How power sector contributed to the banking mess

Imagine you are in the early 2000s and own a conglomerate. The business is generating a lot of surplus cash which you want to invest. You read about setting up power plants, a balance-sheet heavy, annuity-type investment. As you dig deeper, you realise that you need to cough up very little, as your contractor can provide over-priced bills, rendering the investment majorly debt financed. You are convinced about the massive growth projection of macro fundamentals. You are allocated a coal block based on which you raise debt.

And soon, you realise it’s not that easy. Despite all the promises, single-window clearances still take significant time. Environmental and social NoC scans get stuck for years. No matter who messes up, you have virtually no recourse, with a million civil suits already pending in courts. As losses increase, your own willingness to shell out capital reduces.

Later, the Supreme Court cancels your coal block. Without that, no power distribution company (Discom) is willing to sign a power purchase agreement (PPA) with you, and you’re left in the mercy of the merchant market. As interest compounds, the lenders start imposing penalties, causing a vicious circle of cost overruns. Before you know it, the Deemed CoD (commercial operations date) has been missed multiple times and, lo and behold, you’re now a Non-Performing Asset!

As of Aug 2018, a total of 34 power projects with a total capacity of 39 GW are under various stages of stress. Together, they contributed to Rs 1.7 lakh crore of debt under distress. When investors, lenders and regulators are all too pre-occupied with their own interests, the asset creation process suffers.

As of September last year, about Rs 38,000 crore of debt is under National Company Law Tribunal (NCLT), undergoing bankruptcy process. Less than 15% of this debt is expected to be recovered, causing a massive loss to the banks’ balance sheet.

While each case has a different story, the broad contours remain the same. Due to external/ internally-induced factors, losses piled up and costs mounted, which led debtors to tighten covenants, finally causing the whole project to collapse. Sometimes, it seems designed to fail. The PPA and coal linkage allocation are, for example, tied to each other; developers find it difficult to get one without the other.

All this creates the ‘twin balance sheet problem’: companies are not earning enough to pay down their debt within the stipulated time. Consequently, these loans turn into NPAs, requiring banks to take corrective action.

The developers, having burnt their fingers and their credit rating now tarnished, become reluctant to invest in new capacity. Similarly, lenders, having taken the ‘haircuts’, become hesitant to lend and impose stricter conditions. The consequence of all this is that less operational capacity gets added to the nation, impacting growth potential, which comes back to bite everyone.

How did we get here?

In most cases of unresolved assets, we’re looking at banks taking a ‘haircut’ of more than 50%. For the 10 projects already in NCLT and 7 expected to get there, the ‘haircut’ can be as massive as 85%. How did we get here? Were there no checks and balances? Well, there were multiple checks and balances.

Lenders had their own overseeing committees, along with the lender’s engineers, who are supposed to give regular updates about project progress. The government also has a committee in place to keep a close watch on such projects. Finally, timely project commissioning is assumed to be in the interest of the project developer as well, since their credibility is at stake.

But, as has been evident, in many cases, project developers didn’t really seem to care about their face. The lenders, on their part, did a poor job of identifying and highlighting stressed assets. Rather, they acted like school kids, who try, albeit unsuccessfully, to hide their poor results from parents, hoping for a miracle. It thus comes as little surprise, that in more than one case, a single developer has multiple projects under stress.

On its part, the RBI did act, even if it was a little late in the day. Once it tightened its leash, things started to improve. Former RBI Governor Raghuram Rajan’s December 2015 ruling mandating banks to clean up their balance sheets was a momentous and deeply gutsy decision that forced banks to face their demons. Subsequently, banks NPAs swelled to 13.8% of total loans as of FY18.

Most importantly, RBI has shown prompt action, interfering frequently to iron out wrinkles and resolve issues. It has taken bold steps where needed and tried to create mechanisms such as S4A and SDR, which are highly suited to the situation, giving ample flexibility and teeth to banks.

A whole lot of sunlight…

The recent report by the Standing Committee on Energy does a thorough review of the situation in order to understand the underlying causes. Further, the Insolvency and Bankruptcy Code provided a boost to Asset Reconstruction Companies (ARC), allowing for increase in FDI from 49% to 100% in the sector and allowing 100% pass-through status to trusts set up for the acquisition of stressed assets.

All this, along with greater transparency in banks’ books, is positive news. While cases such as IL&FS may still explode and we are forced to ask, how come no-one saw it coming, our electricity capacity is one of the fastest growing among similar countries and the government seems genuinely interested in its welfare.

(The writer is a Mumbai-based banker and author)