Case 070Asset-backed, project and real-asset lendingHard

A hydro project suffers a 20% cost overrun and a one-year delay. Compute the extra interest during construction, the funding gap and who funds it, and the effect on debt service cover.

The situation

Hemalika Hydro Power is building a Rs 2,000 crore hydro plant funded 70% with project debt, Rs 1,400 crore at 10%, and 30% with sponsor equity, Rs 600 crore. Construction was planned for three years; the debt was then to be repaid over 12 years in equal yearly instalments from cash available for debt service (CFADS) of Rs 300 crore a year. The power purchase agreement runs to a fixed end date.

Geological problems add 20% to the hard cost and delay completion by one year. For simplicity, assume the full Rs 1,400 crore is drawn by the planned completion date and accrues interest through the delay year. The loan agreement says the sponsor alone funds overruns up to 10% of the original project cost, and anything above that is funded 70% by the lenders' standby facility and 30% by the sponsor. The lenders' cash lock-up test is a DSCR of 1.30x.

Your task

What is the funding gap, how is it split, what happens to DSCR, and what would you ask for as a lender?

Quick check

How big is the funding gap?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

The gap is Rs 540 crore: Rs 400 crore of overrun and Rs 140 crore of extra interest during construction; the sponsor funds Rs 302 crore and the lenders Rs 238 crore. Debt rises to Rs 1,638 crore and DSCR falls from 1.46x to 1.25x, below the 1.30x lock-up. Stretching repayment to 15 years restores 1.39x. The delay also costs a year of revenue, Rs 300 crore, that never returns.

Step 1Why does a delay cost twice?

Think of a family building a house on a loan while paying rent elsewhere. If the builder is a year late, the family pays another year of loan interest and another year of rent, and the house is still not earning anything for them. A late project pays interest for longer and starts earning later, so a delay hits both the cost of the project and the cash that repays it. For Hemalika, a year of interest during constructionInterest that accrues on project debt before the plant earns revenue; it is added to the project cost and funded like any other cost. on Rs 1,400 crore at 10% is Rs 140 crore. And because the power purchase agreement ends on a fixed date, the year lost at the start is a year of Rs 300 crore of CFADS lost for good.

A construction delay costs twiceYear 0Year 1Year 2Year 3Year 4PlanBuild: Rs 2,000 croreRevenue from year 3ActualBuild: Rs 2,400 croreDelay yearRevenueCost 1: interest keeps runningRs 1,400 crore of debt x 10% for one moreyear of construction = Rs 140 croreadded to the project costCost 2: revenue starts a year lateRs 300 crore of cash for debt serviceis lost for the year; with a fixedconcession end, it never comes back
Planned revenue from year 3 slips to year 4, so Hemalika pays Rs 140 crore more interest during construction and loses a year of Rs 300 crore of cash flow, on top of Rs 400 crore of extra building cost.
Step 2How is the Rs 540 crore split?

Follow the loan agreement's order. The sponsor funds the first 10% of the original cost, Rs 200 crore, alone; the remaining Rs 340 crore is split 70:30, Rs 238 crore from the lenders and Rs 102 crore from the sponsor. The sponsor puts in Rs 302 crore in all, the lenders Rs 238 crore. Debt rises from Rs 1,400 crore to Rs 1,638 crore and equity from Rs 600 crore to Rs 902 crore; the project now costs Rs 2,540 crore with debt at 64.5%. The sponsor's first-loss share is why lenders insist on that clause: it makes the sponsor pay for the risks it is best placed to manage.

Rs crorePlanAfter overrun and delayAfter, 15-year repayment
Project cost2,0002,5402,540
Debt1,4001,6381,638
Equity600902902
Yearly debt service at 10%205.5240.4215.4
CFADS300300300
DSCR1.46x1.25x1.39x
Debt service on Rs 1,638 crore over 12 years rises to Rs 240.4 crore, taking DSCR from 1.46x to 1.25x; spreading it over 15 years cuts the payment to Rs 215.4 crore and DSCR recovers to 1.39x.
The gap, who fills it, and what it does to coverFunding gap, Rs croreOverrun 400Interest 140540Sponsor302Lenders238GapWho funds itDebt service cover (DSCR)Plan: 1,400 over 12 years1.46xAfter: 1,638 over 12 years1.25xAfter: 1,638 over 15 years1.39x1.30x lock-upSponsor funds the first Rs 200 crore alone, then 30% of the rest; lenders fund 70% of the rest.
The Rs 540 crore gap is funded Rs 302 crore by the sponsor and Rs 238 crore by the lenders, and the larger debt pushes DSCR from 1.46x to 1.25x, under the 1.30x lock-up, unless repayment is stretched to 15 years for 1.39x.
Step 3What would you ask for as a lender?

Stretching the tenor fixes the ratio but not the risk, so pair it with more equity, not instead of it. A 15-year repayment brings DSCR back to 1.39x only if the power purchase agreement and the plant's life comfortably outlast year 18; check that tail. Ask the sponsor to fund more than its contractual Rs 302 crore, perhaps enough to hold debt at 65% of the new cost, and ask for a debt service reserve account of six months, so a weak monsoon year in the early operating period does not trigger default. Finally, the geological cause matters: if the problem is solved, this is a one-off; if the tunnel is still uncertain, the lenders should hold back the standby facility until an independent engineer signs off.

Where candidates lose it

The common miss is counting only the 20% overrun and forgetting interest during construction. A year's delay on Rs 1,400 crore at 10% adds Rs 140 crore that has to be funded before a rupee of revenue arrives.

The second is treating the delay as a timing shift only. When the contract ends on a fixed date, a year lost at the start is a year of cash flow lost for good, and the debt has to be repaid from what remains.

What the interviewer asks next

  • What if the sponsor refuses to fund above its contractual share? What can the lenders do?
  • How would you size a debt service reserve account for a hydro plant with seasonal output?
  • The tariff allows the extra cost to be passed through after a regulatory review. How does that change your view?
  • How would you insure against geological risk at the outset?

Company names and figures are illustrative.