL believes that strong policy measures are urgently needed to reform the distribution sector. These include timely m The knowledge and insights gained in this process are constantly shared with issuers availability of dependable financial information, meaningful and regular tariff hikes to enable recovery of economic costs of and investors on relevant topics that impact the credit markets power supply, and significant reduction in the distribution losses. Further, higher and timely provisions of subsidies by the state l Generate awareness about the rigour followed in our ratings process governments are critical to reduce their dependence on short-term borrowings. m As the country’s leading ratings agency, CRISIL has always set standards in analytical rigour, disclosures, and best practices in the industry The government has initiated steps to contain, and gradually improve, the performance of SPUs. These initial measures, however, need to be sustained over a period of time. In absence of any substantive progress over the next 12 to 18 months, the m CRISIL tries to generate familiarity of the market participants with the same asset quality of power sector lenders will weaken, and they will require additional capital to maintain adequate coverage for the l Enhance transparency of our analytical methodology and criteria increased delinquencies. m To develop confidence of the debt market participants, CRISIL constantly endeavours to highlight the analytical methodology and criteria used in its ratings process We hope you will find our insights and analysis useful. We welcome your feedback. CRISIL Ratings hopes that you find this research valuable, insightful, and useful. Your Warm Regards, comments and queries regarding the issues discussed here are welcome. Ramraj Pai Director - RatingsPower Sector Lenders: Will the credit quality trip?
  4. 4. Analytical contacts Table of Contents Name Designation Email Id Meaningful action on reforms critical for health of power sector 1 Pawan Agrawal Director - Corporate & Government Sector Ratings pagrawal@crisil.com Credit quality of power sector lenders - potential risks ahead 5 Nagarajan Narasimhan Director - Corporate & Government Sector Ratings nnarasimhan@crisil.com Power distribution utilities - current issues and what lies ahead 15 Sudip Sural Head - Corporate & Infrastructure Sector Ratings ssural@crisil.com Risks related to fuel and project execution will increase power generation costs 29 Suman Chowdhury Head - Financial Sector Ratings schowdhury@crisil.com FAQs on Power Finance Corporation Limited 37 Anosh Kelawala Senior Manager - Financial Sector Ratings akelawala@crisil.com FAQs on Rural Electrification Corporation Limited 55 Manish Ballabh Senior Manager - Corporate & Infrastructure Sector Ratings mballabh@crisil.com List of Rated Entities in the Power Sector 75 Manoj Damle Senior Manager - Financial Sector Ratings mdamle@crisil.com Rohit Chugh Senior Manager - Corporate & Infrastructure Sector Ratings rchugh@crisil.com Khyati Shah Manager - Corporate & Infrastructure Sector Ratings khyatis@crisil.com Manish Saraf Manager - Financial Sector Ratings msaraf@crisil.com Nitesh Jain Manager - Corporate & Infrastructure Sector Ratings njain@crisil.com Subhasri Narayanan Manager - Financial Sector Ratings snarayanan@crisil.com Vaibhav Kapoor Manager - Corporate & Infrastructure Sector Ratings vkapoor@crisil.comPower Sector Lenders: Will the credit quality trip?
  5. 5. Analytical contacts Table of Contents Name Designation Email Id Meaningful action on reforms critical for health of power sector 1 Pawan Agrawal Director - Corporate & Government Sector Ratings pagrawal@crisil.com Credit quality of power sector lenders - potential risks ahead 5 Nagarajan Narasimhan Director - Corporate & Government Sector Ratings nnarasimhan@crisil.com Power distribution utilities - current issues and what lies ahead 15 Sudip Sural Head - Corporate & Infrastructure Sector Ratings ssural@crisil.com Risks related to fuel and project execution will increase power generation costs 29 Suman Chowdhury Head - Financial Sector Ratings schowdhury@crisil.com FAQs on Power Finance Corporation Limited 37 Anosh Kelawala Senior Manager - Financial Sector Ratings akelawala@crisil.com FAQs on Rural Electrification Corporation Limited 55 Manish Ballabh Senior Manager - Corporate & Infrastructure Sector Ratings mballabh@crisil.com List of Rated Entities in the Power Sector 75 Manoj Damle Senior Manager - Financial Sector Ratings mdamle@crisil.com Rohit Chugh Senior Manager - Corporate & Infrastructure Sector Ratings rchugh@crisil.com Khyati Shah Manager - Corporate & Infrastructure Sector Ratings khyatis@crisil.com Manish Saraf Manager - Financial Sector Ratings msaraf@crisil.com Nitesh Jain Manager - Corporate & Infrastructure Sector Ratings njain@crisil.com Subhasri Narayanan Manager - Financial Sector Ratings snarayanan@crisil.com Vaibhav Kapoor Manager - Corporate & Infrastructure Sector Ratings vkapoor@crisil.comPower Sector Lenders: Will the credit quality trip?
