A. Introduction Air Quality Improvement in the Greater Beijing Tianjin Hebei Region China National Investment and Guaranty Corporation s Green Financing Platform Project (RRP PRC 50096) FINANCIAL ANALYSIS 1. The Air Quality Improvement in the Greater Beijing Tianjin Hebei (BTH) Region China National Investment and Guaranty Corporation s Green Financing Platform Project (the project) will establish a unique platform to leverage financing and scale up investments in green and emission reduction projects throughout the BTH region in sectors such as energy, transport, urban, and agriculture. 1 It will use the financial intermediation loan (FIL) modality. The Ministry of Finance (MOF) will represent the People s Republic of China (PRC) to sign the onlending agreement with both the State Development & Investment Corporation (SDIC) and China National Investment and Guaranty Corporation (I&G) on identical terms to those offered by the Asian Development Bank (ADB) to MOF. I&G will be the executing and implementing agency. I&G will be responsible to MOF for the loan repayment. SDIC will enhance the credit for I&G. I&G will be the financial intermediary, responsible for the overall project management. Bank of Beijing (BOB) will act as entrusted bank and be responsible for disbursing the subloans and collecting subloan repayments. 2. The financial due diligence for the project comprises (i) financial management assessment (FMA) and financial performance analysis of SDIC, I&G, and BOB; (ii) agreement of selection criteria for subprojects; (iii) agreement on due diligence for subborrowers and selection criteria for subborrower; (iv) application of financial structure and instruments for the platform development; (v) financial analysis of proposed initial set of subprojects; (vi) financial risk assessment and management; and (vii) assessment of the platform s financial sustainability. B. Summary of Financial Management and Financial Performance Analysis of Partner Agencies 3. The FMA found that financial management systems and procedures of SDIC, I&G, and BOB are in place to perform the proper financial management and reporting necessary for smooth project implementation. BOB as the entrusted bank has complied with the requirements of establishing sustainable operation systems deemed adequate for project implementation. SDIC and its subsidiary I&G practice accrual-based accounting and follow PRC business accounting standards, which are consistent with international accounting standards. Their accounting procedures are aligned with the MOF-issued regulations and policies, which are considered effective and adequate for the project. The designated accounting and financial staff are recognized as sufficient. However, none of the organizations have experience with ADB loan implementation, and, thus, their staff are not familiar with ADB's guidelines and procedures on FIL-related procurement, disbursement, and safeguards. Moreover, I&G has limited experience in equity investment, and its staff are deemed insufficient for large-scale solicitation and technical assessment of green projects. Appropriate measures to enhance I&G s implementing capacity were agreed with I&G, and are expected to be implemented before loan effectiveness. 4. Both SDIC and I&G are assessed as having the necessary financial strength to sustain their respective businesses and operate long term. I&G is primarily responsible for repaying the loan. If I&G defaults on its debt service obligations, SDIC will assume the repayment obligations. The security arrangement provided by I&G and SDIC were found adequate by MOF to provide sovereign guarantee to the state-owned enterprise. 1 The greater BTH region (referred to as the BTH region) includes Beijing and Tianjin municipalities; Hebei, Henan, Shandong, Shanxi, and Liaoning provinces; and Inner Mongolia Autonomous Region.
2 5. SDIC is one of the PRC s largest state-owned investment corporations and the state investment body in strategic sectors. Wholly owned by the State-owned Assets Supervision and Administration Commission (SASAC), SDIC is engaging in strategic investments in four business units: (i) infrastructure, (ii) prospective strategic industries, (iii) finance and service, and (iv) international business. As of December 2015, its net assets were CNY141 billion. Its net profit margin has been relatively high from 2011 2015, from 9.2% to 12.6%, and its total liabilities-to-asset ratio was below 75% in and after 2012, and stood at 71.5% in 2015. SDIC has maintained its interest coverage ratio above three since 2012. Its financial standing is projected to remain robust. 6. SDIC maintained its debt-equity ratio below 2.0 during the last 5 years, and reduced it to 1.64 in 2015. These ratios indicate that SDIC may have further leverage potential. For noncurrent assets, SDIC has experienced stable growth. Its non-current assets were CNY330 billion in 2015, consisting of available for sale financial assets (15%), fixed assets (52%), and construction in progress (19%). The long-term equity investment has a book value of CNY16 billion, most of which is invested in railway, port, electric power, mining, and financial institutions. A devaluation loss reserve of CNY0.4 billion has been appropriately accounted in 2015. The fixed assets book value is CNY237.3 billion, and the aggregate depreciation is CNY65.7 billion. SDIC has recorded a devaluation allowance of CNY1.0 billion, resulting in net fixed assets of CNY170 billion in 2015. 