The Hindu Business Line : Banks insist on corporate guarantee for debt funding power projects

Bangalore, May 29 State-run banks and financial institutions are insisting on corporate guarantees as a precondition for meeting the debt finance requirements for power projects.

Senior-level banking sources said, “Corporate guarantee is a criterion for debt funding of projects.” But bankers said that such guarantees were routine in addition to physical asset cover. Currently, the prescribed physical asset cover ratio is 150 per cent of the loan value.

The bankers, however, said that for power projects where a payment security mechanism was in place and the cash flows are assured, corporate guarantees would not be a necessary precondition. The back-to-back payment security mechanism arrangement implied a first charge for lenders on project revenues. The project revenues in turn were backed by a long term power purchase agreement supported by an escrow account and a funded State government guarantee. In fact, most private sector power projects have so far accessed debt finance through this mechanism.

Merchant power stations

The bankers said that in the case of merchant power stations, though corporate guarantee was an essential precondition along with the physical assets cover. Merchant power stations are power plants that have no power purchase agreement with bulk buyers. The project funding risks, therefore, considerably escalate, the bankers said.

The bankers also said that the corporate guarantees helped bringing down cost of debt funds to borrowers. Most projects are currently being implemented on a non-recourse basis. Non-recourse implies that lenders have to rely only on project cash flows. The bankers explained that in such a situation, where banks have already migrated to Basel II regime, non-recourse projects would end up with very high risk weights, as high as 150 per cent, implying high interest costs. A guarantee, the bankers explained, would bring down the risk weight and translate into lower financing costs. As a result merchant power plants on a non-recourse basis were unlikely to find favour with lenders without firm debt repayment guarantees.

Awaiting closure

In fact, this was one critical factor holding up financial closure of some planned merchant power stations. One such project that is awaiting financial closure is the GMR group’s 1050-MW Kamalanga Project, estimated to cost about Rs 4,300 crore. This project has a power purchase agreement for only 25 per cent of the generation. The remaining 75 per cent would be sold in the spot markets. But the PPA of 25 per cent was clearly not sufficient for covering the debt servicing costs, at current interest rates.

But few promoters favoured corporate guarantees. GMR Group’s Chief Financial Officer Mr A. Subba Rao, said, “There are other alternatives to corporate guarantees, particularly if project tariffs are low.” In the case of GMR’s Kamalanga project, tariffs are estimated at less than Rs 2 a unit.

In addition, project promoters are also prepared to offer project equity as additional lines of security, instead of corporate guarantees. Few bankers have so far agreed to these forms of collateral for non recourse funding. Infrastructure funding is now headed to becoming a slug fest between lenders and promoters.

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