At present, banks are loaded with liquidity, and many investors are seeking high-rated projects. While banks prefer AA and AAA credit ratings, they are willing to accept A-rated projects as well. Banks have surplus funds to invest, and they are looking at refinancing good rated projects, particularly completed projects with one to two years of operational history.
Interest rates are on the verge of hitting a record low (these rates are projected to rise in the future). Hardly any capital expenditure has been made in the past year by the private sector. Thus, at least a dozen deals ranging from Rs 20 billion to Rs 50 billion have been executed, in which a number of banks have stepped in and provided competitive refinancing rates. This situation will persist for at least the next few quarters until the new capital expenditure cycle kicks in. Till then, refinancing will continue to increase.
Following Covid-19, the development and resilience of toll road projects resulted in a series of transactions with private equity groups. Private equity players have attempted to refinance existing lenders at a lower cost and with a rescheduled repayment model. This also serves as the basis for refinancing. Then, there is the possibility of future expansion, similar to what is unfolding post-Covid. Individuals have begun to understand that the expected rate of growth is larger than previously anticipated. As a consequence, the transactions are designed around a higher growth rate model, and refinancing is taking place to maximise the internal rate of return (IRR). Nonetheless, the current low interest rate environment also favours refinancing.
After a project has been operationalised, up financing is sought. As an outcome, the debt level is increased to enable the repatriation of surplus funds to offer return to equity owners. Another rationale is that when equity investors take the initial loan during the construction phase, certain loan terms such as the security package or covenants are not entirely satisfactory. Thus, refinancing entails not only obtaining cash and lowering costs, but also negotiating more reasonable debt limits or covenants.
Regarding hybrid annuity model (HAM)-based projects, the refinancing rates currently available are all based on either the repo rate or the MCLR (marginal cost of funds based lending rate), both of which are expected to climb. Thus, this works well for HAM projects, as they are insulated against inflation and interest rates in the future, allowing any rise or decrease to be passed on. However, for non-HAM projects, particularly in the solar sector, solutions such as fixed rate loan terms for a reasonable time period are being looked at to lower risks associated with interest rate fluctuations. Besides, there is a significant amount of refinancing through infrastructure investment trusts (InvITs). India Infrastructure Finance Company Limited (IIFCL) added two products to its offerings – the first is InvIT funding and the second is bond funding. Since the Reserve Bank of India permitted IIFCL to invest in infrastructure bonds and categorise them as loans, long-term infrastructure bond financing has now been made available.
Sector trends
The road sector is witnessing a lot of action with respect to refinancing through InvITs. The highest number of InvITs are present in this sector with more coming up. Refinancing is also being explored in the real estate sector, particularly commercial real estate assets that have already been leased out. There
have been few major deals, owing to the reluctance of banks to engage in under-construction real estate projects. There have been a few refinancing agreements in the manufacturing sector. It is both an elongation of the tenor and a cost reduction.
In toll roads, the primary reason for refinancing is that the growth model has changed. There is a higher expectation of toll than was previously anticipated. Once the EPC contractor decides to exit a road project and invest its equity in under-construction road projects, the project is transferred to a private equity player, which is where the refinancing occurs. Meanwhile, under construction HAM projects are being financed at a debt equity ratio of 70:30. In a low interest rate regime, promoters want a top-up based on the expected cash flow for such projects once they are completed.
When a Powegrid transmission project is foreseen at, say, 70:30 debt equity ratio during construction, it is more of an annuity-based model, and more top-up is required so that the equity is released. If these transmission projects are transferred to an InvIT, debt refinancing occurs. In case of a solar project that is under development, the predictions of lenders are based on a 90 per cent probability that the sun will shine and the power will be generated. However, based on these projects’ one-year performance, it has been observed that the generation is greater than what was envisaged and thus, in order to harness this kind of cash flow, refinancing occurs. Besides, there are a few other deals taking place in port and telecom projects.
Debt refinancing avenues
In the future, the renewable energy industry will see an increase in the number of InvITs. This is because, in today’s renewable energy market, the majority of lenders are chasing projects that have SECI-based, NTPC-based or GUVNL-based PPAs, as this is where the bulk of financing happens. Individuals seeking to refinance a solar installation in Andhra Pradesh, Tamil Nadu, or Rajasthan on a standalone basis face severely restricted refinancing opportunities. This is due to the absence of a payment track record. However, from the standpoint of an InvIT or a private equity firm, a portfolio must be managed with mentioned returns to equity holders.
As a result, there is a possibility of a few SECI-based projects being blended with some of the discom projects in order to get a good return, and when a proposal for an aggregation comes up, the odds of achieving AAA rating or AA+ rating increase because of a cash flow pooling concept. This has occurred mostly in the road sector, but will soon happen in the renewables space as well.
Furthermore, evidently there is a focus on environmental, social and governance issues along with no carbon emission projects becoming institutionalised in the country. Gradually, green funds will come into the picture to pursue these types of projects, and while they are currently financing them on an individual project basis, they will also take the path currently taken by the road sector.
Going forward, as InvITs are analysed more closely, a concern arises. According to regulations, any listed InvIT that needs to raise debt greater than 49 per cent of the asset value must have an AAA rating, which requires meeting extremely stringent covenants such as the debt service coverage ratio. It is uncertain how long InvITs will continue the AAA rating. Besides, once the assets move beyond the SECI or NTPC counterparty, down to discoms, it may be challenging.
Taking into consideration a situation where debt levels are restricted at the InvIT level, the unit holders will take a hit as they suffer a lower leverage. There is a need for evaluation that must take place on a case-to-case basis to recognise the quantum of the debt refinancing potential.
The initial InvITs were only funded by private banks like ICICI Bank and Axis Bank. The State Bank of India (SBI) has recently emerged as a major player. Barring this, there is a limited number of public sector banks, private banks, infrastructure debt funds and mutual funds available in the market. There has been limited participation from the Employees Provident Fund Organisation. Life Insurance Corporation of India is also yet to participate and invest in the product.
The Securities and Exchange Board of India has created an enabling regulatory framework for InvITs, instilling confidence among all stakeholders. There are two forms of listed InvITs – private listed InvITs and public listed InvITs. For privately listed InvITs, one possibility is to eliminate the requirement of high leverage and AAA rating. It should be discussed between unit holders and lenders, who have their own underwriting committees.
Based on a panel discussion among Subhendu Moitra, Chief Credit Officer, IIFCL; Vishal Gupta, Senior Vice-President, SBI Capital Markets Limited; Prashant Murkute, Vice-President and Group Head of Corporate Credit Department, Axis Bank; and Akshay Gupta, Executive Director, Infrastructure Funds, Kotak Investment Advisors Limited at a recent Indian Infrastructure webinar on debt refinancing.