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THE CORNER OFFICE: REC CMD on SEB finances
- Deterioration in the financial health of SEBs has gained wide attention and the Prime Minister's Office (PMO) has appointed a high level committee headed by Mr V K Shunglu to review the financials of SEBs. The Committee has been asked to submit its report by February 2011.
- Increase in losses of SEBs has raised concerns relating to asset quality of power financing companies.
- Stiff competition from banks and various government initiated schemes like RGGVY, R-APDRP is impacting business growth for REC in the T&D segment.
- Higher competition and rising cost of funds is leading to spread compression. REC had reported spreads of 330bp for 1HFY11.
- Dr J M Phatak is the Chairman & Managing Director of Rural Electrification Corporation (REC). Before joining REC, he was Additional Secretary, Ministry of Panchayati Raj, Government of India. Dr Phatak is an IAS officer of the 1978 batch from the Maharashtra cadre, with 32 years of service. He has extensive experience in city governance. He has served as Principal Secretary, Urban Development, Government of Maharashtra.
Implications of deterioration in SEB finances
Escrow mechanism provides comfort on asset quality
We hosted a conference call with Dr J M Phatak, Chairman & Managing Director of
Rural Electrification Corporation (REC), to understand the impact of deterioration in
SEB financials on the Power and Financial sectors and to get an update on the business
scenario for REC.
Our key takeaways
Deterioration in the financial health of SEBs has gained wide attention and the
Prime Minister's Office (PMO) has appointed a high level committee headed by
Mr V K Shunglu to review the financials of SEBs. The Committee has been asked
to submit its report by February 2011.
Increase in losses of SEBs has raised concerns relating to asset quality of power
financing companies. However, Dr Phatak states that with Escrow cover, REC
does not foresee asset quality problems. REC had witnessed increase in NPAs in
FY07, but this was largely on account of delay in receipt of state grants by SEBs in
the north eastern states, impacting debt servicing. Even in 2QFY11, there were
delays in debt servicing obligations by a private developer, as merchant prices
had corrected, impacting project cash flows. However, as the installment was
paid before the quarter ended, provisions were not necessary.
Stiff competition from banks is impacting business growth for REC in the T&D
segment. Banks have been offering competitive rates, taking away market share
from REC. Further, various government initiated schemes like RGGVY, R-APDRP in
urban areas have given higher funds to SEBs, resulting in lower demand for loans
by these entities.
Higher competition and rising cost of funds is leading to spread compression.
REC had reported spreads of 330bp for 1HFY11. However, incrementally its spreads
are likely to compress to ~300bp. While spread compression may not be significant
in 3QFY11, it would remain under pressure, going forward
V K Shunglu Committee appointed by Prime Minister's Office to review SEB
financials; to submit report by February 2011
Deterioration in the financial health of SEBs has gained wide attention and the Prime
Minister's Office (PMO) has appointed a high level committee headed by Mr V K Shunglu
to review the financials of SEBs, particularly in relation to the losses incurred and projected
distribution losses over the period April 2010 to March 2017.
The Committee has been asked to submit its report by February 2011 and suggest
potential corrective steps, especially in relation to their accounting practices.
The Committee has also been asked to review the electricity tariffs, including the role of
state governments, state tariff regulator and SEBs / SDCs in periodic tariff revisions,
besides examining the geographical and spatial compulsions and determine their
operational impact.
The Committee has also been asked to review organizational and managerial structure,
manpower employed and future requirements to achieve financial viability in distribution
of power by 2017.
Members of the Committee include Mr V K Shunglu (Former Comptroller and Auditor
General of India), Dr J M Phatak (CMD, Rural Electrification Corporation), Mr Satnam
Singh (CMD, Power Finance Corporation), Mr Gurdial Singh (Chairman, Central Electricity
Authority) and representatives from SEBs / Discoms.
Key issue is to ascertain the quantum of power supplies to agriculture sector
The issue that several State Electricity Regulatory Commissions (SERCs) face is that
they do not accurately know what the T&D losses are, how much power is consumed by
critical segments like agriculture, etc. In such a scenario, it becomes very difficult to
plan with a certain trajectory and formulate loss reduction mechanisms.
