CHAPTER 6 PROJECT FINANCE

CHAPTER 6 PROJECT FINANCE 164

In project financing, the project, its assets, contracts, inherent economies and cash flows are separated from their promoters or sponsors in order to permit credit appraisal and loan to the project. The assets of the specific project serve as collateral for the loan, and all loan repayments are made out of the cash flows of the project. In this sense, the loan is said to be of non-recourse or limited recourse to the sponsor. Thus, project financing may be defined as that scheme of financing of a particular economic unit in which a lender is satisfied in looking at the cash flows and the earnings of that economic unit as a source of funds, from which a loan can be repaid, and to the assets of the economic unit that The financing of long-term infrastructure, industrial projects and public services, based upon a non-recourse or limited recourse financial structure, where project debt and equity is used to finance the project are paid back from the cash flow generated by the project. In the past, project financing was mostly used in oil exploration and other mineral extraction through joint ventures with foreign firms. The most recent use of project financing can be found in infrastructure projects, particularly in power and telecommunication projects. Project financing is made possible by combining undertakings and various kinds of guarantees by parties who are interested in a project. It is built in such a way that no one party alone has to assume 165

the full credit responsibility of the project. When all the undertakings are combined and reviewed together, it results in an equivalent of the satisfactory credit risk for the lenders. It is often suggested that project financing enables a parent company to obtain inexpensive loans without having to bear all the risks of the project. This is not true. In practice, the parent company is affected by the actual plight of the project, and the interest on the project loan depends on the parent stake in the project. Project financing is a loan structure that relies primarily on the cash flow of the project for repayment, with the assets, rights, and interests held by the project as secondary security or collateral. Project finance is especially attractive to the private sector because they can fund major projects off balance sheet. The major ingredients of the Project Finance are: - The project is long term infrastructure or a public service. Repayment of the loan is derived primarily from the cash flow of the project on completion. Assets, rights, and interests of the project are held as collateral and as a secondary security. 166

There is limited recourse or non-recourse and debt is primarily paid from the cash flow of the project. National Housing Bank Policy On Project Finance The NHB plans to lend under project financing on a large scale. It has taken new initiative and made policy changes. The Project Finance Department has adopted a New Project Finance Manual for its operations. The highlights of the manual include provisions for Rating Model for Projects and also the borrowing institution. Under the existing system, only the borrowers are rated for assistance. The new Manual has been developed with assistance from CRISIL. The Bank has also adopted a series of risk management measures so that risks involved in project finance are minimized. Further, Bank has amended its Project Finance Policy from time to time with a view to broaden the scope of the scheme. Private Sector and Joint Sector entities have been made eligible for borrowing under the scheme. Further, Housing Projects belonging to economically weaker section and low income group have been included in Project 167

to play an important role in the various interventions in rural areas that the Bank proposes to take up. Over the last few years, the micro finance sector has emerged as the largest congregation of microfinance leaders from within and outside India. Micro finance institutions are gradually brining the poor, especially poor women into the formal financial system and enabling them to access credit and fight poverty. sustainable housing finance programme for the poor who are attached to the Self Help Groups (SHGs) in various parts of the country. In view of the significance of the MFI / NGOs as effective intermediaries for HMF, to reach out to the low income groups in both rural and urban areas, NHB has taken a series of initiatives to engage the MFIs / NGOs in housing by providing long term financial support, technical assistance and training so as to enable them for increased participation in housing finance. Under the programme, the housing loans are provided by the MFIs to Self Help Group (SHG) or Joint Liability Group (JLG) members attached to the MFIs either for new construction or for renovation / repair of their existing houses, work sheds with necessary water and sanitation facilities, incremental housing (repair 168