7. SDIC s asset quality is equally good. As of December 2015, for current assets, it holds CNY72.5 billion in cash and CNY16.7 billion in tradable financial assets. Its gross account receivable is moderate at CNY9.2 billion, and CNY2.1 billion of bad debt loss has been written off, resulting in CNY7.1 billion in net account receivables. The book value of inventory is CNY10.8 billion, consisting of raw material and produced commodity. The downward impact of reducing coal price has been properly considered, and CNY0.8 billion of fair value loss has been reserved, leading to a net balance sheet inventory value of CNY10 billion. Construction in process is an important indicator for assessing SDIC s sustainability. As of December 2015, this increased to CNY64 billion, a 35% rise from the previous year. Most of the construction in progress is for power plant and port construction projects, with stable cash-flow generation capability. Hence, SDIC has maintained its assets in good quality, and the asset liquidity improved in 2015. 8. SDIC has promptly overcome the slowdown in domestic growth since 2014. However, compared to the debt financing scale, the cash flow from operation alone is not sufficient to meet the corporation s repayment obligation. Typically, SDIC relies on new capital injection as well as the cash flow from operation to service the debt. Moreover, SDIC has the highest domestic rating of AAA issued in December 2015 by the United Credit, one of the PRC s largest credit rating agencies and it can easily issue corporate bonds at low interest rates in the stock exchanges. 2 In addition, each year SDIC gets SASAC s capital injection. In 2015, SDIC got government equity investment of CNY14 billion, and it borrowed CNY71 billion from banks and the debt market, which together are sufficient to repay that year s debt service of CNY55 billion. 9. I&G was the first nationwide guaranty company. As detailed in the FMA, after several restructurings, I&G is a joint-stock limited company listed in the New Third Board, an Over-The- Counter capital market recently launched in the PRC. SDIC remains I&G s largest and 2 For the 2016 rating, refer to: http://www.lianhecreditrating.com.cn/uploadfiles/20160602183517673.pdf.
3 controlling shareholder, directly holding 47.2% of shares and, through its SDIC Innovation Fund (Beijing), holding an additional 1.73% of shares. As of the end of 2015, I&G had CNY4.5 billion of registered capital, CNY10.4 billion of total assets, CNY115.3 billion of aggregated bank credit lines, and CNY418.2 billion of accumulated guarantee amount provided to more than 20,000 borrowers. I&G s leverage is prudently used, and debt is controlled at from 14% to 44% of equity and stood at 16% by the end of 2015. From 2011 to 2015, the outstanding guarantee continuously increased, and in 2015 reached CNY171.1 billion. I&G s profitability is strong. In 2015, net income was CNY603.1 million. Its high net profit margin has been maintained and in 2011 2015 averaged 49.2%, indicating I&G has a strong profit-making capability. 10. For the past 4 years from 2012 2015, external audit reports for SDIC, I&G, and BOB had an unqualified opinion. BOB fully complies with the regulator s prudential regulations. The financial management risks were assessed to be low. Risk analysis of SDIC and I&G indicates two substantial risk factors: (i) financial sustainability of the project implementation structure, and (ii) project management office staffing. The analysis concludes that the project is still doable with consideration of I&G s capacity and SDIC s resources. The overall project risk can be mitigated to a low level if the recommended measures are adopted. C. Financial Selection Criteria 11. s are required to meet selection criteria to ensure sustainability of the green financing platform. 3 12. The financial viability criteria comprise the following: (i) estimated subproject investment and operations costs, as well as cash inflows, must be clearly presented and reasonable; (ii) financial internal rate of return (FIRR) shall be greater than the weighted average cost of capital (); (iii) FIRR must be robust under various sensitivity scenarios; (iv) payback period of subprojects shall match the repayment period of subloans; and (v) average debt-service coverage ratio shall be at least 1.2; if any subproject has debt-service coverage ratio less than 1.2, I&G will require the subborrowers to provide additional credit enhancement measures. 13. All subborrowers must be financially creditworthy and not have a poor credit record, as recorded in the People s Bank of China credit history database. The subborrowers must be capable of contributing at least 20% of the total subproject investment cost as counterpart financing. D. Financial Assessment of Initial Group of s 14. During project processing, 11 subprojects were identified that have a high degree of readiness and conformed to ADB guidelines for project financial management and analysis. 4 The analysis was based on the incremental financial costs and benefits as assessed in the feasibility studies that were available. 3 Selection criteria are in Appendix 2 of the project administration manual (accessible from the list of linked documents in Appendix 2 of the main text of the report and recommendation of the President). 4 Asian Development Bank (ADB). 2005. Financial Management and Analysis of Projects. Manila.
