Minimising of project execution risks and introduction of strong deterrents for non-performers are the only long-term solutions to ensure seamless funding for infrastructure projects, says Srishti Ahuja Taneja, Director, Transaction Advisory Services, Ernst & Young.
Public sector banks like State Bank of India are reportedly reluctant to finance infrastructure projects under the hybrid annuity model (HAM). Your reaction? This is a classic case of 'once bitten, twice shy'. In general, lenders are now more cautious in funding infrastructure projects owing to their experience with several problematic assets over the last decade. The case of HAM projects stands out as the government has gone an extra mile to allay some of the risks that the highway build-operate-transfer (BOT) concession model had in the past. Of the 26 HAM projects awarded till December 2016, less than a third have been able to achieve financial closure.
The key concern that lenders have pertains to the execution capability of some of the winners who are either relatively inexperienced in the BOT space, or have stretched balance sheets. Another big concern that the lenders have is regarding the protection available to them under the HAM concession agreement in case of a termination event, especially during the construction period.
The direct repercussion of this negative sentiment is that it will slow down NHAI's progress in achieving its highway awards target - around 10,000 kilometres of projects expected to be awarded in financial year 2016-17 against the targeted 25,000 kilometres. A natural consequence of this will be that NHAI will give out more projects on engineering procurement and construction (EPC) basis. The agency seems to be gearing towards the same with the recently raised additional capital of Rs 185 billion (from EPFO and LIC via bonds) and the expected value unlocking from assets to be bid out under the toll-operate-transfer (ToT) model. However, this does not augur well for the sector in general, as we will be moving back by several years to the scenario where bulk of the work awarded by NHAI was on EPC basis, with sector players merely focussed on construction and project delivery.
I do feel that the established players with proven track record will regardless be able to achieve financial closure for the HAM projects with ease. One interesting trend here is that private sector banks are becoming active in the space and have backed projects won by some of the established players, lending funds for longer tenures at single-digit interest rates.
Is the lenders' demand of upfront stake increase of promoters from the existing 20 to 40 per cent feasable?
As 40 per cent of the project cost is funded by the authority, assuming an 80:20 debt-to-equity ratio, equity comprises only 12 per cent of the project cost. Further, the concession agreement entails that if the project is terminated due to concessionaire default, the termination payment is only 60 to 80 per cent of the debt due, subject to a maximum of 16 to 32 per cent of the project cost, respectively. Therefore, lenders perceive significant risks in these projects.
Of late, banks have been arguing to increase equity contribution to 40 per cent or 24 per cent of a project's cost. This will ensure participation by only committed bidders with adequate experience and capital. However, this short-term via media will restrict resources of serious bidders to a limited number of projects.
The only long-term solution is that execution risk will need to be minimised through sustained support on speedy clearances and land acquisition, protecting lenders during the construction period through increase in termination payments, etc., and putting in place strict deterrents for non-performing bid winners. Unlike in the past projects, the government will need to play a more active role in ensuring on-the-ground support.
Does this leave infrastructure developers with EPC as the only viable alternative?
EPC is the low-hanging fruit. The projects have limited risk and capital requirements from the private sector's perspective. The entire capital is locked in from NHAI, with the agency also responsible for toll collection and maintenance.
In an ideal scenario, the private sector should focus on undertaking these activities and NHAI should continue to focus on creating more bankable opportunities for the private sector to develop, with the overall objective of creating new and world-class infrastructure for the country. Therefore, the current gradual shift to EPC is not desirable from a long-term perspective.
Also, EPC bids have also been very aggressive, with a few recent bids won at 25 to 30 per cent discount to NHAI's base price. This raises the same concerns that are applicable to BOT projects - sustainability of such businesses and quality of highways being created.
What would be the best way to address concerns pertaining to recovery of funds lent for infrastructure projects?
Prevention is better than cure. The long term and only solution to this is detailed diligence of a project by the developers at the time of bidding and by the lenders at the time of financial closure, and avoiding the temptation of bidding aggressively. The key risks for highway projects are execution and tolling. Delay in project execution leads to significant increase in interest during construction, while reducing the concession period to service debt. Further, toll projects have an inherent risk that actual revenues may be lower than projected and this may impair debt serviceability. In the recent past, government support has helped in obtaining faster control of land and other clearances for highway projects. Execution has increased from around 4 kilometres per day in 2014-15 to over 5.5 kilometres per day in the current fiscal. There needs to be continued focus on eliminating any roadblocks in getting clearances for projects to ensure their timely completion.
For the not-so-well performing operational highway projects, lenders now have a better recourse to end them under strategic debt restructuring (SDR). For under-construction projects with over 50 per cent execution, the government has already approved one-time fund infusion in the BOT projects languishing for want of funds. Lenders, initially wary of NHAI having the preference over debt servicing, are now on board to allow the agency to infuse one-time funding in BOT projects to avoid them from being written off as non-performing assets. However, the challenge would be to monitor execution of the projects after the fund infusion. This could be effectively handled through an escrow mechanism, where the money is directly distributed among sub-contractors, thereby eliminating leakage of funds.
Is the government required to provide more innovative solutions on the policy front to assuage both lenders and developers?
The main concern faced by developers is lack of funds and exposure to financing, construction and tolling risks. Lenders are typically concerned over the viability of projects, perceived issues in debt serviceability and downside protection in case of termination.
The government has already tried to address the funding risk through introduction of the HAM model, where the developer is required to fund only 60 per cent of the project cost. Easier exit norms, including divestment of up to 100 per cent equity stake in operational BOT projects, will help in release of funds for future projects. Execution risk has been mitigated with faster online clearances and government intervention.
Banks, on the other hand, are wary of lending to smaller players with limited execution track record. There also has been a demand to increase termination payments to no less than 90 per cent of debt due, especially for HAM projects during the construction period. The Ministry of Road Transport and Highways (MoRTH) will need to consider the default risk perceived by lenders to maintain the momentum of recent HAM bids. An important learning to be taken from the BOT implementation is the need for speedy clearances of claims and release of arbitral awards from NHAI.
As per the recent NHAI policy, 75 per cent of arbitral award needs to be immediately released by NHAI against a bank guarantee submitted by the developer. This is expected to release locked funds for developers to take on newer projects.
In short, the government has already taken the right steps to address developers' and lenders' concerns alike. However, stricter mechanisms to curb non-serious bidders and continued focus on expediting the execution process with default risk mitigated would be key for the sector, going forward.
- MANISH PANT