/ renovation) with maximum loan component of Rs.50000/-. This assumes much significance in the context of affordability and sustainability of the programme. The loans are repayable within a period of maximum 10 years. Public Agencies The list of eligible borrowers includes a number of different categories. Public Agencies are eligible to borrow under Project Financing. These are agencies incorporated under the enactments of the Central or State legislatures or under the Companies Act, 1956 such as: State Housing Boards/Improvement Trusts, State Slum Clearance Boards/Authorities, Development Authorities, Municipal Corporations/Councils, New Town Development Agencies, Local Authorities for Housing & Urban Development, Public Sector Companies for employee housing projects, Agencies set up or notified by Government for Specific Housing Programmes (e.g. Earthquake rehabilitation etc). Microfinance Institutions, SHGs, NGOs & Societies Microfinance Institutions/Self Help Groups/NGOs/Societies registered under the Societies Act, 1860 and companies registered 169

under Section 25 of Company Act, are also eligible to borrow under this scheme. Joint Venture and Public Private partnership are also eligible to borrow. Further, the scope of the project finance loan policy has been widened by making eligible private sector entities. Eligible Purposes The Bank offers financial assistance for various types of projects right from township development, land acquisition and development, slum redevelopment projects etc. The same are enumerated below under three main heads namely special projects, general projects and short term facility: Special Projects Borrowing can be made for special project like slum development projects, housing for low income groups and economically weaker sections of society and special project like Gujarat earthquake project. General Projects General Projects includes Township cum housing development 170

projects, Construction of houses on individual plots or group housing, Land acquisition for the purpose of township and housing development, Land development for housing including provision of facilities like roads, water supply, water drains, sewerage system and development of land into buildable plots. However, funding is extended to public agencies or joint sector companies. Special housing projects for people affected by natural calamities like Tsunami in Andhra Pradesh and earthquake in Gujarat are also covered under the scheme. The Bank also extends financial assistance for water and sanitation programme being undertaken by Micro Finance Institutions/Non Government Organizations /Urban Local Bodies as a part of their Housing finance programme. Employee Housing The corporate sector may plan to provide housing facility to their employees in the factory premises or nearby the factory. This not only reduces the cost of transportation and time consumption but also the efficiency of employee is enhanced. Further, the degree of attachment of the employees to the organization increases and this reduces the attrition rate. Employee housing is beneficial to the employer as well as to employees. However the cost of housing project may not be within the reach of the employer. Under the 171

circumstances, project financing may be availed by the company from the NHB. The monthly returns generated by way of rent received from the employee will serve the project financing. Hence, employee housing scheme is also eligible for assistance under project financing. Short Term Facilities The NHB can also grant short term finance facility up to a maximum period of 2 years to public agencies engaged in housing projects. Takeover of term loan liabilities of public housing and development agencies can also be considered by NHB under the scheme of project financing. Interest Rate On Project Financing The National Housing Bank offers fixed or floating interest rates on project financing. The interest rates are determined based on the Prime Lending Rate of the Bank. NHB reviews and resets the interest rates from time to time, depending upon the market conditions, commercial interest etc. Such changes in the rate of interest shall be applicable on the outstanding balances in the loan accounts under the floating rate option. In 172

respect of fixed interest rates, NHB has the option to review and reset the rates on outstanding loans on completion of 3 years. Borrowers will have the option to either accept the revised rates or to prepay the outstanding amount without any prepayment levy if they find the revised rates unacceptable. Prepayment Charges Prepayment of loans is permissible with payment of prepayment levy. On floating rate loans the prepayment levy is 0.50 per cent of amount to be repaid. On Fixed rate loans, it is 0.50 to 1.50 per cent depending on the residual maturity. Larger the residual maturity, higher will be the prepayment charge. Extent And Duration Of Financing The extent of financing is based on the type of project and also the rating assigned by National Housing Bank. It varies between 65 to 100 per cent of the project cost. For example, Gujarat Earthquake Project of 2001 was eligible for 100 per cent financing. The loan under project financing can be granted up to maximum period of 15 years. For projects of national and social importance, a moratorium of 3 years can be available. 173

Security The National Housing Bank will seek security against project financing. The nature of security depends upon the nature of borrowing agency and the project. The security may be Mortgage/charge over immovable property acceptable to NHB, Charge over receivables, bank guarantee, Government guarantee, corporate guarantee, charge on book debts, fixed deposit receipts and hypothecation of property. National Housing Bank provides excellent customer service by quick disposal of project proposals and individual attention. It will also provide requisite financial and technical expertise and guidance in project information, if required by the borrowers. A Review Of Project Finance Scheme Of The Bank The progress of the project finance scheme of NHB has been explained with the following table which contains data on the number of projects approved, amount sanctioned and the assistance disbursed. 174

