Issuance of bonds for private hydropower companies.

The ongoing general convention of CPN-UML has delayed budget speech for the new fiscal year. The government was preparing to table budget in the parliament on Friday. But Chandra Mani Adhikari, member of National Planning Commission (NPC), said it won´t be possible to table budget on Friday. Sources at the Ministry of Finance also said it won´t be possible to table budget in the parliament on Friday. They also said the ministry was yet to finalize the new date. The convention, which was scheduled to conclude on Wednesday, is likely to continue for two more days.

Now hydropower developers are keeping an eye on upcoming budget as hydropower development is the country’s top priority. Government knows that without the involvement of private sector, it is almost impossible to solve the long standing energy crisis.

It is imminent that government will come up with special package for the developers. One of the incentives that is likely to happen is “NPR 10 million for every MW as a cash inventive” (Cash incentive instead of tax discount for hydroprojects

A lot of people are speculating various reforms in the hydro field when the budget is announced shortly. But in this post, I will talk about the “need for allowing hydro developers to issue bonds” 

Before moving towards the relevance of issuing bond, here is a snapshot of financial arrangement by Nepalese developers so far.

·         Hydropower in Nepal is typically designed at 30:70 model (30 percent equity and 70 percent Debt)

·         The repayment period of debt varies from 10 to 15 years from Commercial Operation Date (COD).

·         Commercial and Development banks are the main source of debt for the private developers.

·         The current interest rate for hydropower projects is in between 10 to 11 percent per year.

So what is the main problem here?

The main problem here for the developers is the interest rate. The current interest rate that banks are charging at the moment is not justifiable. It is on the higher side.

On top of that, banks charge floating interest rate. The argument of Nepalese bank is also valid. There is no practice of hedging in Nepal. They also claim that the matching funds are problematic. Since Nepalese banks collect major deposits for short periods of one to two years only, it is very difficult for them to finance a fixed rate for entire loan tenure of 10 to 15 years for hydropower projects. Therefore, floating interest rates are offered to minimize the risk on the part of the financers, which leaves the developer with a higher risk. Also, the general trend in Nepal is that the interest rate will easily go up when there is a liquidity crisis. But it is hard to expect decrease in interest rate even if there is a liquidity surplus.

Solutions:-

For any investors, the ultimate target is to earn profit from their investment. We all know hydropower in Nepal is moving at a slow pace although we have seen significant improvement in the recent years. Investors will be attracted more when they see increased return in hydropower sector. Thus, it contributes to solve the energy crisis in Nepal ultimately.

The long debate between the developers and banks over the interest rate can be solved if hydropower developers are allowed to issue bond. Obviously, there should be a proper mechanism for it. The following instruments can be used.

1) Effective Credit Rating System while issuing bonds

2) Cash flow generating hydropower projects.

3) Flexible regulations for insurance companies in Nepal. Currently, 90 percent of the premium collections have to be deposited in FD in Nepalese banks by law

4) Flexible Statutory Liquidity Ratio (SLR). SLR is the portion of total deposits that financial institutions have to maintain as liquid assets such as cash, government securities and precious metals. The current SLR is 12 per cent for commercial banks, 9 per cent for development banks and 8 per cent for finance companies. Class ‘B’ and ‘C’ financial institutions that do not collect call deposits have to maintain SLR of 6 per cent. The inclusion of hydro bonds in SLR could be mutually beneficial to both banks and hydro developers since banks are forced to invest in government treasury bills for a return of as low as 1 percent in order to meet the regulatory cap.

For those of you who are curious about the financial impact due to introduction of hydro bond, I will do a comparative analysis of two cases.

Case I:- Financial of a hydro project without the hydro bond

Assumptions

1) Scheme:- RoR

2) Project size:- Up to 25 MW (there is a fixed PPA rates for projects below 25 MW)

3) PPA Rates:- Standard PPA rates and escalation.

4) Project cost:- NPR 180 million per MW (I understand the cost is site specific. But the acceptable figures for banks at present is between NPR 160 million to NPR 180 million)

5) Plant Factor:- 65% (65% plant factor is the typical nature of Nepalese river that is designed at Q40 percentile. But higher the better)

6) Interest Rate:- 11 percent (current market rate is in between 10 to 11 percent. For this examination, I will use fixed term interest rate)

7) Royalty:- As per the government rules.

8) Operation & Maintenance Cost:- Standard practice  

9) Debt Equity Ratio:- 70:30

10) Corporate Tax:- As per the government rules

11) Loan Tenure:- 12 years from commercial operation

Case II:- Financial of a hydro project with hydro bond

Assumptions

1) Scheme:- RoR

2) Project size:- Up to 25 MW (there is a fixed PPA rates for projects below 25 MW)

3) PPA Rates:- Standard PPA rates and escalation.

4) Project cost:- NPR 180 million per MW

5) Plant Factor:- 65% (65% plant factor is the typical nature of Nepalese river that is designed at Q40 percentile. But higher the better)

6) Interest Rate:- 5 percent (To be in a safe side, I go for a higher side. Organization like IFC is planning to issue local bond for not more than 2 percent. Also the assumption here is to issue local bond right after Commercial operation of the project)

7) Royalty:- As per the government rules.

8) Operation & Maintenance Cost:- Standard practice  

9) Debt Equity Ratio:- 70:30

10) Corporate Tax:- As per the government rules

11) Bond Maturity:- 12 years.

For details regarding PPA rates, tax and so on please visit Details regarding fees, tenure, taxation policy, royalty, VAT and custom

RESULTS

Case I:- Financial of a hydro project without the hydro bond

Equity IRR	21.02%
Equity Pay Back Period in yrs	5.50
Year	1	2	3	4	5
EPS	15.79	18.44	21.23	24.16	27.25

Case II:- Financial of a hydro project with hydro bond

Equity IRR	39.28%
Equity Pay Back Period in yrs	2.55
Year	1	2	3	4	5
EPS	29.03	30.56	32.09	33.62	35.140

The results look impressive. However, these results should be taken with a pinch of salt. The assumptions I made here may not be same. Also, no one knows how to make most out of bond issue although the developers are demanding the bond issue for private hydro companies. May this upcoming budget will address the issue and come up with a better model.