Finding Favour

Viability, potential and refinancing prospects under HAM

The hybrid annuity model (HAM) has been witnessing steady uptake since its debut in January 2016 and in recent years, HAM awards have surpassed all other types of awards. The award percentage of HAM projects is expected to remain between 40 per cent and 50 per cent in the future as well. HAM will be the primary model used to award contracts un­der the public-private partnership (PPP) route. While engineering, procurement and construction (EPC) will also continue to do well, the Na­tio­nal Highways Authority of India (NHAI) pre­fers the HAM approach for awarding contracts. A total of 229 projects have been awarded, excluding those that were discontinued owing to the lack of right of way (RoW) one year after the date of award. When the deed termination clauses of the concession agreement were drafted, project developers had insisted that this be included. HAM’s attractiveness stems from its similarity with the EPC and conventional build-operate-transfer (BOT) models.

HAM’s viability

Under HAM, 80 per cent RoW is guaranteed. In nearly 90 per cent of projects, RoW has not been an issue and whenever a hurdle has arisen regarding this, NHAI has responded constructively. Similar to an EPC contract, there is a provision for mobilisation advances.

The overall equity requirements under HAM are also substantially lower, in the range of 10-15 per cent depending on the developer’s stren­gth. In the majority of cases, it is 12-15 per cent. Additionally, in a first, the government has included compensation provisions such as deed termination and termination fees for even the pre-construction phases of development, despite the fact that termination payments have historically been made only after the project reaches its commercial operation date (COD).

Bidding scenario

The overall bidding trends for HAM show that out of the total 229 projects awarded so far, 95 per cent have been bid at a premium-to-base price of the authority while 5 per cent have been bid at a discount price to the base price. The top five developers – Dilip Buildcon, PNC Infratech, Ashoka Buildcon, Ashoka Concessi­o­ns and H.G. Infra Engineering – have a 36 per cent share in terms of the awarded length under HAM.

A noteworthy development is that during the past four to six quarters, most EPC projects have been awarded at a substantial discount to NHAI’s base price. This is inducing developers to move away from the EPC mode towards BOT-HAM. This further explains the increased number of bidders for HAM projects. The price differential between NHAI’s estimate and the bid project cost has shrunk, which explains why developers are turning away from EPC projects for HAM projects. This has resulted in an inc­rea­sed number of bidders for every bid, which also affects the price at which players are bidding. Overall, am­ong the awards thus far, only 5 per cent of projects have been bid at a discount to NHAI’s price.

Financial closure update

Almost 75 per cent of HAM projects awarded till February 2022 have achieved financial closure (adjusted for projects awarded in the previous fiscal year, as some have not yet received an appointed date or would have achieved financial closure but have not yet been publicly declared).

A significant distinction between HAM and conventional BOT projects is the permitting risk. Permitting risks are reduced significantly as a result of the RoW being made available in ad­vance. Additionally, lenders have insisted on certain undertakings that are usual for any project finance transaction. During the development ph­a­se, upfront equity is infused, as this clause is contingent on the developer’s reputation and market standing. If the developer has a strong st­anding, the upfront equity infusion is relatively minimal; however, for less-known developers, the upfront equity infusion could be as high as 50 per cent, with the rest to be infused within a specified term. Addi­tio­nally, the developer is expected to fund any cost overruns.

For instance, until a debt service reserve account (DSRA) is created, sponsors typically provide an undertaking that they will cover any shortfall in the creation of the DSRA, particularly in projects where the DSRA is not included in the project cost. However, if the DSRA is included in the project cost, it is created concurrently with the InvIT infusion through disbursement; otherwise, if it must be made from the operating cash flow or if there is a deficit, the sponsor undertaking often covers it. In some instances, the sponsors extend commitments to cover debt payments as well, at le­ast until the project stabilises. Operations and maintenance (O&M)-related expenditures are a regular occurrence, where these exceed the anticipated amount as part of the initial base case model provided to the lenders. If the am­ount exceeds that, the sponsor will provide an undertaking.

Risks in consideration

When the entire project life cycle is taken into account, what is also considered is how risk transforms from the under-construction period to the operational period.  During the construction phase, there are several risks, including ex­ecution and permitting risks, although at a re­duced level. There have been isolated instan­ces where RoW availability is significantly lower than the minimum condition of 80 per cent sta­ted in the concession agreement.

As the project advances, the critical milestone to monitor is the 75 per cent completion mark, at which point the project enters the ad­vanced stage of construction. Once the project reaches the provisional COD (PCOD), a substantial shift in risk occurs, as there is increased insight into revenue and execution issues.

Unlike conventional annuity projects, where the annuity amount is the bidding criterion, here the bidding parameter is the net present value of the bid project’s cost along with O&M cost. As a consequence, annuity is derived from the completion cost, which is why it is equally significant.

Refinancing opportunities

So far, 54 projects totalling 3,672 km with a to­tal debt of Rs 265 billion have achieved PCOD. Additionally, in the next 24 months, 83 projects totalling 3,434 km with a total debt of around Rs 450 billion are expected to achieve PCOD. Many of these would be on the lookout for bond issuances in case the rates are in line with their expectations.

Significant adjustments have been made to the HAM model concession agreement. For the clause “payment during const­ru­c­tion”, several significant amendments have been made, in­clu­ding 10 instalments of 4 per cent each eq­ualling 40 per cent of the bid project cost (ad­justed for price index multiple), a first payment milestone at 5 per cent phy­sical prog­ress, and a tenth payment mile­sto­ne at 90 per cent physical progress.

With regard to “interest on annuities”, in­terest will be due and payable on the reducing balance of completion costs at a rate equal to the average marginal cost of funds-based lending rate of the top five scheduled commercial banks plus 1.25 per cent.

Based on a panel discussion with Rajeshwar Burla, Group Head, Corporate Ratings, ICRA Limited, at a recent Indian Infrastructure webinar

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