Table 6.1 Performance of Project Finance Window (Rs. In Crore) Year No. Of Project Amount Sanctioned Amount Disbursed till June 2000 311 904.47 467.43 2000-01 14 NIL 50.5 2001-02 30 758.32 NIL 2002-03 0 NIL 73.06 2003-04 19 111.26 44.49 2004-05 12 197.82 27.16 2005-06 4 537 365 2006-07 6 560.82 171.6 2007-08 12 819.5 449.49 2008-09 14 248.3 35.41 2009-10 6 312.07 51.53 2010-11 6 78.8 312 Cumulative 434 4528.36 2042.67 Source: Compiled from Different Annual Reports of National Housing Bank 175

Graph 6.1A Number Of Projects Sectioned 35 30 25 20 15 Series1 10 5 0 176

Graph 6.1B Amount Sanctioned And Disbursed Under Project Financing 900 800 700 600 500 400 Series1 Series2 300 200 100 0 177

From the table 6.1 given above, is clear that financing under Project Finance Window is not showing a consistent trend. During the period of study one finds that there are great ups and downs as far as number of project assisted and amount sanctioned and amount released is concerned. During the year 2002-03, no project was approved. Hence, no financial assistance was sanctioned. However, during the year 2002-03, disbursement of Rs. 73.06 crore was made year 2001-02, 30 projects were approved. The amount sanctioned was Rs. 758.32 crore but no disbursement was made during the year. Again, 2001-02 is the year where the number of projects approved is highest. Further, during the year 2007-08, 12 projects involving a financial commitment of Rs. 819.50 crore were sanctioned. This is the highest amount sanctioned in a single year. The amount disbursed in the year stood at Rs. 449.49 crore. During the year 2008-09 and 2009-10, the amount disbursed is quite insignificant if compared to the amount sanctioned during the same year. However, during the year 2010-11, the amount disbursed is quite large compared to the amount sanctioned in the same year. It may be mentioned that the Project Financing is of long term nature and it takes years to get a project completed. The amount under project financing is released in installments and in proportion 178

to the completion of the project. However, it must be noted that the gap between the amount sanctioned and amount disbursed is too large. As on June 2011, 434 projects have been approved for which an amount of Rs. 4528.36 crore has been sanctioned. But against this amount, Rs. 2042.67 crore has been released. This is only 45 per cent of the sanctioned amount. Need not to say, it can easily be concluded that projects financed under the scheme of Project financing are moving at snail pace. Total sanctions under the scheme of Project Financing are almost 40 per cent of the total sanctions under scheme of Refinance. Further, total disbursement under the Project Financing is one fifth of the total disbursement made under Refinance Scheme. Hence, it is clear that financial progress under Project Financing has lagged behind the financial progress under Refinance operations. Though the NHB has tried to widen the scope of the scheme in 2003 and thereafter, by including the private sector and joint sector entities as eligible borrowers under Project Financing, yet progress is slow. It was expected that the Bank will play a more meaningful role in the years to come. Projects for housing construction for the economically weaker sections of society and low income group are also being financed under this scheme so that a social purpose is served. However, more is needed on the part of National Housing Bank. 179

Gujarat Earthquake Project With a view to ameliorate the large-scale destruction of property and infrastructure caused by the Gujarat Earthquake in January 2001, National Housing Bank formulated guidelines for providing financial assistance to state government agencies engaged in relief work in Gujarat. NHB, with financial assistance from RBI, introduced a special scheme with 100 per cent refinance facility in 2000-01, applicable to Scheduled Banks and HFCs in respect of their lending in the earthquake affected areas of Gujarat for acquisition/construction of new housing units or for purchase of existing dwelling units provided they were not more than 10 years old and were certified as structurally sound. The loan ceiling was Rs.5.00 lakhs for rural/semi-urban areas and Rs.10.00 lakhs in case of urban/metropolitan areas. The refinance rate was 6.50 per cent and the on-lending rate was fixed at 8.00 per cent. NHB provided moratorium of 3 years over the normal 15-year period of refinance repayment. Similar moratorium was to be extended by the borrowing institution to individual borrowers. Under this Scheme, National Housing Bank has sanctioned 2 projects of Gujarat State Disaster Management Authority (GSDMA) and 1 project of Gujarat Rural Housing Board (GRHB) with a loan 180