That is where the R-APDRP comes in; it aims to measure electricity consumption by
installing meters, etc. Several states have also gone for separate agriculture feeders to
quantify the electricity consumed by agriculture.
Stiff competition from domestic banks; slowdown impacting business targets
Stiff competition from banks is impacting business growth for REC in the T&D segment.
Banks have been offering competitive rates, taking away market share from REC. Further,
various government initiated schemes like RGGVY, R-APDRP in urban areas have given
higher funds to SEBs, resulting in lower demand for loans by these entities.
While there is some slowdown in the T&D segment, the generation segment is seeing
robust demand. For REC, T&D segment comprise 51% of the outstanding loan book. On
an incremental basis, lending towards the generation segment is higher, and in 1HFY11,
59% of the incremental disbursals were towards the generation segment.
Spreads under pressure
Higher competition and rising cost of funds is leading to spread compression. REC had
reported spreads of 330bp for 1HFY11. However, incrementally its spreads are likely to
compress to ~300bp. While the impact may not be significant in 3QFY11, spreads would
remain under pressure, going forward.
To offset the impact of rising cost of funds, REC has recently increased its lending rates
by 25bp to 11% for borrowers with A+ credit rating.
Escrow mechanism provides comfort on asset quality; certain hiccups felt
Increase in losses of SEBs has raised concerns relating to asset quality of power financing
companies. However, Dr Phatak states that with Escrow cover, REC does not foresee
asset quality problems.
For REC, 18-20% of its loans are government-guaranteed while others are covered
under escrow mechanism. NPAs are currently at near-zero levels. Most state governments
(exceptions being Jharkhand, Madhya Pradesh, etc) are not providing any guarantees.
REC had witnessed increase in NPAs in FY07, but this was largely on account of delay in
receipt of state grants by SEBs in the north eastern states, impacting debt servicing.
Even in 2QFY11, there were delays in debt servicing obligations by a private developer,
as merchant prices had corrected, impacting project cash flows. However, as the
installment was paid before the quarter ended, provisions were not necessary.
SEBs: Weakest link in India's power chain
Cash losses up 10x in two years, DER at 10x, net worth = 0.6x of losses
PFC's annual review of SEBs' financial health indicates a meaningful deterioration, with
FY09 losses of Rs500b+ (up 100% since FY07) and cash losses of Rs213b (up 10x in
two years). These losses correspond to ~33% of the state fiscal deficit. For FY10, the
initial estimates for losses stand at Rs680b, up 30% YoY.
Cash losses for SEBs on subsidy received basis ballooned to Rs213b in FY09, v/s cash
profits of Rs15b-23b for SEBs over FY03-08 after the implementation of the Electricity
Act 2003. This compares with a shortfall of Rs108b in FY02.
Historically, while a large part of the subsidy provided was reimbursed by state
governments, the reimbursement in FY09 was 61% of the provisions due to the poor
financial health of the state governments. The subsidy provisions also increased to
Rs297b in FY09 from Rs197b in FY08 and Rs136b in FY07.
At the end of FY09, SEBs' net worth was Rs297b and debt was Rs2.8t, resulting in DER
of 9.5x. Interestingly, the net worth of Rs297b is just 0.6x of FY09 losses without subsidy
and 1.3x of losses with subsidy. Of the 84 utilities, 32 utilities had negative net worth
and 18 utilities had DER of more than 3.5x.
Over FY06-09, SEB debt increased from Rs1.9t in FY06 to Rs2.8t in FY09 and almost the
entire increase in debt was being contributed by commercial banks. The contribution of
commercial banks to total debt has increased from 57% in FY06 to 70% in FY09.
We believe the shortfall is unlikely to decline quickly. This necessitates serious
reforms and could possibly include several interim steps like: (i) a 30% one-time
tariff shock, which is not politically acceptable, (ii) state government bearing
the losses, which is not economically feasible, and (iii) players in the value chain
facing regulatory action. Commercial banks financed Rs1t incremental borrowing
over FY06-09 and total exposure stands at Rs3t (FY09).
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