In an effort to promote private investment in the power sector, the government of India (GoI) has formulated the concept of 'ultra mega power projects (UMPPs). These UMPPs have the potential to impact the credit profiles of the sponsors over the medium term, says top Indian rating agency, CRISIL.

The project costs of Rs150 billion-170 billion are large, and the proposed ratio of debt to equity is high, in the context of the bidders' balance sheets. In addition, the funding of the projects' equity components will stress sponsors' financial flexibility, and there are risks inherent in the funding and implementation of such long-gestation projects.

Seven UMPPs, of 4,000 MW each, are currently on the anvil. Project-specific SPVs set up by government will carry out initial developmental activities, such as acquiring land and obtaining initial consents. The central government will select developers (sponsors) for setting up the projects, through a process of international competitive bidding; ownership of the SPVs will then be transferred to the respective sponsors.

UMPP projects are estimated to cost in the region of Rs.150-170 billion, with possible debt:equity ratios of 70:30. This will result in substantial amounts of debt: an individual SPV could need to borrow as much as Rs120 billion. For CRISIL-rated sponsors, the rating implications of these projects could be significant.

Though the projects will be undertaken through special purpose vehicles (SPVs), there will normally be strong reasons for consolidating the debt residing in these SPVs with that of the sponsors. To rate the impact of these UMPP projects on rated sponsors' CRISIL has chalked out a new rating analysis.

To begin with, CRISIL will examine the equity holding of the sponsor in the SPV. Some bidders have formed consortia to bid for projects, thus spreading out the risk; in other cases, however, the SPV may be a wholly-owned subsidiary of a sponsor.

Thereafter, CRISIL will analyse the project's funding pattern. The larger the equity component, the lower would be the impact on the sponsor's credit profile; however a large equity investment would have its own downside, eating into the sponsor's liquidity or increasing its financial leverage.

CRISIL will also examine the sponsor's commitment to the project vis-à-vis the size of its own balance sheet. Finally, CRISIL will factor in any strategic benefit the sponsor expects to gain from the SPV: for instance, the sponsor might also be the EPC contractor for the project.

If the UMPP SPV is a joint venture, with no single identifiable parent, CRISIL will not normally consolidate the debt in the SPV with that of any individual sponsor. Instead, a sponsor's equity contribution to the SPV, and its share of economic risks in the venture (such as additional support in the event of distress, or additional contributions in case of cost over-runs), would be factored into the rating.

On the other hand, in instances where the UMPP SPV is a wholly-owned subsidiary of a rated sponsor, CRISIL will determine whether to take a consolidated view of the UMPP subsidiary and the sponsor.

This will entail an examination of several analytical issues, including: the stated posture of the sponsor's management on support to the subsidiary; evidence of support, such as guarantees or letters of comfort, that the sponsor may have provided to the lenders of the subsidiary; commonality of business between the sponsor and the subsidiary; and, most importantly, CRISIL's view on the nature and extent of support that the subsidiary can expect from the sponsor at a time of distress.

In CRISIL's opinion, there will generally be a strong case for consolidation of wholly-owned UMPP subsidiaries, considering sponsors' strategic interest and large equity exposures in these subsidiaries. Even when it chooses not to consolidate a UMPP subsidiary, CRISIL would factor the economic risks mentioned above into the sponsor's rating.

In general, projects of this magnitude are likely to result in a negative bias to sponsors' credit profiles. Substantial borrowing in project SPVs (analysed using the criteria outlined above), and the resource commitments that the equity investments will entail, are the two immediate routes through which this impact would materialise. The negative impact of these projects could be offset by the strength of sponsors' balance sheets.