5/25 scheme may benefit projects with stable cash flows

In a freewheeling interview, Rakesh Singh, Group Head – Investment Banking, Capital & Commodity Markets, HDFC Bank has asked one simple question. Despite having alternate sources of funding available in India, is anyone seeking those at all? On top of it, the banker also raised a valid question through this interview that instead of blaming banks for not releasing funds, do project promoters have enough equity to pour in while bidding for projects? Edited excerpts:

In India, enough has been talked about land acquisition, forest clearances, resettlement etc., but when it comes to finance, the issue seems to be unresolved despite having resources. Why are we not utilising these funding resources at the fullest to resolve the finance crunch in the infrastructure sector?
We must understand project finance in the traditional sense. Project finance works only when all material approvals for a particular project are in place and the same is then handed over to a successful bidder like the bidding for UMPP was done in India. The bidder can then straightaway proceed for financial closure. This will ensure there are no time and cost over-runs on account of delay in approvals.

However, if the financing is available but the bidder continues to run from pillar to post to obtain necessary approvals then it means that the implementing agency has not handed over a complete project proposal, which then leads to cost over-runs. When a particular project reaches a bank for financing, we need to examine it to ensure that all material approvals are in place. If not, then these projects are not ready for finance.

When a promoter of the project fails to repay the debt to the bank, it causes non-performing assets within the banking system. Such situations also lead to the failure of the promoters in meeting the return expectations of their shareholders, which has a direct bearing on market capitalization of the borrower and their ability to raise funds in the capital markets to complete these projects.

But then, what about alternate funding options…
On alternate funding options, it merits a question. Is anyone seeking those alternate funds at all? Not many, because, there are only two kinds of projects – (a) the projects which are under construction and cannot tap the bond markets (a source of alternate financing) and (b) completed projects that have begun revenue generation, which despite having the option open to use alternate mode of finance may not use this option as banks which had funded such projects are happy to keep the loan on their books at lower returns given no completion risks and a steady stream of revenue. However, of late, such completed projects are gradually opting for financing from the bond markets.

Now, while PMG has cleared projects worth Rs 4.5 lakh crore, recently, and with EC granting permission to more than 50 projects in just six months, does India have capacity to fund such flow of projects annually? What according to you must be the funding requirement, annually, to support India´s infra sector and do you see any increase in the coming fiscals?
The banking system requires providing credit to all the sectors including infrastructure. And, at this time, when commodity prices are lower, large part of credit is available for the infrastructure sector. So a large part of credit for financing infrastructure is available within the banking system and alternatively bond markets can be tapped for alternate mode of finance.

With the Reserve Bank of India allowing banks to raise funds through bond market for financing infrastructure, it will certainly ease pressure on banks for using short term liabilities to fund infrastructure funds.

Nonetheless, I think the biggest challenge that everyone talks about is whether banks have enough funds to support the infrastructure sector. But my counter question is do promoters have enough equity to pour in while bidding for such projects?
Assuming that infrastructure projects have lower equity requirement at around 20-25 per cent of the actual projects cost, at least Rs one lakh crore of equity will be required from promoters for these projects. This is a large requirement and has to be met from the capital markets.

So in that case, can only major players bid for a large chunk of projects?
The government must attract foreign entities to form joint ventures with domestic players as well as mid-size players, which will help India to gain international funds at lower rate of interest. So, with this approach, the government can achieve bridge equity requirements to a large extent.

According to CDR cell, half of all restructured loans in the Indian banking system, or almost Rs 1.2 trillion, were in sectors like infra including power and iron & steel. What is the way forward?
I think these assets should be allowed to go through corporate debt restructuring but simultaneously banks must evaluate whether they are better off if these assets are put up for sale. If these assets are put on sale at an opportune time, then equity shareholders and banks get adequate time to recover the money invested. However, if the assets are put on sale earlier, then obviously the banks have not given the promoter a chance to revive the company. So in both the cases, I would recommend that CDR is necessary.

But in that case every debt-ridden company will come for CDR and will take undue advantage. In any case, going for CDR will hamper the company´s credit ratings too…
Basically, CDR happens due to a variety of reasons including project delays and even due to failure of the management to anticipate certain business situations. A fair chance should be always given to the right companies to recover after assessing their revised financial viability. Banks should also evaluate as to which companies they refer to CDR as there are chances that a particular company goes for CDR more than once, which indicates lack of managerial and financial resources.

Recently, the Reserve Bank of India has eased norms on raising funds through bonds and 5/25 refinancing schemes. Now, how will this help banks to mitigate the asset liability management problem?
Overall, the 5/25 scheme has its own pros and cons. If you look at the positive aspects of the scheme, it will enable mapping the debt to the project´s life thereby improving project viability. The extension of the scheme to existing projects is also a step in the same direction. On the flip side, though the tenor can be increased, the refinancing risk at the end of the predetermined period (say five or seven years) continues to reside with the project SPV and hence the bank.

Overall, the scheme may benefit infrastructure projects with stable cash flows but may not be as good for non-infrastructure and non-utility sectors such as steel, cement etc., as these sectors go through a cycle. So in a certain up-cycle, a company can make profits and not retire debt but in a down-cycle it may make lower profits and end up not servicing the loan.

We must appreciate that infrastructure debt is typically longer tenor. While some banks have raised infrastructure bonds with maturity in the range of 10 years, which will help ease asset liability mismatch to some extent, banks will find it difficult to raise bonds of longer duration due to a limited pool of buyers (pension funds, provident funds and insurance companies) in the local market.

– Rahul Kamat