Weekly Update: How will financing of NSM projects work?

Developers are in the process of finalizing their bids for National Solar Mission (NSM) projects. The use of Viability Gap Funding (VGF) mechanism for the first time, resulting in significantly different cash flow profiles, poses many interesting questions for developers. Financial structuring will play a very important role in determining bid outcomes.

SECI has the right to claw back VGF in case of project underperformance. Hence, lenders will not allow VGF to be used for capital repayment to a developer
Top-tier sponsors that can provide corporate guarantees or recourse to lenders will likely benefit from most competitive financing
If adequate sponsor support is not available, the lender is directly concerned with the risk associated with the treatment of VGF disbursement

As VGF is disbursed only after construction, developers need to finance the entire capital cost upfront. It is worth bearing in mind the key headline numbers: i) normative capital cost of a plant of INR 65m/MW (USD 1m/MW, EUR 0.8m/MW); ii) VGF of INR 10m/MW (USD 160,000/MW, EUR 120,000/MW); iii) Solar Energy Corporation of India’s (SECI’s) minimum equity investment stipulation of INR 15m/MW (USD 240,000/MW, EUR 177,000/MW); and iv) lenders expect to provide no more than 70-75% of total project cost as senior debt.

Project developers might argue that subject to satisfaction of key lender covenants, the bulk of the financing requirement above their minimum equity investment of INR 15m/MW (USD 240,000/MW, EUR 177,000/MW) should come from debt financing. And in order to improve their bid competitiveness, they would like the VGF disbursement to be used to distribute capital back to themselves as equity providers (suggesting possible use of preference capital or shareholder debt structures).

The problem, however, arises due to SECI’s right to claw back the VGF in case of project underperformance. Senior lenders will likely see a serious risk in this and will therefore not allow VGF to be used for capital repayment to a developer. They may even argue that VGF is pure equity risk. Notwithstanding the recent revision, whereby SECI has accepted second claim on project assets, they may want to see a structure that has sufficient cushion for both senior debt and VGF in an underperforming project. This opens up opportunities for gaining a competitive advantage through financing structures around, equity structures, letters of credit, corporate guarantees, etc. For example, top-tier sponsors, which can provide corporate guarantees or recourse to lenders, will likely benefit from the most competitive financing. This puts pure play solar IPPs at a disadvantage vis-a-vis larger industrial houses. (And they are already limited by not being able to make effective use of accelerated depreciation options. See our previous blog here.)

In addition, if adequate sponsor support is not available, the lender is directly concerned with the risk associated with the treatment of the VGF disbursement: Should VGF stay in an escrow account for the lenders security (very inefficient from the point of view of the developer)? Or should it go to repay senior debt? Or will debt/equity be able to come to a mutual agreement? Could strong EPC/O&M guarantees provide some answers? Interesting possibilities!

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