  6. 6. Insights A knowledge sharing endeavour from CRISIL Meaningful action on reforms critical for health of power sector The power distribution companies (discoms) in India have, historically, been riddled with losses and beset by inefficiencies. While most state electricity boards (SEBs) have met the requirement of trifurcation into generation, transmission and distribution entities, as mandated by the Indian Electricity Act, 2003, the stated objectives of the reorganisation have not been fully met. CRISIL believes that the focused efforts initiated by the Government and key stakeholders have the potential to address the challenges facing the entire power value chain. While the first meaningful steps have been taken, the sustainability of the reforms programme will be critical. Mounting power purchase costs further weaken discoms financials CRISIL estimates the net losses (subsidy booked basis) of discoms at around Rs.350 - 400 billion for 2010-11 (refers to financial year, April 1 to March 31). The widening revenue gap, because of inadequate and delayed tariff revisions, high aggregate technical and commercial (AT&C) losses, and sizeable outstanding debt with significant interest costs have led to the mounting losses of discoms. Profitability pressures appear set to increase further for discoms because of their susceptibility to volatility in fuel costs, escalating capital costs, and project risks on the generation front. These factors are likely to translate into an annual increase of 10 to 12 per cent in average power generation costs over the next two years, which will largely be passed on to the discoms. Discom distress can affect entire power value chain, including financiers The central power utilities have, thus far, been protected from the discoms woes because of the one-time settlement scheme and payment security mechanisms set in place in 2001 by the Ahluwalia Committee. The discoms losses have, however, now begun to stretch the working capital requirements of the generation companies. The cascading effect of the problems faced by discoms will not be limited to the power sector. The discoms have continued to borrow from banks, often supported by state guarantees, over the past two years. Some banks are approaching their exposure limits for the sector, and already, exhibit increased reluctance to lend further to the sector. CRISIL estimates that large loss funding has significantly increased discom debt to around Rs.2.1 trillion as on March 31, 2011. Given that a significant portion of the debt has been used to finance losses rather than create productive assets, the debt only adds to the sectors inefficiencies.Power Sector Lenders: Will the credit quality trip? 1
  7. 7. Insights A knowledge sharing endeavour from CRISIL Meaningful action on reforms critical for health of power sector The power distribution companies (discoms) in India have, historically, been riddled with losses and beset by inefficiencies. While most state electricity boards (SEBs) have met the requirement of trifurcation into generation, transmission and distribution entities, as mandated by the Indian Electricity Act, 2003, the stated objectives of the reorganisation have not been fully met. CRISIL believes that the focused efforts initiated by the Government and key stakeholders have the potential to address the challenges facing the entire power value chain. While the first meaningful steps have been taken, the sustainability of the reforms programme will be critical. Mounting power purchase costs further weaken discoms financials CRISIL estimates the net losses (subsidy booked basis) of discoms at around Rs.350 - 400 billion for 2010-11 (refers to financial year, April 1 to March 31). The widening revenue gap, because of inadequate and delayed tariff revisions, high aggregate technical and commercial (AT&C) losses, and sizeable outstanding debt with significant interest costs have led to the mounting losses of discoms. Profitability pressures appear set to increase further for discoms because of their susceptibility to volatility in fuel costs, escalating capital costs, and project risks on the generation front. These factors are likely to translate into an annual increase of 10 to 12 per cent in average power generation costs over the next two years, which will largely be passed on to the discoms. Discom distress can affect entire power value chain, including financiers The central power utilities have, thus far, been protected from the discoms woes because of the one-time settlement scheme and payment security mechanisms set in place in 2001 by the Ahluwalia Committee. The discoms losses have, however, now begun to stretch the working capital requirements of the generation companies. The cascading effect of the problems faced by discoms will not be limited to the power sector. The discoms have continued to borrow from banks, often supported by state guarantees, over the past two years. Some banks are approaching their exposure limits for the sector, and already, exhibit increased reluctance to lend further to the sector. CRISIL estimates that large loss funding has significantly increased discom debt to around Rs.2.1 trillion as on March 31, 2011. Given that a significant portion of the debt has been used to finance losses rather than create productive assets, the debt only adds to the sectors inefficiencies.Power Sector Lenders: Will the credit quality trip? 1