component of Rs. 542.31 crore and Rs.0.99 crore respectively. The project was completed during the year 2002-03 and full amount was utilized by Gujarat State Disaster Management Authority (GSDMA) and Gujarat Rural Housing Board. Un-Habitat Water & Sanitation Project Projects on Water Supply and Sanitation have been financed by National Housing Bank with external Assistance from Agencies like UN-HABITAT. During the year 2008-09, NHB signed an agreement of co-operation with UN-Habitat for collaborating on water supply and sanitation projects for low income households. Under the agreement, UN-Habitat agreed to provide US$ 3,75,000 to NHB for the water and sanitation components of housing micro finance project, for standalone water and sanitation project and for capacity building and training. The amount is kept in and administrated through a Revolving Fund. During the year 2010-11, an amount of $1,27,500 has been received by the Bank in the second installment and in turn NHB has disbursed Rs.25.00 lakh to Nanayasurabhi Development Financial Services for construction of estimated 312 toilets for the members of SHGs operating in 3 districts of Tamil Nadu and Rs.1.50 crore for 181

construction of estimated 5000 toilets for individual members of the registered Primary Milk Producers Co-operative Societies affiliated to Kaira District Co-operative Milk Producers Union Ltd (KDCMPUL), Gujarat. Additional funds for the above disbursements were provided by NHB from its Special Fund. One national level workshop on water and sanitation has been organized in Nagpur, under the Programme of UN Habitat. Further, during 2009-10, Rs.1 crore was sanctioned to Friends of Programme. An amount of Rs.55 lakh has been disbursed. Under this programme, around 1054 toilets are to be constructed in the States of Maharashtra, Orissa, Karnataka and Madhya Pradesh. The programme is being implemented by FWWB through its various partner organizations. Housing Project For The Victims Of Tsunami During the end 2004, the Tsunami cyclone stroked parts of India, Sri Lanka, Indonesia & Thailand causing unprecedented loss to life and property. The Government of India and various other institutions came forward to extend all possible support to rehabilitate the affected people and restore normal life. 182

With a view to extend financial assistance to victims of Tsunami in coastal Andhra Pradesh, National Housing Bank sanctioned Rs. 70 crore in the year 2004-05 to Andhra Pradesh State Housing Corporation Limited for construction of 40,000 dwelling units. The project has been completed successfully. The Bank also introduced a scheme to extend refinance assistance to Housing Finance Companies (HFCs) and Scheduled Commercial Banks (SCBs) for both, construction of new houses/flats and major repairs in the Tsunami affected areas, at a concessional rate of 5 per cent per annum. Slum Improvement Project In Dharavi Half of the 14 million people in Mumbai, India's commercial capital, live in slums. A number of non-governmental organizations (NGOs) are working to help these communities but one NGO that stands out for its work with slum and pavement dwellers is the Society for Promotion of Area Resource Centers (SPARC).National Housing Bank has made direct finance to SPARC, for solving the housing problems of slum dwellers in Dharavi, Mumbai, one of the biggest slums in India. National Housing Bank granted project finance for construction of 144 flats for slum dwellers. 183

Conclusion: Project financing is generally taken up by big financial institutions that have a rich and varied experience in the field of financing. It requires an elaborate appraisal of the project for the market, technical, financing, economic and managerial angles. The project financing generally done for three projects which are highly capital intensive, involve huge sunk cost and have a long operational life. The housing projects are also of such nature. The NHB has created a Project Financing Department and have adopted a new Project Finance Manual which lays down the guidelines to be followed while deciding financing of a project. The scope of the project financing has been enlarged recently by the NHB. The private sector entities and micro finance institutions have been also made eligible to borrow. Special purpose projects like rehabilitation projects for the victims of natural calamities and the financing projects of like land development projects; water and sanitation projects have been financed by NHB under the scheme. A review of the scheme of project financing reveals that the progress of scheme is slow. There is a large gap between the amount sanctioned and amount disbursed. Only 45 per cent of the sanctioned amount was disbursed till June 2011. Further, a comparison of project financing with refinancing operation reveals that achievement of project 184

financing is shorter than those of refinancing operation. There is a need to improve the performance of that scheme. NHB should select only those projects which are technically and financially sound and the implementing agency has rich experience of implementing the projects. 185