4 15. For subsequent subprojects, I&G will conduct a similar financial analysis and apply the same selection criteria. I&G will also conduct its own due diligence of these projects, in accordance with ADB guidelines. 16. Financial viability of subprojects. Capital costs civil works, equipment and materials, installation, and related expenses (e.g., design and technical services) were estimated on the basis of investment cost estimates from feasibility studies. Provisions were made for physical and price contingencies, as appropriate. The incremental financial benefits from the projects consist primarily of (i) revenue accruing to the project sponsors from energy sales (for example, for renewable energy or district heating projects), or (ii) energy savings accruing (for example, on energy service company [ESCO]-sponsored energy efficiency projects). 17. To derive each subproject s FIRR, annual incremental cash flows over the subprojects technical useful life were used. The FIRR was computed on an after-tax basis in real terms: (i) physical contingencies, but no price contingencies and financial charges, included in investment cash flows; and (ii) real operating cash flow, without considering the impact of inflation. Each FIRR was compared with the respective for the respective subproject. The respective was calculated after tax in real terms, using the estimated capital structure and costs of capital. The subloan interest rate from ADB loan proceeds ranged from 5.2% to 6.0% and loan tenors ranged from 2 to 7 years, based on initial credit assessments done by BOB and I&G. Where guarantees were provided, I&G s guaranty fee of 2% of capital expenditure per year (matching the loan tenor) was assumed to be paid upfront at the project start. The cost of equity is assumed to be 8%, as assumed in previous ADB projects in China. 5 The corporate income tax rate is 25.0%. Value-added tax was assumed to be 17% (where applicable). 18. Financial analysis results, including each subproject s capital investments, FIRR, and, along with the subborrower s debt service coverage ratio, are in Table 1. Table 1: Projected Financial Indicators Total Investment (CNY million) FIRR (%) (%) DSCR 1 Waste Heat Recovery for District 245.90 15.35 4.38 2.12 Heating 2 Harnessing Biomass Energy from 360.27 11.30 3.74 1.11 Agricultural Waste in Hebei 3 Desulfurization and Denitrification 49.98 15.07 4.40 1.83 System to Reduce Emission in Tianjin and Shanxi 4 Distributed Energy for Shilong Economic 46.67 15.41 3.25 1.84 Development Park in Beijing 5 Green Leasing 621.80 13.91 3.63 1.84 6 Distributed Energy for Space Heating in 39.25 22.80 2.88 2.69 Zhengding District, Hebei 7 Scaling Up Energy Efficiency in 2.13 12.85 3.98 1.09 Buildings 8 Wind Farm Development in Shandong 350.00 4.78 3.28 0.75 9 Investment in R&D for Smart Electronic 82.96 20.98 8.00 N/A Bicycles 10 Investment in R&D of Energy Saving Equipment 103.66 19.08 7.76 N/A 5 ADB. 2013. Report and Recommendation of the President to the Board of Directors: Proposed Policy-Based Loan to the People s Republic of China for the Qinghai Delingha Concentrated Solar Thermal Power Project. Manila.
5 Total Investment (CNY million) FIRR (%) (%) DSCR 11 Waste Heat Recovery for District Heating in Hebei 202.71 10.57 2.74 1.05 DSCR = debt service coverage ratio, FIRR = financial internal rate of return, R&D = research and development, = weighted average cost of capital. N/A = Not applicable (because these projects represent early stage equity investments by I&G). Source: Asian Development Bank estimates. 19. As shown in Table 1, some subprojects may not meet the debt service coverage ratio criterion. In this case, I&G will require the subborrowers to provide additional guarantee. E. Sensitivity Analysis 20. A sensitivity analysis considering various adverse scenarios (higher capital expenditure or operational expenses, or lower tariffs) shows that the subprojects would remain financially viable, with FIRRs exceeding the subprojects s (Table 2). Table 2: Sensitivity Analysis of Financial Internal Rates of Return (%) CAPEX O&M Cost +10% +10% 1 4.38 13.32 10.12 2 3.74 10.01 9.75 3 12.65 13.32 10.12 4 3.25 13.37 10.16 5 3.63 12.07 9.17 6 2.88 20.65 21.62 7 3.98 11.09 12.74 8 3.28 3.76 3.86 9 8.00 18.21 13.83 10 7.76 16.56 12.58 11 2.74 8.67 5.60 CAPEX = capital expenditures, O&M = operations and maintenance, = weighted average cost of capital. Source: Asian Development Bank estimates. F. Financial Sustainability of the Green Financing Platform 21. The platform s financial sustainability was tested based on assumptions of (i) ADB loan terms and conditions; (ii) cross currency exchange rate projections using the purchasing power parity methodology; (iii) entrusted bank service rate; (iv) staffing of the project management office and staff costs per annum; (v) allocation of human resources expenses to the financial instruments; (vi) allocation of total ADB funding to the financial instruments as agreed with I&G; (vii) onlending terms and conditions from I&G to final subborrowers and subprojects; (viii) an assumed withdrawal schedule for financial instruments; and (ix) compensation probability, recovery rate, and guarantee loss rate. 22. The model indicates that in the base case with realistic assumptions, I&G should be able to cover its project management costs, potential losses from its guarantee, and the equity investment, and make a net benefit of CNY300 million. Assuming that this amount will be used to increase I&G capital, the platform will generate a sustainable guarantee program in energy efficiency and low carbon development of an additional CNY1.5 to CNY3 billion. 6 6 Following the regulations of the China Banking Regulatory Commission, a guarantee company is permitted to leverage its registered capital 10 times to issue guarantees.