  8. 8. Meaningful action on reforms critical for health of power sector Focused efforts by Government and financiers to address the challenges Road ahead The following concerted measures are geared towards addressing the challenges faced by the sector: CRISIL believes that some of the initial steps will be sustained over the medium term, and that l Commitment of State Governments: Following the formation of the Shunglu Committee further build-up of stress will be arrested and the annual losses contained. CRISIL projects on State Power Utilities, the state power ministers adopted a 12-point resolution in July that the discom sectors net losses (subsidy booked basis) will be contained at broadly the 2011, addressing the key problems faced by discoms and the commitment of monetary same levels for 2011-12 and 2012-13. However, the debt will increase to Rs.3.3 trillion as on and administrative support by state governments to resolve the challenges plaguing the March 31, 2013, from Rs.2.1 trillion as on March 31, 2011. CRISILs base case assumptions for discom sector. Timely tariff filing with the objective of bridging revenue gaps and 2011-12 and 2012-13 are as follows: automatic pass through of fuel cost increases were some of the key points adopted in the resolution. The state governments have also adopted a resolution to shore up the balance l Regular tariff hikes, given the 12-point resolution, the recent tariff hikes, and the sheets of discoms by converting state government loans to equity and clearing up subsidy curtailed lending by banks dues. l Reduction of AT&C losses taking benefit of the R-APDRP scheme l Lenders efforts: At the same time, in an attempt to discipline the fiscal management of l State government subsidy to increase, given the fact that funding from banks and discoms, banks and power financiers have come together and begun linking disbursal of financial institutions will not be available for weaker discoms, compelling state funds to improvement in discoms performance. This is to ensure that weak discoms do governments to bridge the gap not take advantage of competition amongst lenders. CRISIL believes that concrete action according to the plan laid out by the main stakeholders-- l Performance-linked credit mechanism: The Ministry of Power (MoP) is also the Government of India, state governments, and the lenders--will be key to addressing the contemplating merit-linked credit disbursal to discoms based on their operating challenges facing the discom sector. If progress on this front is delayed, the adverse impact on performance and credit rating. l AT&C loss reduction: The MoP launched Government of India-funded Restructured the power value chain as well as power financiers would begin to manifest itself over the next Accelerated Power Development and Reforms Programme (R-APDRP) in July 2008 aimed 12 to 18 months. at bringing down the AT&C losses in the sector. With a corpus of Rs.100 billion for Part-A CRISILs opinion piece, Power Distribution Utilities current issues and what lies ahead details projects and Rs.400 billion for Part-B projects, the R-APDRP scheme can go a long way in the challenges that the discoms continue to face. The commentary, Risks related to fuel and reducing the AT&C losses. The cumulative sanctions and disbursements under this project execution will increase power generation costs, addresses emerging challenges for scheme since inception have been Rs.220 billion and Rs.40 billion, respectively. the generation sector, and their fallout on discoms. The governments efforts have spurred initial action on the ground. At least five states have announced tariff hikes for 2011-12 over the past two to three months. While these tariff hikes fall short of the required increase to bridge the losses, some discoms have announced hikes after long gaps. These are encouraging signs and CRISIL believes that despite political compulsions, such hikes will have to continue over the medium term in order to bridge the large revenue gap. However, it is the seriousness and urgency with which further steps (particularly pertaining to progress on AT&C loss reduction and timely receipt of state government subsidy) are implemented, that will have a crucial bearing on the health of the sector.Power Sector Lenders: Will the credit quality trip? 3
