Diversified Pool: Sector looks at new financing options

Sector looks at new financing options

While it is difficult to say that the financing scenario in the road sector has improved, it has certainly been evolving in recent times. With a diversified mix of funding sources and the ever-increasing involvement of global investors, the sector has managed to see an increased investment flow. Asset recycling, both in the form of acquisitions and monetisation, has been on the rise. While investors initially eyed only operational assets, under construction assets too are on their radar now. The toll-operate-transfer (TOT) model is being acclaimed as the mainstay of the huge financing needs of the Bharatmala programme. However, the National Highways Authority of India’s (NHAI) precarious financial health has been acknowledged for quite some time now. While the Ministry of Road Transport and Highways (MoRTH) has constantly reiterated that there is an abundance of funds in the sector, NHAI’s financial capabilities have come under the scanner. Nonetheless, concerns of the authority’s mounting debt burden have been rejected by the ministry and the authority as well.

From the treasury

Huge investments have been made in the road sector with total investments increasing by more than three times from Rs 519 billion in 2014-15 to Rs 1,588 billion in 2018-19. Budgetary support accounted for 48 per cent of the investments in 2018-19 and internal and extra budgetary resources (IEBR) accounted for 39 per cent with private investment accounting for 14 per cent

Funds amounting to Rs 830 billion were allocated to the MoRTH under Union Budget 2019-20. The allocation for central sector schemes/projects stood at Rs 827 billion, marking an increase of 5.56 per cent over Rs 785 billion in the previous fiscal year. During 2018-19, IEBR of Rs 620 billion was approved, against which Rs 612 billion was raised through long-term borrowings, which include funds from the Life Insurance Corporation of India (LIC), banks, the National Social Security Fund and bonds. In 2019-20 the approved IEBR is Rs 750 billion .

The “extra” budgetary sources

In the wake of the government failing to provide the necessary resources for highway development, NHAI, in August 2018, signed an MoU with the State Bank of India for an unsecured loan worth Rs 250 billion. The loan will be provided for a period of 10 years with a three year moratorium on repayments. It is the largest one-stroke loan to have been sanctioned to NHAI by any institution. The authority also signed an MoU with the National Investment and Infrastructure Fund. The MoU is related to cooperation in the formation of special purpose vehicles (SPVs) to execute the fund arrangement for large size road projects, particularly greenfield projects, to be executed by NHAI in the future. Meanwhile, as per reports, LIC has offered a line of credit (LoC) worth Rs 1.25 trillion to the authority to fund highway projects. The LoC is valid through 2024. The borrowings from the LIC will be in the form of bonds to be issued by NHAI. These funds will be used to finance the Bharatmala programme.

Financial closures – Relatively easy to achieve

The growth in bank credit to the road sector has decelerated in the past three-four years. Credit growth turned negative in 2017-18 on account of the mounting stress on the banks’ books. However, the gross bank credit deployment to the sector grew marginally during 2018-19 and 2019-20 (April-May 2019). However, the hybrid annuity model (HAM) has renewed the confidence of banks. HAM-based projects awarded in the past few years have seen active interest from lenders. So far, 70-75 per cent of the awarded HAM projects have achieved financial closure.

Focus on being asset wise

Asset recycling is being considered as the next logical step for the country’s burgeoning investment needs. Amidst a slowing economy, Union Budget 2019-20 has laid emphasis on investment-led growth. To this end, asset monetisation and recycling is an important mechanism for raising funds. The two successful models for asset monetisation implemented in the country are infrastructure investment trusts (InvITs) and TOT.

TOT is a good mechanism for professionalising assets and freeing up government capital. The first bundle of nine highways spanning a length of about 680 km was monetised successfully for Rs 98 billion. However, the second bundle received a lukewarm response from investors and is being remodeled. Meanwhile, the third TOT bundle, spanning about 566 km, has been put on the block.

NHAI recently organised a road show for TOT Bundle III, which comprises nine stretches spread across 566 km in Uttar Pradesh, Bihar, Jharkhand and Tamil Nadu, and will have much lower capital works (about Rs 4 billion lower) compared to previous TOT bundles. Besides, about 43 per cent of the bundle length is under annuity for 8-10 years. The authority has invited private investors to bid for the highway project bundles and come up with innovative investment models for the sector.

InvITs are slowly gaining acceptance in the country. Investors that had earlier adopted a wait-and-watch approach are more optimistic today with growing knowledge about the product as well as various encouraging regulatory changes made by the Securities and Exchange Board of India. Till date, IRB Infrastructure Developers Limited, Oriental Structural Engineering Limited and L&T Infrastructure Development Projects Limited have listed their assets under InvITs. While private players have started tapping this route for deleveraging their balance sheets, the time is ripe for the government to consider the route for raising funds too.

With regard to asset acquisitions, investors have shown a clear preference towards acquiring operational assets with stable cash flows over under-construction assets. However, they are making efforts in developing capability and expertise to manage under-construction assets before testing the waters. Moreover, they are more comfortable in taking central government counterparty risks than state government risks. Industry experts believe that the pipeline of operational assets will remain robust for the next two years.

Long-term investors (pension funds, sovereign wealth funds [SWFs] and private equity [PE] players) are eying the stressed assets space for which they have entered into partnerships with domestic financial institutions to set up stressed asset funds or asset reconstruction companies. Since the infrastructure sector (including roads) accounts for close to 20 per cent of the total stressed advances of banks, there are significant opportunities for long-term investors to turn around assets and book returns.

Diversified funding mix in sight

Banks continue to be selective in their approach towards the road sector. However, they have no reservation in funding HAM projects. The challenge lies in cases where sponsors/concessionaires have no prior experience in executing projects. However, some reluctance can be seen among public sector banks due to sectoral caps, high stress, etc. While lenders are looking at the TOT model, there are concerns related to the long concession period. Forecasting traffic and inflation growth is very difficult, thereby impacting revenue estimates. Thus, a lower concession period of 15-20 years has been recommended for the TOT model. Meanwhile, most lenders are reluctant to finance greenfield build-operate-transfer projects. They are refinancing operational toll road projects with caution. The Reserve Bank of India has advised banks to not lend to InvITs. The fundamental reason behind this is to tap investors such as PE and SWFs for funds. However, the lender community is comfortable in taking exposure to an InvIT through the SPV as the debt level is low and the rating is AA and above.

In a nutshell, efforts on part of the government have gone a long way in re-establishing confidence and enthusiasm of lenders in the road sector. Going forward, the sector’s long-term financing needs can be taken care of by attracting patient capital. Apart from focusing on newer models for the government to raise funds, it is also important to encourage alternative sources such as bonds, non-banking finance companies and infrastructure debt funds – particularly for developers – that can supplement traditional financing sources such as commercial banks. While the response from the investor community has been fairly encouraging due to regulatory impediments and financial stress, these products are yet to realise their full potential in the country’s financial ecosystem.