Powering infra through refinancing

Solar and highways are set to drive fresh investments over the next two years

The government’s goals of reaching renewable energy generation of 175GW by 2022, speeding up the construction pace in roads and bridging the infrastructure deficit along the length and breadth of the country are headline-worthy initiatives.

A report of the Global Infrastructure Hub (GI Hub) indicates that the government’s spending in rail and electricity is strong. The country needs over $3.9 trillion till 2040 under the current investment trends and to improve performance across its peer group, the investment needs to jump to $4.5 trillion.

Bank funding

Private investments and bank funding have played a pivotal role in the growth story of Indian Infrastructure.

Bank funding is a principal source of debt financing for most infrastructure projects. This has been continuously falling due to sectoral caps and the absence of large-scale projects. Fund-guzzling road projects and thermal project awards have slumped due to the weak sector sentiment.

Notwithstanding the softened interest rates, infrastructure projects have always commanded high interest rates during the pre-commissioning period, contrary to investors’ expectations.

Bankers have traditionally absorbed the construction risk and made way for the project to graduate to the capital market. The National Highways Authority of India’s (NHAI) annuity projects and stray toll projects have tapped the capital markets successfully in the past.

However, toll projects continue to grapple with uneven traffic growth and rocky inflation, thereby placing the project under cash-flow risk.

While in mature toll roads, 6 per cent y-o-y traffic growthcommensurate with economic growth could comfortably meet debt service needs, project companies rated in the sub-investment grade categories will be required to grow at 9-10 per cent continuously to meet debt service as per India Ratings and Research’ (Ind-Ra) FY18 Infrastructure Outlook.

Hybrid annuity model

The new format, namely hybrid annuity model, was launched to rejuvenate the road sector and lessen the equity burden on the already stressed developers.

Although lenders are gradually getting familiar with the contract structure, the low equity component in these projects will weigh on the funding decisions and the lenders may be caught off guard over the projects’ period.

In view of execution delays in the first phase of road PPP projects, the authority bids projects only after 80 per cent of the land acquisition is completed, which will arrest the cost overruns.

On the other hand, renewable projects typically enjoy a fairly short construction period because of the modular nature and the near full availability of land prior to construction.

The aggressive bidding culture reminiscent of toll roads has created jitters among the lending community. The non-performing assets in roads and power not only stem from external factors like inflation associated risks, delays in permits and approvals but also from the sub-optimal financial structures, namely, absence of working capital lines to meet counter-party payment delays, inadequate contingency cost provisions and funded debt service reserves.

Operational risks in power projects largely emanate from the structural weakness in state power utilities/discoms. Several renewable energy projects are embarking on capital market transactions; at this juncture, the counter-parties’ insensitivity to the projects will not only jeopardise the potential issuances that can help deepen the infra-debt markets but also add a premium, which has become an accepted practice for renewable energy projects.

Financial re-engineering or restructuring is unlikely to yield the desired results unless coupled with plugging of the operational lacunae.

Given the growth of infrastructure projects in the past decade, the time is ripe for refinancing of these projects and the sector has already taken it up.

Investment trust model

Ind-Ra estimates the refinancing opportunity at over ₹560 billion out of the total debt of ₹1,730 billion across various infra sub-sectors in its portfolio till FY19. Of this, solar is expected to be in the forefront (in terms of the number of deals) with refinancing to the tune of 33 per cent, followed by 27 per cent in the highway sector. Increasingly, developers or new sponsors have attempted to align their repayments with cash inflows through a new debt structure.

While we believe that the infra-debt market will deepen with an even demand from investors for all the risk categories, appetite exists only for highly rated instruments. Hence, project companies explore innovative structures to refinance their existing debt.

Also, debt-laden sponsors have gradually embraced the investment trust model, launched a few years ago, by cherry-picking projects with reasonable operational performance to refinance and trim the debt loads.

Sponsors with sizeable operating projects in roads and power are the likely beneficiaries of this model. InvITs not only free up the locked equity capital for sponsors but also enhance project sustainability.

While undertaking refinancing or bank funding or accessing the capital market, comprehensive risk management is a prerequisite. That’s because bad decisions are difficult to reverse and all that has worked in the past may not apply forever.

R Venkataraman is Senior Director, Siva Subramanian, Associate Director and Divya Charen C, Senior Analyst – Infrastructure Ratings, at India Ratings & Research

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