  9. 9. Meaningful action on reforms critical for health of power sector Focused efforts by Government and financiers to address the challenges Road ahead The following concerted measures are geared towards addressing the challenges faced by the sector: CRISIL believes that some of the initial steps will be sustained over the medium term, and that l Commitment of State Governments: Following the formation of the Shunglu Committee further build-up of stress will be arrested and the annual losses contained. CRISIL projects on State Power Utilities, the state power ministers adopted a 12-point resolution in July that the discom sectors net losses (subsidy booked basis) will be contained at broadly the 2011, addressing the key problems faced by discoms and the commitment of monetary same levels for 2011-12 and 2012-13. However, the debt will increase to Rs.3.3 trillion as on and administrative support by state governments to resolve the challenges plaguing the March 31, 2013, from Rs.2.1 trillion as on March 31, 2011. CRISILs base case assumptions for discom sector. Timely tariff filing with the objective of bridging revenue gaps and 2011-12 and 2012-13 are as follows: automatic pass through of fuel cost increases were some of the key points adopted in the resolution. The state governments have also adopted a resolution to shore up the balance l Regular tariff hikes, given the 12-point resolution, the recent tariff hikes, and the sheets of discoms by converting state government loans to equity and clearing up subsidy curtailed lending by banks dues. l Reduction of AT&C losses taking benefit of the R-APDRP scheme l Lenders efforts: At the same time, in an attempt to discipline the fiscal management of l State government subsidy to increase, given the fact that funding from banks and discoms, banks and power financiers have come together and begun linking disbursal of financial institutions will not be available for weaker discoms, compelling state funds to improvement in discoms performance. This is to ensure that weak discoms do governments to bridge the gap not take advantage of competition amongst lenders. CRISIL believes that concrete action according to the plan laid out by the main stakeholders-- l Performance-linked credit mechanism: The Ministry of Power (MoP) is also the Government of India, state governments, and the lenders--will be key to addressing the contemplating merit-linked credit disbursal to discoms based on their operating challenges facing the discom sector. If progress on this front is delayed, the adverse impact on performance and credit rating. l AT&C loss reduction: The MoP launched Government of India-funded Restructured the power value chain as well as power financiers would begin to manifest itself over the next Accelerated Power Development and Reforms Programme (R-APDRP) in July 2008 aimed 12 to 18 months. at bringing down the AT&C losses in the sector. With a corpus of Rs.100 billion for Part-A CRISILs opinion piece, Power Distribution Utilities current issues and what lies ahead details projects and Rs.400 billion for Part-B projects, the R-APDRP scheme can go a long way in the challenges that the discoms continue to face. The commentary, Risks related to fuel and reducing the AT&C losses. The cumulative sanctions and disbursements under this project execution will increase power generation costs, addresses emerging challenges for scheme since inception have been Rs.220 billion and Rs.40 billion, respectively. the generation sector, and their fallout on discoms. The governments efforts have spurred initial action on the ground. At least five states have announced tariff hikes for 2011-12 over the past two to three months. While these tariff hikes fall short of the required increase to bridge the losses, some discoms have announced hikes after long gaps. These are encouraging signs and CRISIL believes that despite political compulsions, such hikes will have to continue over the medium term in order to bridge the large revenue gap. However, it is the seriousness and urgency with which further steps (particularly pertaining to progress on AT&C loss reduction and timely receipt of state government subsidy) are implemented, that will have a crucial bearing on the health of the sector.Power Sector Lenders: Will the credit quality trip? 3
