Road Financing: Evolution, experience and future outlook

Evolution, experience and future outlook

Banks have been the conventional loan providers for road projects in the country. However, in the past few years, several long-term investors have emerged in the market. These institutional investors put their money into operational assets for a longer period of time. Their preferred routes of investment are toll-operate-transfer (TOT) bundles, or acquisition of a portfolio of operational road assets. In the case of investment in TOT bundles, investors gain the right to collect tolls from the road project for a long duration while also operating and administering the asset. This is in exchange for a hefty one-time payment by the investors to the government. In the other investment option, they can purchase a portfolio of road assets that have been constructed, with operations already started by the developers.

The National Highways Authority of India (NHAI) has begun to look at asset monetisation on two tracks, one through TOT projects and the other through infrastructure investment trusts (InvITs). In the next five years, NHAI plans to raise Rs 1 trillion by monetising highways under the TOT model. Meanwhile, the Securities and Exchange Board of India has given NHAI approval to launch its first InvIT to raise Rs 51 billion. NHAI’s decision to directly monetise road projects as they become operational is a huge step that will give a lot of confidence to all market participants. With the amount of revenue NHAI is generating through TOT and InvITs, rising debt will not be a matter of concern and will remain sustainable in the near future. In fact, there will be more cash in the system for long-term investments in the road sector. Through all of these efforts, NHAI has created a road map for raising more capital for its future requirements.

Recent developments

The road sector has witnessed significant progress in recent years, owing to NHAI’s concentration on promoting hybrid annuity model (HAM) projects. HAM projects were launched to revive public-private participation in the road sector after interest in BOT projects dwindled. These projects ensure the proper allocation of risk among all the stakeholders. However, declining bank rates have led to project refinancing risks for older HAM projects. The amount of annuity will be lower, as it is directly linked to the bank rates. There will undoubtedly be headwinds in the road sector.

The state governments have a critical role to play with respect to ensuring last-mile connectivity as well as providing optimum locations for logistics-related infrastructure. The state sector has undertaken a number of road projects, contributing substantially to road sector development. Most lenders have recently been exposed to sectoral exposures. Previously, public sector banks had no sectoral exposure, but this has begun to change. The difficulties that lenders used to experience in funding road projects, particularly for greenfield road assets, have now been alleviated under the new HAM concession agreement. This has benefited the sector by attracting a large number of financiers.

Private equity firms have been instrumental in developing the road sector. They are considering investing in TOT projects and NHAI’s upcoming InvIT. NHAI has become much more proactive in the sense that certain issues that had been pending for a long time have finally been resolved. For instance, one of the major issues among lenders was the termination payment. That flow has now been improved considerably. NHAI has also come up with a standard operating procedure, which was one of the primary requirements from the lenders’ perspective. NHAI’s overall measures have given the lending sector a lot of confidence.

Lending decisions

The financial wellness of the entity that has won a bid is of key importance to the lender. One of the main factors taken into account while making a financing decision is the engineering, procurement and construction (EPC) contractor’s prior experience in implementing projects. Lenders ensure that new participants that approach them for borrowing funds have 100 per cent upfront equity. The lenders’ community wants NHAI to offer smaller packages for newcomers to the market. As a result, NHAI would be able to categorise projects into “large” and “small”, making project management easier. The lenders are in discussions with NHAI to develop a tripartite agreement structure that would clearly define the rights and responsibilities of all parties involved in the transaction. They also intend to introduce a unique monitoring system – a cutting-edge programme that allows for real-time monitoring through drones and global positioning systems.

In the case of expressway financing, lenders need to move away from their historical methodologies of judging only the traffic numbers. After conducting a comprehensive assessment that includes discounted cash flows for the project, as well as the way railways are expanding their capacity to transport heavy commodities, the financial viability of projects should be visualised. As per the lending community, expressway financing necessitates a strong concession arrangement. Given that it is a new alignment, lenders conduct a thorough traffic study to ensure that the risk is effectively mitigated on their end. As far as the financing of expressways is concerned, lenders generally avoid selecting newcomers as EPC contractors. Projects with optimistic traffic projections and robust concession agreements, and contractors with good construction experience are better able to attract funding.

NHAI is considering relatively new asset monetisation options such as InvITs and securitisation of toll revenues. When it comes to asset pooling and cross-collateralisation of cash flows, an InvIT is a far more secure alternative. It can have both annuity road assets as well as toll road assets. It will also encourage existing private equity investors to reinvest funds in greenfield road assets, in turn leading to increased equity flow in the sector. The road sector has primarily raised funds through loans, but many InvITs are now aiming to raise bonds, which would result in increased exposures. However, the Reserve Bank of India has imposed a restriction, limiting the debt in InvITs to 49 per cent, making InvIT bids stronger.

There has been some sort of refinancing in TOT-1, TOT-3 and TOT-5 projects. There has been a consistent strain on TOT projects, mainly due to the reduction in toll collection last year. Toll projects have been significantly impacted, especially during the first wave of the Covid-19 pandemic, but now traffic is beginning to reach normalcy, and lenders are looking forward to refinancing TOT projects.

Future outlook

Over the past few years, the road sector has seen record construction rates. The government has consistently undertaken a number of policy initiatives, including addressing operational challenges, reviving languishing projects, and providing time-bound dispute settlement. Further, the introduction of novel project implementation models such as HAM and TOT to monetise existing assets, as well as the launch of the Bharatmala Pariyojana, has had a substantial impact. The current emphasis on roads and highways development is projected to continue over the next few years. In addition various opportunities are likely to emerge in the near future. The State Bank of India financed projects worth Rs 220 billion in 2020, and its target for 2021 is Rs 270 billion-Rs 280 billion. In comparison to previous years, the lending community anticipates higher exposure to the road sector in the years to come. This fiscal, the lender community will be primarily focusing on refinancing toll roads and underwriting HAM projects.

Based on inputs from a panel discussion among Ajay Chaudhary, National Head, Project Finance, Wholesale Business Group, L&T Infrastructure Finance; Subhendu Moitra, Chief Credit Officer, IIFCL; and Supratim Sarkar, Executive Vice-President and Group Head, SBI Capital Markets, at the recent “Road Development in India” conference