The hybrid annuity model (HAM) was launched in 2016, seeking to revive private sector investment in the road sector that had dried up due to the inability of the build-operate-transfer model to attract investors. In its early days, HAM appeared to be a lucrative option for private investors seeking to share financial risk with the government. Consequently, the share of HAM in the National Highways Authority of India’s (NHAI) award activity increased substantially from about 8 per cent in 2015-16 to about 53 per cent in 2016-17. The interest in HAM seems to have moderated now, and this is partially attributable to developers having their portfolios full with HAM orders and also to the overall moderation in project award activity. The market for HAM has been a fairly closed one with the majority of projects being awarded to a mix of five to six key players. Delays in land acquisition combined with funding constraints faced by private developers have been among the prime reasons for the slow pace of project award and increasing project terminations. Nonetheless, an emerging trend is the acquisition of HAM assets by financial investors. This will free up equity with the developers and allow them to bid for new projects. Meanwhile, the Ministry of Road Transport and Highways on its part is making attempts to deal with the pre-construction issues and avert the potential cost and time overrun crisis.
Bidding scenario under HAM
The bidding scenario under HAM has displayed quite a skewed trend, with large players bidding much more aggressively for road projects compared to smaller players. Besides, the bidders have been quite prudent with respect to HAM projects, resulting in no more than 5-10 bids being received for the projects, and the lowest bids being about 15 per cent higher on average than NHAI’s estimated engineering, procurement and construction (EPC) costs. The competitive intensity for HAM projects, in particular, has reduced on account of a large order backlog created by the companies over the past two years. As banks are cautious and tend to shy away from projects not backed by experienced sponsors with strong financials, only developers with healthy financials are bidding for HAM projects. Also, a limited number of players have the capacity only to bid for more projects.
Trends in financial closures
Delays in achieving financial closures have been among the key issues faced during the implementation of HAM projects. However, the problem started surfacing only after 2017-18. With regard to financial closures, a sample of 41 HAM projects spanning 2,244 km has been tracked by India Infrastructure Research. The analysis shows that initially financial closure of HAM projects was relatively easy, hence there was a delay of only five-eight months. However, with the lending freeze on public sector banks and a few issues with HAM now surfacing, financial closures have become difficult, thus explaining the over 10-month delay. Some bidders have won a disproportionate number of projects and as a result they now have orders that add up to over three times their annual revenue, creating difficulties in achieving financial closure. Road developers have been facing difficulties in obtaining loans and bank guarantees due to low equity requirements on the part of the developer under the model. As a result, smaller developers, many of which have switched from EPC to HAM for the first time, are struggling to secure funding after bidding aggressively and banks tightening capital requirements. Apart from securing sanctions for term loans, availing of bank guarantees is also a big challenge for construction companies, considering their large order book. Availability of bank guarantees has also been constrained due to weaker health of public sector banks and increased risk perception of banks for non-fund-based limits. This is on account of the unconditional nature of bank guarantees, large exposure of construction companies to non-fund-based limits as compared to fund-based limits and limited cash flow cushion available to honour bank guarantees in the case of its invocation. Apart from this, the falling bank rate has started to impact the cash flow streams of HAM projects as the corresponding reduction in the cost of borrowing has been slow.
Land acquisition issues
Despite a number of HAM projects being able to tie up funds, nearly one-third of them are still awaiting appointed dates on account of delays in land acquisition or regulatory clearances. The cost of land acquisition has increased steadily from Rs 13 million per hectare in 2015 to Rs 28 million per hectare in 2018. Further, the government does not accord the mobilisation advance until the appointed date is fixed, and that is announced only after the government secures 80 per cent right of way for a project. Although 80 per cent land availability offers an edge for swifter project completion, the delay in providing encumbrance-free land continues to weigh on the road sector.
Even though there is a provision that allows for descoping unavailable land from the overall project and issuing a partial completion date if the developer completes the project on the available land, disputes between the developer and the government often hinder a quick resolution. Quick reassessment and approval of revised bid project cost post descoping of the unavailable land poses a challenge from a credit perspective as delays in the former can result in deferral in term debt disbursement by lenders and in turn impede project progress.
An emerging trend – Acquisition by financial investors
There has been an emerging trend in terms of the acquisition of ongoing HAM projects. Private equity players are eyeing these projects with the idea of diversifying their portfolio of traffic-linked toll roads. Further, their in-house project management and engineering teams will closely monitor all phases of construction to ensure that the projects are completed on time and within budget. Recently, Cube Highways acquired two under-construction road projects owned by KNR Constructions Limited and five HAM projects owned by Dilip Buildcon Limited. Meanwhile, Canadian pension fund Caisse de depot et placement du Quebec and Sekura Roads are in talks with GR Infraprojects to acquire the latter’s seven ongoing HAM road projects.
HAM for the future?
The future outlook for HAM does not seem too promising. That said, with BOT still absent from the market while the industry awaits tweaks to the model, a robust mix of EPC and HAM projects is the way forward. Banks, on their part are likely to continue to be selective in funding infrastructure projects due to liquidity constraints and pile-up of sour loans. In addition, most of the developers have stretched balance sheets that will make financial closures difficult to come by. These factors, combined with prudent bidding, will re-duce the share of HAM projects in the overall pie of project awards in the next few quarters. With the first round of HAM projects likely to achieve completion in the near term, these are best suited for acquisition by investors. Though an opportunity area for global investors, the delay in transmission of bank rate cuts can disrupt cash flow streams, in turn, lowering equity returns to investors. Moreover, the delay in execution of some projects due to slow equity infusion from weak sponsors and land acquisition issues will further wane investor interest in the segment.
Further, the quality of independent engineers and authority engineers has not been up to the mark. To address this issue, the government has already appointed monitors and initiated third-party quality checks. In addition, there is a need to undertake skill development for improving the quality of design and safety consultants. In the wake of funding concerns, the government must take a pragmatic view towards awarding projects on HAM and decide on a suitable portfolio based on a mix of different contracting modes. There is also a need to evaluate projects on a case-to-case basis.
Rolica Bhatnagar with Deeksha Soni