  10. 10. Insights A knowledge sharing endeavour from CRISIL Credit quality of power sector lenders - potential risks ahead Executive Summary Given the funding needs of upcoming private sector power projects and state power utilities (SPUs), CRISIL believes that the exposure of lenders to the power sector will continue to increase over the medium term. While the incremental exposure of banks will remain primarily to private generation projects, specialised lenders such as Power Finance Corporation Ltd (PFC) and Rural Electrification Corporation Ltd (REC) will continue to be the key financiers to the SPUs. Despite challenges in lending to the power sector, lenders have maintained healthy asset quality thus far, with negligible reported gross non-performing assets (NPAs). The banks diversified loan portfolios and comfortable capitalisation, partly offsets the impact of NPAs. The credit risk profiles of the specialised power sector lenders is supported by their strategic importance to the Government of India, their comfortable capitalisation and earnings, and their asset protection mechanisms (refer to CRISIL article, Frequently asked questions [FAQs] on PFC and REC, for further details). Systemic risks in lending to the power sector have increased significantly in the recent past, primarily because of increasing losses and the substantial debt of the SPUs, particularly, distribution companies. CRISIL believes that attempts to reform the distribution sector is likely to lead to improved efficiency and reduced transmission and distribution losses, and arrest the build up of stress in the distribution sector. If, on the other hand, status quo continues, asset-side risks will increase for power sector lenders, especially for specialised lenders such as PFC and REC. The pace and degree of reforms in the sector, therefore, will be a key monitorable over the next 12 to 18 months. Overview of borrowings by the power sector The borrowings of the power sector - the SPUs, central power utilities (CPUs), and private sector power utilities - are estimated at around Rs.6.5 trillion as on March 31, 2011. Of this, lenders - banks, infrastructure financing non-banking finance companies (NBFC-IFCs), such as PFC and REC, and other IFCs, and India Infrastructure Finance Company Ltd (IIFCL), extended around 75 per cent of the power sectors borrowings (see Chart 1). The remaining 25 per cent of the sectors borrowings is from sources such as bonds, the central and state government loans, and foreign currency borrowings.Power Sector Lenders: Will the credit quality trip? 5
  11. 11. Insights A knowledge sharing endeavour from CRISIL Credit quality of power sector lenders - potential risks ahead Executive Summary Given the funding needs of upcoming private sector power projects and state power utilities (SPUs), CRISIL believes that the exposure of lenders to the power sector will continue to increase over the medium term. While the incremental exposure of banks will remain primarily to private generation projects, specialised lenders such as Power Finance Corporation Ltd (PFC) and Rural Electrification Corporation Ltd (REC) will continue to be the key financiers to the SPUs. Despite challenges in lending to the power sector, lenders have maintained healthy asset quality thus far, with negligible reported gross non-performing assets (NPAs). The banks diversified loan portfolios and comfortable capitalisation, partly offsets the impact of NPAs. The credit risk profiles of the specialised power sector lenders is supported by their strategic importance to the Government of India, their comfortable capitalisation and earnings, and their asset protection mechanisms (refer to CRISIL article, Frequently asked questions [FAQs] on PFC and REC, for further details). Systemic risks in lending to the power sector have increased significantly in the recent past, primarily because of increasing losses and the substantial debt of the SPUs, particularly, distribution companies. CRISIL believes that attempts to reform the distribution sector is likely to lead to improved efficiency and reduced transmission and distribution losses, and arrest the build up of stress in the distribution sector. If, on the other hand, status quo continues, asset-side risks will increase for power sector lenders, especially for specialised lenders such as PFC and REC. The pace and degree of reforms in the sector, therefore, will be a key monitorable over the next 12 to 18 months. Overview of borrowings by the power sector The borrowings of the power sector - the SPUs, central power utilities (CPUs), and private sector power utilities - are estimated at around Rs.6.5 trillion as on March 31, 2011. Of this, lenders - banks, infrastructure financing non-banking finance companies (NBFC-IFCs), such as PFC and REC, and other IFCs, and India Infrastructure Finance Company Ltd (IIFCL), extended around 75 per cent of the power sectors borrowings (see Chart 1). The remaining 25 per cent of the sectors borrowings is from sources such as bonds, the central and state government loans, and foreign currency borrowings.Power Sector Lenders: Will the credit quality trip? 5
