The gross Non
Performing Assets (NPAs) of banks in India were Rs.3.23 lakh crore (USD 48 bn)
as on March 31, 2015 as per RBI, and estimated at approx. Rs. 6 lakh crore (USD
88 bn) as on March 31, 2016. The NPAs are mainly in infrastructure sector,
textile, iron & steel etc. As per various reports the growth rate of Indian
economy is projected at 7% for FY 2016-17. However, the credit growth rate in
the country has declined in infrastructure and manufacturing sector as lenders are
struggling with growing NPAs. Infrastructure sector forms a major part of bank
credit with share of 36 per cent (as on November 2015). Of which Road &
Other infrastructure forms 30 per cent of the bank credit. The peaking levels
of NPAs have cautioned banks in selective and conservative lending approach.
Government of India is putting efforts for revival of Economic scenario by way
of several reforms. In road infra sector, 10,000 Km of highway contracts worth
Rs. 1 lakh crore (USD 15 bn) were awarded and 6000 Km were constructed in
2015-16. Government has targeted to award 25000 Km and construct 15000 Km for
2016-17. This would result in award of contracts worth Rs.2.50 lakh crore (USD
37 bn). The government has set target to increase the per day road construction
from 20 Km to 40 Km. The newly introduced Hybrid Annuity Model (HAM) is
reviving the interest of developers/contractors in the road projects.
The Ministry of
Railways is working on several projects that includes modernization/ renovation
of railway stations, tracks, faster trains etc. having expenditure of Rs.8.6
lakh crore (USD 127 bn). The Indian Railways has rolled out plans to redevelop
400 stations. The Ministry of Railways will be also taking up 21 port-rail
connectivity projects, at an estimated cost of more than Rs.20,000 crore (USD 3
bn), under the port-connectivity enhancement objective of Sagarmala, the
flagship programme of the Ministry of Shipping. In addition, another six
projects are being considered by the Indian Port Rail Corporation Limited (IPRCL).
The Aviation Ministry planned to improve and modernize the airport
infrastructure in the country. To boost air connectivity, the government has planned
to revive 160 airports and airstrips, each of would cost about Rs. 50-100 crore
(USD 7 – 15 mn). Government has planned to develop 200 low cost airports for
connecting tier II & III cities. Airport Authority of India (AAI) has planned
to invest Rs.15,000 crore (USD 2.20 bn) over the next four years in the
development and upgradation of airports. Government's vision of creating 100
smart cities will require an investment of over USD 150 billion over the next
few years.
All the above upcoming
projects provide enormous opportunities of growth for the EPC/Construction
sector. Going with the scope of growth available, the companies in the sector
would require fund based and non fund based facilities from banks for undertaking
these projects. Having experienced the large scale of NPAs from the
infrastructure/EPC sectors, it creates a challenge for banks to meet needs of
EPC sector. In light of this, it is
important to visit some of the prudent practices which could help in
constructive lending to the EPC sector while mitigating the risks of defaults.
Monitoring
Project Progress
The time has gone when
the lenders used to issue Bank Guarantees (BGs) and remain under the impression
that being EPC project, the BGs will get returned on completion of the project.
In many of the cases, it has been seen that the beneficiaries stipulate onerous
clauses in the guarantee formats which prevent auto reduction of liability
under the BG with the achievement of progress of project. Many a time
justifications are provided that performance BG requirement is linked to
complete product delivery and cannot be reduced with the intermediate milestone
achievements. While accepting such logics, banks need to remember that they should
be providing the performance BG related to contractor’s performance, his
capability to complete a project with the required standards, based on the
detailed analysis of his strengths, past track records, years of experience,
credibility and reputation achieved in the field, but banks are not institutions
to provide the product performance insurance in the disguise of performance BG.
Remember, there is huge difference in
cost of insurance premiums and BG commissions. Inflexibility of project
authority is another prime reason which is sighted for insertion of onerous
clauses/deletion of mandatory clauses. Such stubborn practices are not good for
the long term progress of the sector. With the changing time, it is imperative for
lenders to regularly monitor the progress of the projects. Lenders need to have
regular update on the progress of project and milestones achieved. Such reports
can be submitted by borrowers along with monthly stock/receivable statements. Many
such reports/details are generally ready with contractors as they also maintain
project progress status for billing/accounting/taxation and various other
purposes. Since delays may cause increase in project cost and if the same are
not condone by the project authorities, it may thereat invocation of bank
guarantees.
