IDFs are the best route to refinance existing projects

Sadashiv Rao, Chief Risk Officer, IDFC Ltd tells Rahul Kamat that IDF-NBFC is a safer route compared to IDF-Mutual Fund, as in the latter, the fund manager can invest in any project (under construction) which will have risk involved in it, and investors may not like to invest in high-risk projects.

The idea of Infrastructure Debt Funds was envisaged three years ago. However, we haven't witnessed any headway in this context except in a few areas. What are your thoughts on how successful the concept of IDF would be in India?
The thought process of starting IDFs from the government was different. The government particularly felt that banks are already overexposed to the infrastructure sector and they also have their own internal limits on lending to the sector. Therefore, the government thought of creating new entities to take some pressure off from the banks. That was the whole purpose of the government setting up IDFs. They are investment vehicles which can be sponsored by commercial banks and NBFCs in India in which domestic/offshore institutional investors, specially insurance and pension funds, can invest through units and bonds issued by IDFs.

IDFs would essentially act as vehicles for refinancing existing debt of infrastructure companies, thereby creating fresh headroom for banks to lend to fresh infrastructure projects. One must understand that, at present, over Rs 1 lakh crore assets are waiting for refinance, and IDF is the best route. Most of the assets are in the road sector.

How can the IDF be formed? Are there any stringent methods involved which may see a lukewarm response from investors?
The IDF can be formed under two methods: One is under the mutual fund route and the other is the NBFC route. The mutual fund is the trusted route. Infrastructure Debt Funds (IDFs), can be set up either as a Trust or as a Company. A trust-based IDF would normally be a Mutual Fund (MF), regulated by SEBI, while a company-based IDF would normally be an NBFC regulated by the Reserve Bank of India.

IDF-NBFCs would take over loans extended to infrastructure projects which are created through the Public Private Partnership (PPP) route and have successfully completed one year of commercial production. Such take-over of loans from banks would be covered by a Tripartite Agreement between the IDF, Concessionaire and the Project Authority for ensuring a compulsory buyout with termination payment in the event of default in repayment by the Concessionaire.

IDF-Mutual fund can finance any project. Even under-construction projects can be financed. However, under the NBFC route, it shall invest only in PPP and post COD infrastructure projects which have completed at least one year of satisfactory commercial operation and are a party to a Tripartite Agreement with the concessionaire or original lender, the project and IDF for ensuring a compulsory buyout with termination payment.

Coming back to my previous question. How successful will IDFs be in the country?
I may not like to comment on the success of the IDF at this point of time because the concept is in its early stages. However, there are some constrains involved in the whole process of setting up an IDF, and to be honest IDFs have hardly taken off. Primarily because there are very few investors, who are interested in investing in in the mutual fund route. In IDF-MF, investors will bear a higher risk with the possibility of higher returns and funds from this vehicle can be invested in all infrastructure sectors. Though it provides a larger canvas, very few investors will invest in this route keeping in mind the high risk involved. So whichever IDFs have taken off, have been raised only under the NBFC route. In addition, given that the domestic market generally has an appetite for debt up to 15 years and also has floating interest rates, IDFs offer an opportunity to offer fixed rates for a longer duration. The investors in an IDF are largely domestic and foreign institutional investors, especially insurance and pension funds that have long-term resources. Banks and financial institutions would only be allowed to invest as sponsors of an IDF.

What are the typical constraints which have not allowed IDFs a successful alternate method?
PPP projects are primarily confined to roads, ports and airports. In the roads sector, the concessioning authority is NHAI. Now understand the framework.

If an entity is looking to raise funds trough IDF-NBFC, it will be liable to refinance projects which are operational or have completion of date (CODs) in place. It means under a Tripartite Agreement, an IDF will take over a portion of the debt of the concessionaire availed from senior lenders. Which means as an IDF it has to get their (senior/existing lenders) approval to sign the Tripartite Agreement.

Now, in the future, if the project gets terminated, then IDF gets the first priority over the termination payment that the concessionaire authority will make to the party or to the borrower. That means the existing lenders will get second priority. In this case why would the existing lender give away its priority, unless it has been convinced on some benefits? That's one of the reasons why IDF under NBFC is taking time.

The second reason is, for the last two-three years, banks have not lent much to the infrastructure sector. Typically, the operational projects are low risk projects, hence, why will a bank let go of a low-risk project to an IDF when they (banks) don't have a pipeline of projects? So because of these two primary reasons, IDFs are taking their own time to start.

I hope you are not facing any of these issues?
No. In fact, the advantage we have at IDFC is that we have a good number of projects in our portfolio where IDFC is a sole lender. So we don't require senior lenders' approval to sign the Tripartite Agreement. The moment we get the RBI license, we can kickstart by seeding IDFs in our own assets.

Are there any other limitations on how much an IDF can invest in?
Of course, there are three limitations. The maximum exposure that an IDF-NBFC can take on individual projects will be at 60 per cent of its total capital.

The second limitation is an IDF can fund 85 per cent of debt of the project. Now the debt is not the actual debt but which is defined by NHAI. For e.g, in a road project worth Rs 500 crore, a contractor might have appraised the same project as a lender at Rs 800 crore, but NHAI's debt will be limited to 70 per cent of Rs 500 crore i.e., Rs 350 crore. So an IDF will lend to the 85 per cent of Rs 350 crore. The third limitation is tax limitation or income-tax exemption. Income-tax exception is a subject to a loan not exceeding the 20 per cent of the IDF's corpus. Here the corpus is not defined. It can be both–debt and equity.

It looks like the whole concept of IDFs is complicated…
IDFs ae not complicated but the framework under which they have been prepared is surely complicated.

Meanwhile, your competitors are ahead of you. Why is IDFC going slow on IDFs?
We are not going-slow at all. Last year, in June, we have signed the first Tripartite Agreement because of some issues from NHAI. The NHAI was insisting that IDF should give a good guarantee commission from IDFC. So after lot of back and forth negotiations with NHAI, we mutually agreed to a respectable number, 0.05 per cent.

Initially, how much would you be raising?
We have received an internal approval of up to Rs 500 crore of capital. Just for your information, the rating agency has rated other IDFs like L&T Infra and ICICI and L&T Infra as an AAA rated institution on a standalone basis with a leverage of 9:1 that many number of times. We think that with Rs 500 crore of capital and nine times, in a year to come, we can go up to Rs 5,000 crore of assets maintaining AAA rating.

How about the opportunities for international funding agencies?
There are two opportunities for foreign institutions. As per the framework, sponsor IFCs would be allowed to contribute a maximum of 49 per cent to the equity of the IDF-NBFCs with a minimum equity holding of 30 per cent of the equity of IDF-NBFCs. Post investment in the IDF-NBFC, the sponsor NBFC-IFC must maintain minimum CRAR and NOF prescribed for IFCs. So IDFC as a sponsor cannot hold 100 per cent equity in IDF. Hence there is an opportunity for international and domestic investors to invest the balance 51 per cent. The second opportunity is to lend to the IDF. Foreign institutions should feel comfortable on the credit risk point of view, as IDF-NBFC will invest in only operational projects.