  12. 12. Credit quality of power sector lenders - potential risks ahead Chart 1: Source of borrowings by power sector as on March 31, 2011 Chart 2: Growth trend in power sector advances 8 7 Others 6 25% 5 Rs. Trillion 5 year CAGR of 31% Banks 4 42% 3 Other IFCs 5% 2 1 0 2006 2007 2008 2009 2010 2011 2013 (P) PFC + REC 28% As on March 31, Banks to remain major lenders This article focuses on these key lenders exposure to the power sector, and assesses their asset quality. The share of power sector advances in the banking industrys total advances has almost doubled to 7.3 per cent as on March 31, 2011 from 3.7 per cent as on March 31, 2008. CRISIL Lenders power sector exposures to increase further estimates the banks outstanding undisbursed sanctions as exceeding Rs.1.3 trillion as on March 31, 2011. Disbursements from existing sanctions and conversion of non-fund exposures CRISIL believes that the lenders power sector advances will continue to increase steadily over to fund-based exposures may increase the share of power sector advances to about 7.8 per the medium term. The lenders power sector advances have grown at a compound annual cent of banks total advances by March 31, 2013 (see Chart 3). growth rate (CAGR) of about 31 per cent to Rs.4.8 trillion as on March 31, 2011 from Rs.1.3 trillion as on March 31, 2006. Chart 3: Growth in banking industrys power sector advances CRISIL estimates that advances to the sector will grow further, at a CAGR of 23 per cent over 4.5 9.0% 7.8% the next two years to about Rs.7.3 trillion as on March 31, 2013 (see Chart 2). The growth will 4.0 Undisbursed Sanctions 7.3% 8.0% be driven primarily by the strong pipeline of undisbursed sanctions to the power sector. 3.5 6.2% 7.0% Rs. Trillion 3.0 6.0% 4.8% 2.5 4.0% 3.8% 5.0% Nevertheless, growth in power sector advances may moderate, given the lenders increasing 2.0 3.7% 4.0% caution in disbursing to the sector, especially to the SPUs. The banks, in particular, have 1.5 3.0% slowed down fresh sanctions to new power sector projects. The sector will also look to the 1.0 2.0% 0.5 1.0% lenders to fund its ongoing investments in transmission and distribution, increasing working 0.0 0.0% capital requirements due to increased losses of distribution companies, and projects under 2006 2007 2008 2009 2010 2011 2013 (P) As of March implementation. Power sector Advances Undisbursed sanctions Share in total advancesPower Sector Lenders: Will the credit quality trip? 7
  13. 13. Credit quality of power sector lenders - potential risks ahead Chart 1: Source of borrowings by power sector as on March 31, 2011 Chart 2: Growth trend in power sector advances 8 7 Others 6 25% 5 Rs. Trillion 5 year CAGR of 31% Banks 4 42% 3 Other IFCs 5% 2 1 0 2006 2007 2008 2009 2010 2011 2013 (P) PFC + REC 28% As on March 31, Banks to remain major lenders This article focuses on these key lenders exposure to the power sector, and assesses their asset quality. The share of power sector advances in the banking industrys total advances has almost doubled to 7.3 per cent as on March 31, 2011 from 3.7 per cent as on March 31, 2008. CRISIL Lenders power sector exposures to increase further estimates the banks outstanding undisbursed sanctions as exceeding Rs.1.3 trillion as on March 31, 2011. Disbursements from existing sanctions and conversion of non-fund exposures CRISIL believes that the lenders power sector advances will continue to increase steadily over to fund-based exposures may increase the share of power sector advances to about 7.8 per the medium term. The lenders power sector advances have grown at a compound annual cent of banks total advances by March 31, 2013 (see Chart 3). growth rate (CAGR) of about 31 per cent to Rs.4.8 trillion as on March 31, 2011 from Rs.1.3 trillion as on March 31, 2006. Chart 3: Growth in banking industrys power sector advances CRISIL estimates that advances to the sector will grow further, at a CAGR of 23 per cent over 4.5 9.0% 7.8% the next two years to about Rs.7.3 trillion as on March 31, 2013 (see Chart 2). The growth will 4.0 Undisbursed Sanctions 7.3% 8.0% be driven primarily by the strong pipeline of undisbursed sanctions to the power sector. 3.5 6.2% 7.0% Rs. Trillion 3.0 6.0% 4.8% 2.5 4.0% 3.8% 5.0% Nevertheless, growth in power sector advances may moderate, given the lenders increasing 2.0 3.7% 4.0% caution in disbursing to the sector, especially to the SPUs. The banks, in particular, have 1.5 3.0% slowed down fresh sanctions to new power sector projects. The sector will also look to the 1.0 2.0% 0.5 1.0% lenders to fund its ongoing investments in transmission and distribution, increasing working 0.0 0.0% capital requirements due to increased losses of distribution companies, and projects under 2006 2007 2008 2009 2010 2011 2013 (P) As of March implementation. Power sector Advances Undisbursed sanctions Share in total advancesPower Sector Lenders: Will the credit quality trip? 7
