Finally the Cure?

Long term financing has been ailing the infrastructure sector making alternate non-banking financing options like Infrastructure Debt Funds (IDFs) more viable. Rahul Kamat and Garima Pant explore the IDF environment in India.

The yawning infrastructure gap in the country is seeking closure to unleash its locked growth potential. The 12th Plan projects an investment of $1 trillion or Rs 55,00,000 crore in infrastructure, with a vision to have 48 per cent of the investments coming from the private sector. Though the figure of $1 trillion was based on the 9 per cent growth target when the 12th Plan was announced, the investment target will have to undergo a change as the growth estimated is 5.5 per cent.

But even at the projected figure, the vast gap demands substantial investment to be infused into the infra sector. The approach paper of the 12th Plan says that the share of the private sector in investments will have to rise to as much as 48 per cent from 37 per cent in the 11th Plan to achieve this.

“Because of inflation and the growing economy, projects are getting bigger and bigger. And without infrastructure we cannot move forward. So logically, we must facilitate banks to lend comfortably to infrastructure in whatever way they can,” says Santhosh Nayar, Chairman & Managing Director, India Infrastructure Finance Company Ltd (IIFCL). He adds, “We have to develop markets outside the banks for funding and also see what we can do to reduce the risk in infrastructure funding.”

Infrastructure projects need long-term finance for cyclical slowdowns that are guaranteed to reverse themselves from killing them off prematurely. Banks are now responding to higher safety margins vis-a-vis higher capital and liquidity requirements by increasing their lending rates, trimming risk assets, and being more selective. There is a clear cut mismatch in lending strategies while funding any infrastructure projects by banks. For example, a road project with 30 year of project cycle, the banks offers loan up to only 12 years. As a result, banks have not been able to provide long-term financing and the job will now have to be done by creating a market for long-term bonds, with insurers and pension funds (domestic and foreign) playing a major role. And that can be possible only via IDFs.

Aiding Indian infra
The world over, the longest-term investors are insurers and pension funds. Pension funds as a way to finance infrastructure is new to (but highly recommended for) India, where insurers find it difficult to invest in long-term project debt. The ever-widening gap in banks' asset liability profile has also compelled policy-makers to find alternate solutions like IDFs, that are meant to supplement bank finance in the country's infrastructure by taking over a chunk of Rs 15,44,700 crore loans outstanding as on January 2014.

In a significant move, Canadian Pension Plan Investment Board (CPPIB) has strung together three high-profile deals with Shapoorji Pallonji, Piramal and L&T in the past one year, stepping up interest in India's real estate and infrastructure. Australia's Hastings Funds Management Ltd, a Melbourne-based infrastructure manager, also recently struck a partnership with the Aditya Birla Group, which will initially offer debt financing through a dedicated India fund for already-built infrastructure, such as airports and toll roads. It was reported that the two companies will not be looking to finance fresh infrastructure projects through the venture.

What makes IDF a lucrative proposition for the foreign investors is the fact that the government has reduced the tax for foreign investors on interest income from bond investments in IDF-NBFCs. It has been reduced to five per cent compared with 20 per cent for other bond investments. This will significantly improve the post-tax return of foreign investors. In fact, regulations allow a lower risk weight for the purpose of capital adequacy (50 per cent instead of 100 percent for other NBFCs).

Ergo, in the years to come, India can expect more aid from the Canadian and Australian Pension Funds. According to a source, which is closely monitoring moves of some private financial institutions, some companies are already in touch with the Canadian and Australian Pension Funds. “IDFC and IL&FS are in advanced talks with these two Pension Funds to rope in their funds in IDF,” a source says. Meanwhile, these two institutions are also in advance talks with multilateral financial institutions like World Bank, Asian Development Bank and International Finance Corporation for financing Indian infrastructure. “The overall concept of IDF will certainly ease pressure from public sector banks, which are overexposed to the infrastructure sector, and with the foreign investors coming in, it will be an ideal example for domestic investors too” observes VG Kannan, Managing Director and CEO, SBI Capital Markets.

Experts believe that rules must change and special vehicles meant to develop infrastructure, such as IDFC and IIFCL, must develop the expertise to vet projects and guarantee their debt servicing.

The startups
Of the various infrastructure projects, the projects that need urgent financing are in the power, roads, ports and airport sectors. Among these, power (other than solar) is perhaps the only project that could be termed bankable, i.e., it could repay principal and interest over a reasonable period of 7-10 years. All others have a long life of over 25 years, and therefore, yield lower returns. The other three sectors could barely pay interest on debt over the years and repayment of principal would pose an unreasonable burden on their cash flow even after 25 years or so.

According to Reserve Bank of India data, banks have maximum exposure to two industries Roads (Rs 153,700 crore) and Power (Rs 475,800 crore). Industry estimates indicate that there are nearly 150 national highway projects operational where these funds can be invested and are long in term in nature.