Depending on the size
and exposure to the projects, consortium lenders may decide to appoint Lender’s
Independent Engineer (LIE) for providing quarterly/half yearly update on the
projects. When a small housing loan is processed, banks send independent valuer
to the project site for report on the physical progress of the project. After
sanction of home loan, before each disbursement also valuer revisits the project
site and submits report on further progress made. Based on such reports, home loan
disbursements are made. Taking this as basic concept of prudence, it is
important that bankers as a community may adopt the practice of obtaining independent
project progress reports.
Interactions
with the Project Authorities
In my experience, I
have seen that visiting the project sites from time to time gives a real
understanding of the project, progress made and provides opportunity for
interaction with the project authorities and project team of the borrower/contractor/sub-contractors.
This exposes us to the ground level reality of the development, issues
involved, satisfaction of the project authorities with the work being done by
the contractor. Periodic visits help in seeing the real progress made at the
project. It provides opportunity to have a one to one dialogue with project
authority helping in understanding whether the project is moving as per the
timelines or there is likelihood of extension/penalties which may affect the BGs
issued, and liquidity of the contractor.
Milestone
Based Bank Guarantees
It is seen that when
borrowers submit single bank guarantee for the entire contract, it causes in
incurring commission for the entire value and period. With the achievement of
project milestones, the requirement of BG value also reduces, however pursuing
the project authorities approving reduction in BG value is a herculean task.
Therefore, borrowers need to negotiate with the project authorities at the
inception only for allowing multiple BGs having different values and periods
linked with project milestones (value and period). This supports in easy
cancellation of BGs with the achievement of project milestones, unlocking the
BG limits and saving of cost.
Project
Specific Limits
Banks sanction open ended
fund based and non fund based working capital limits to EPC companies generally
without limiting to any specific project. Learning from the past experiences,
it would be prudent that while a portion of the overall limit may be carved out
for general bidding purpose, banks need to strive for approving project
specific limits for contracts awarded to the borrower. Carving out of project
specific limit would automatically lead to the requirement of detailed
assessment of the project as well periodic monitoring. Such practice would help
in better understanding and control of the project performance, and
risks/issues involved.
Building
up Margins
Implementation of
projects in infrastructure/construction sector depends on many factors
involving various clearances like right of way etc. The BGs issued also have to
be extended by the contractors due to delays in getting these approvals. As
many of the projects come in hinterlands, IBA approved transporters are also
sometimes not available in these project areas for supplies/transportation of
materials. Apart from this, as mentioned earlier, the inflexible nature of
project authorities also leads to waiver of prudent mandatory clauses, or
insertion of onerous clauses. Considering all these factors and importance of
cash flows, it is important that like DSRA Reserves are monitored by lenders,
the cash/FDR margins for LC/BGs also needs to put in the centre of monitoring.
It has to be a financial Lever and depending on the project intricacies, insertion
of onerous clauses of waiver of mandatory clauses, project progress, extensions
allowed, banks need to increase/build up the margin for such exposures.
Escrow
Arrangements
In the past it has been
seen that some borrowers diverted the advance payments received from one
project to other projects in their difficult times. This results in affecting
the progress of the various projects, dissatisfaction of the project
authorities and invocation of BGs. In order to avoid such circumstances, it
would be prudent to monitor the cash flows of the projects through Escrow A/c
arrangements. This is specially required when there is a sub-contract
arrangement. The standard formats of BGs stipulate effectiveness of BG only
after receipt of advance payments in to account of the borrower with the BG
issuing bank. Such compulsory clauses should not be relaxed.
Concurrent
Auditor
RBI has made it
compulsory forming consortium arrangements for borrowers availing more than
Rs.100 crore (USD 15 mn) (SMA2 A/cs) of borrowings from banks. Many mid/large EPC companies are banking under consortium arrangement. The
EPC companies being involved with many projects, it is essential for the
consortium to have real understanding on the project cash flows of the borrower.
Control on the cash flows is one of the most critical aspects in lending. I had
written earlier about this in my article (Time
to set New Normal : Adopting Cash Flow Based Monitoring). In all the
restructured cases banks appoint Concurrent Auditor for monthly/quarterly
reports on the cash flows, receivable position, intergroup/related party
transaction etc. Considering the multiple project cash flows, it would be prudent
that consortium adopts practice of appointing Concurrent Auditors in lending to
EPC contractors. Such practice would help in understanding the project cash
flows.
Needless to say, the
Early Warning System (EWS) put in practice by banks in India is component
of the overall monitoring framework and has to be followed for timely
mitigation actions.
With the efforts of Government of India many
contract opportunities are opening for the EPC/Construction sector and providing
room for business growth to contractors as well as lenders. Prudent controlling
and monitoring practices would not only support in constructive lending but
also protect the interest of all the stakeholders in long term.