  14. 14. Credit quality of power sector lenders - potential risks ahead Strong growth in the banks power sector advances has resulted in a gradual increase in their past 5 years to Rs.1.8 trillion as on March 31, 2011. Their share in lending to the SPUs has, market share over the past few years; banks have a market share of about 56 per cent as on however, reduced in recent years on account of intensifying competition from banks. March 31, 2011, and are expected to maintain market share over the medium term because Nevertheless, CRISIL believes that PFC and REC may remain the key lenders to the SPUs, and of the pipeline of undisbursed sanctions. meet nearly half of the SPUs incremental funding requirements by March 2013. Chart 4: Trend in market share of power sector lenders Increasing systemic risks: A cause for worry? 100% 5% 6% 6% The gross NPAs of power sector lenders are currently negligible; the banks gross NPAs in 80% power sector advances remain at less than 0.2 per cent as on March 31, 2011. PFC and RECs 38% 38% 48% gross NPAs are at 0.2 per cent and 0.3 per cent, respectively, as on June 30, 2011. 60% 40% However, the lenders asset quality remains exposed to increased systemic risks in the power 47% 56% 56% sector, especially in SPU exposures (refer to CRISIL article, Meaningful action on reforms 20% critical for health of power sector’ for details). SPUs account for nearly two-thirds of the 0% power sector exposure of lenders as on March 31, 2011 (see Chart 5). CRISIL has, therefore, 2006 2011 2013 (P) As of March analysed the impact of this exposure on the lenders asset quality. Banks PFC and REC Other IFCs Chart 5: Sector wise composition of power sector advances as on March 31, 2011 Exposure to private sector projects to drive banks power sector advances growth Currently, the shares of SPUs, CPUs, and private sector in the banking industrys power sector Private Central 22% 15% advances are estimated at 63, 17, and 20 per cent, respectively. The share of the private sector is low, because the numerous private sector generation projects are still in the implementation stage and the borrowers also have access to alternate funding arrangements such as foreign currency borrowings and buyers credit. As project implementation gathers pace, projects may draw on the undisbursed sanctions, and substitute non-fund-based exposures with fund-based ones. Banks are expected to meet about three-fourths of the private sectors incremental funding requirements. The share of funding to the private sector State 63% is, therefore, expected to increase to about 30 per cent over the next 2 years. PFC and REC to remain key lenders to SPUs Among infrastructure-financing companies, PFC and REC are key lenders to the power sector, especially the SPUs. Their combined advances have grown at a CAGR of 24.4 per cent over thePower Sector Lenders: Will the credit quality trip? 9
  15. 15. Credit quality of power sector lenders - potential risks ahead Strong growth in the banks power sector advances has resulted in a gradual increase in their past 5 years to Rs.1.8 trillion as on March 31, 2011. Their share in lending to the SPUs has, market share over the past few years; banks have a market share of about 56 per cent as on however, reduced in recent years on account of intensifying competition from banks. March 31, 2011, and are expected to maintain market share over the medium term because Nevertheless, CRISIL believes that PFC and REC may remain the key lenders to the SPUs, and of the pipeline of undisbursed sanctions. meet nearly half of the SPUs incremental funding requirements by March 2013. Chart 4: Trend in market share of power sector lenders Increasing systemic risks: A cause for worry? 100% 5% 6% 6% The gross NPAs of power sector lenders are currently negligible; the banks gross NPAs in 80% power sector advances remain at less than 0.2 per cent as on March 31, 2011. PFC and RECs 38% 38% 48% gross NPAs are at 0.2 per cent and 0.3 per cent, respectively, as on June 30, 2011. 