Standard & Poor's Ratings Services said that it had revised its outlook on India-based power utility Tata Power Co. Ltd. to negative from stable. At the same time, we affirmed our 'BB-' long-term corporate credit rating on Tata Power and our 'BB-' issue rating on the company's senior unsecured notes.

"The outlook revision reflects our expectation that Tata Power's cash flow and financial risk profile could deteriorate over the next six to nine months because the company has breached a debt-to-equity ratio covenant on loans to its Mundra project," said Standard & Poor's credit analyst Rajiv Vishwanathan. "The availability of loans to the project, which Tata Power's 100%-owned subsidiary Coastal Gujarat Pvt. Ltd. (CGPL) controls, could therefore be limited."

The outcome of Tata Power's negotiations with lenders on the technical breach in the loan covenant is yet to be finalized. In the absence of the waivers, CGPL will not be able to avail of the loan facility once its drawdown reaches the currently approved level of 83% of the project facility. Nevertheless, we understand that current disbursements from project facilities have not been curtailed. In our view, Tata Power is likely to receive waivers from lenders to the project.

Tata Power has booked an impairment in CGPL assets resulting from a sharp depreciation of the Indian rupee against the U.S. dollar over the past 12 months. The currency depreciation has also increased CGPL's foreign currency debt. The reduction in CGPL's equity and its higher debt resulted in the breach of the debt-to-equity ratio covenant.

We may lower the rating on Tata Power if: (1) the company is unable to secure a waiver from its lenders on the breach of covenant; or (2) an increase in expenditures due to the Mundra project or otherwise substantially weakens Tata Power's financial risk profile. A ratio of funds from operations to adjusted debt of less than 10% on a sustainable basis would indicate such deterioration.

We may revise the outlook to stable if Tata Power: (1) secures the necessary waiver, and construction at the Mundra project continues as planned and within budget; (2) faces no material deterioration in its business and sustainably maintains its financial risk profile, such that its ratio of funds from operations to adjusted debt is 10%-12%.

"In our view, limited availability of project loans will increase Tata Power's project expenses because the company is likely to fund the construction of the remaining units of the Mundra power plant," said Mr. Vishwanathan. "This also increases the uncertainty over the timing of commissioning of some units of the power project."

The Mundra project also exposes Tata Power to a risk that coal prices could increase because the company can only partially pass through fuel costs to customers. Tata Power's stakes in coal companies provide a natural hedge to higher coal prices and support its cash flows. Nevertheless, the hedge does not fully eliminate the company's exposure to coal price volatility. Tata Power is negotiating with bank lenders a mechanism to include the cash flows from the coal companies in the calculation of financial covenants for the Mundra project.