Giving some impetus to the sector, the first tripartite agreement by India Infradebt Fund, an infrastructure debt fund promoted by ICICI Bank, Bank of Baroda, Citibank and LIC with National Highways Authority of India (NHAI) was inked in February.

In addition, even IDFC has inked a tripartite agreement last year in June, and will be raising Rs 500 crore in the years to come.

Meanwhile, IL&FS Infra Asset Management has already raised Rs 750 crore as the first part of its $5 billion infrastructure debt fund. It is expected that, in the next month, IL&FS will raise another tranche of Rs 750 crore from domestic insurance companies and banks, taking its total to Rs 1,500 crore for the year. To facilitate the IDF, IL&FS has inked pacts with five public sector general insurance companies General Insurance Corporation of India (GIC), National Insurance Company, Oriental Insurance, New India Assurance and United India Insurance.

Therefore, the government is focusing on passing supportive legislations and providing the right environment through which long term players such as pension funds and other investors can come into long term investments vehicles like infrastructure debt financing. “If you look at the Employee Provident Fund (EPF) or the Pension Fund Regulatory and Development Authority (PFRDA) funds or other pension funds, there are several hundred billion rupees available for long term investments,” says Ramesh Bawa, Managing Director and CEO, IL&FS Financial Services.

“The deep pockets of LIC carry tremendous scope as well. Favourable policies from the government in this regard will aid in attracting larger investments in the IDF,” he adds. This is where entities like IDF will join hands with banks to identify their mature loan assets in the infrastructure sector, which could be considered as eligible for funding from IDF. This initiative will contribute to lessening the banks' infrastructure exposure, which in turn would enable them to undertake fresh infrastructure projects.

The worry factor
However, there are certain constrains which have popped up and made IDF move at a snail's pace. The constrains, though look minuscule, at this point of time, may slow down the pace of IDFs in India. Under a Tripartite Agreement, an IDF will take over a portion of the debt of the concessionaire availed from existing lenders. An IDF has to get the approval of existing lenders to sign the Tripartite Agreement.

In the future, if a project is terminated, then the IDF gets the first priority over the termination payment that the concessioning authority will make to the concessionaire or to the borrower. That means that existing lenders will get second priority. “It is the job of the IDF to convince the existing lenders that the benefits of getting the IDF into the lending consortium outweighs this potential reduction in termination payment,” says Sadashiv Rao, Chief Risk Officer, IDFC.

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, banks are reluctant to sell their loans down.

“If the senior lenders in the IDF-NBFC route have a sense of insecurity, then it can be solved,” says Rajat Misra, Vice President, Project Advisory and Structured Finance, SBI Caps.

Clear the air first
Experts are of the opinion that the government should first clear the air by differentiating refinance and restructuring, so that investors can be clear in their approach. Nayar believes that the Indian market is maturing everyday and the growth will come. “The question is when. There is lack of clarity in India as to what is restructuring and what is refinancing. Many people present refinancing as restructuring. Interest rates need to come down. Projects cannot be financed at 13-14 per cent rates of interest,” he adds.

Jagannarayan Padmanabhan, Director, CRISIL Infrastructure Advisory, says that having Infrastructure Debt Funds is good, but they are viable only at the execution stage. “We first need to regain the confidence of players in the industry,” he says. Once the market sentiment and environment improves and investor confidence comes back, the infrastructure sector will see more cash flow coming in. We believe that the infrastructure debt funds are an ideal vehicle to facilitate long term financing of infrastructure development.

Box
Non-banking financing options for infrastructure
The scheme was developed keeping in view the asset-liability mismatch of banks while lending to infrastructure projects. Typically, the liabilities of banks are of three years, while loans for infrastructure development are given for eight to 10 years or even more. However, when the scheme was launched by the government for infrastructure projects, it could not initially achieve the expected interest from the lenders or borrowers mainly due to certain features like additional cost to lenders or borrower without any certainty of actual takeout, as actual takeout is conditional on the project achieving minimum debt service coverage ratio of 1.10 during first year after COD. Further, there was resistance in operating level of lenders for transferring a good loan asset to IIFCL, without any gain to existing lender. “Since banks in India are conservative they don't want to sell those assets which are paying high interest rate after the construction risk is over and want to transfer only potentially bad loans thereby affecting the quality of IIFC's balance sheet,” says an analyst.

How does IDF work?
Banks and non-banking financial corporations (NBFCs) will set up mutual funds or other NBFCs, which in turn will sell mutual fund units to foreign funds or insurance companies to raise money. The money will then be used to buy out infrastructure loans from banks. These loans will finance public-private-partnership (PPP) projects only. Once the said period of the partnership is over, the project will be handed over to the National Highways Authority of India (NHAI) or the government, depending on the case. Moreover, banks can only sell loans to IDFs after the project becomes commercially feasible.