60% 40% However, the lenders asset quality remains exposed to increased systemic risks in the power 47% 56% 56% sector, especially in SPU exposures (refer to CRISIL article, Meaningful action on reforms 20% critical for health of power sector’ for details). SPUs account for nearly two-thirds of the 0% power sector exposure of lenders as on March 31, 2011 (see Chart 5). CRISIL has, therefore, 2006 2011 2013 (P) As of March analysed the impact of this exposure on the lenders asset quality. Banks PFC and REC Other IFCs Chart 5: Sector wise composition of power sector advances as on March 31, 2011 Exposure to private sector projects to drive banks power sector advances growth Currently, the shares of SPUs, CPUs, and private sector in the banking industrys power sector Private Central 22% 15% advances are estimated at 63, 17, and 20 per cent, respectively. The share of the private sector is low, because the numerous private sector generation projects are still in the implementation stage and the borrowers also have access to alternate funding arrangements such as foreign currency borrowings and buyers credit. As project implementation gathers pace, projects may draw on the undisbursed sanctions, and substitute non-fund-based exposures with fund-based ones. Banks are expected to meet about three-fourths of the private sectors incremental funding requirements. The share of funding to the private sector State 63% is, therefore, expected to increase to about 30 per cent over the next 2 years. PFC and REC to remain key lenders to SPUs Among infrastructure-financing companies, PFC and REC are key lenders to the power sector, especially the SPUs. Their combined advances have grown at a CAGR of 24.4 per cent over thePower Sector Lenders: Will the credit quality trip? 9
  16. 16. Credit quality of power sector lenders - potential risks ahead Approach to categorising risks in power sector exposures Chart 6: Risk matrix of SPU exposures Bihar Cluster IV Himachal Pradesh Jammu & Kashmir SPU exposures (Lowest) West Bengal North Eastern States (excluding Assam) Most SPUs have weak financial risk profiles, because of mounting losses and large debt, and State Government ability to support Jharkhand delays in receipt of subsidies from the state governments. CRISIL has undertaken a detailed Madhya Pradesh Kerala Assam Cluster III Punjab analysis, and prepared a risk matrix (see Chart 6) to ascertain the impact of SPU exposures on Uttarakhand Orissa Rajasthan Uttar Pradesh lenders asset quality. Andhra Pradesh Goa Chhattisgarh Cluster II Haryana l Given that SPUs continue to operate as an arm of, and depend on, the state governments, Gujarat Maharashtra Tamil Nadu for support, a two-dimensional heat map has been prepared to juxtapose the lenders SPU exposure against the risk clustering of state finances to arrive at the eventual risks in Cluster I Delhi Karnataka (Highest) the portfolio. Low Risk Moderate Risk High Risk l The X-axis represents the risk profile of SPUs. Exposure to SPUs has been classified into Risk profile of State Power Utilities low, moderate or high risk, based on a combination of three factors: the gap between the distribution companies average revenue receipts (ARRs) and average cost of supply Highest Risk High Risk Moderate Risk Low Risk (ACS), their aggregate technical and commercial (AT&C) losses, and outstanding debt. The risk profiling of distribution companies is used as proxy for SPUs as a whole, given the The lenders SPU exposures have, thus, been categorised into four risk categories - from low strong linkages among generation, transmission and distribution companies. risk to highest risk - as indicated in Table 1: l The Y-axis represents the state governments ability to support the SPUs. Based on the Table 1: Risk categorisation of SPU exposures health of state finances, states have been classified into four - with Cluster I denoting Per Cent Rs. Trillion highest ability, and Cluster IV, lowest ability. Clustering of the states financial risk profiles Highest Risk 40 1.2 is based on analyses of state finances on three key parameters - fiscal management, self- High Risk 30 0.9 reliance, and debt-servicing ability. Moderate 20 0.6 Low 10 0.3 Total SPU exposure 100 3.0 Table 1 indicates that the lenders exposure to the high- and highest- risk categories of SPUs is around 70 per cent. Private sector exposures Additionally, private sector projects are increasingly facing challenges because of uncertainties regarding regulatory clearances, availability of fuel, and ability to pass on rising fuel costs (refer to CRISIL article, Risks related to fuel and project execution will increase power generation costs for details). CRISIL has, therefore, also assessed the extent of risks in private sector projects.Power Sector Lenders: Will the credit quality trip? 11

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