The government should explore various options that can nurture IDF in an industry-friendly way, writes Vivek Rao.
While conceptually Infrastructure Debt Funds (IDFs) would be very attractive for all stakeÂholders of the infrastructure sector including private sector developers, banks as well as the goverÂnment, IDFs would have to address certain challenges.
While the IDFs under the non-banking finance company (NBFC) structure have been given tax-free status, the IDFs under the mutual fund route are liable to tax in line with any other debt mutual fund. So, the post-tax return of such funds may not be that attractive to investors, particularly given the competitive corporate bond issuances in the market.
Post-tax return would have to be viewed in conjunction with the availability of long term funds. While on the one hand, infrastructure projects would require 15-20 year money retail investors, particularly for IDFs-MF, may be unwilling to invest in any paper with maturity beyond seven years. The IDFs would also have to address this asset liability mismatch and focus their fund raising almost entirely on insurance and pension funds and these have a rating restriction which stipulates a minimum AA rating requirement for investment assets.
Finally, for the IDF offering to be attractive to the SPV developer, the IDF loan has to be able to save the SPV at least 100 basis points from his current cost of borrowing and his possible revenue securitisation cost.
An IDF may be set up either as a trust or company. A trust-based IDF (Mutual Fund) would be regulated by Securities and Exchange Board of India (SEBI), while an IDF set up as a company, NBFC, would be regulated by the Reserve Bank of India (RBI).
The fund would try to garner resources from domestic and off-shore institutional investors, especially insurance and pension funds. Banks and financial institutions would be allowed to sponsor IDFs.
Benefits of IDF
In an attempt to lure insurance companies to invest in infrastructure funds, the Insurance Regulatory and Development Authority (IRDA) in its exposure draft on investment norms for insurance companies said that total investment in housing and infrastructure should not be less than 15 per cent of the fund for life insurers and 5 per cent for general insurers. IRDA has also indicated that investments in IDFs, as approved by the authority, on a case-to-case basis shall be deemed for investments in infrastructure.
An NBFC with a minimum capital of Rs 150 crore can set up an IDF. Such a fund (though for an NBFC, â€œfundâ€ may be a misnomer, since it would be a company, under the Indian Companies Act) would be allowed to raise resources through rupee or dollar denominated bonds of minimum five-year maturity. These bonds could be traded among the domestic and foreign investors. ICICI Bank and IDBI Bank have announced their intentions to set up IDFs and are expected to launch their IDFs in the near future.
Currently, bank loans to infrastructure SPVs are on floating rates, with a reset clause every 12-18 months, while the IDFs will issue fixed interest paper to its investors. It will also subscribe to fixed interest rate bonds of infrastructure SPVs. For the IDF offering to be attractive to the SPV developer, the IDF loan has to be able to save the SPV at least 100 basis points from his current cost of borrowing and his possible revenue securitisation cost. The IDFs are expected to invest in bonds of project SPVs that have already been constructed and have 1-2 years of operational history. Thus there is no moratorium period.
Through bond subscriptions, IDFs will step in and take over the debts of the banks up to 85 per cent thereby freeing bank funds to enable them to further lend to other infrastructure projects. The IDF would be based on a tripartite agreement between developer, lender (bank) and the IDF, giving seniority to IDF in debt servicing, particularly in any default related debt re-payments.
As per the tri-partite agreement, the IDFâ€™s loan/bond subscription will be senior to all other lenders to the SPV, and since the concessioning authorities guarantee up to 90 per cent of all debt repayment, even in a default situation, it is being believed that investments in infrastructure SPVs where the concessioning authority is a government entity, like NHAI or the Major Port Trusts or Airports Authority of India, etc, would get a AA rating. Of course, this belief has to be qualified by the fact that this is as yet un-tested.
IDF loan/bond subscription has to be able to save the SPV at least 100 basis points from the current cost of borrowing and possible revenue securitisation cost.
A mutually supportive role
A key aspect that needs attention is the area of credit enhancement. Given that it is unlikely that an infrastructure project SPV would have a rating higher than A, how then would the IDF manage to have a rating of AA or more? The IDF needs to have an AA or higher rating so that it falls within â€œapproved investmentsâ€ for insurance companies (the insurance regulator considers all investments in instruments rated below AA as un-approved investments).
Thus, it is necessary to have a mainstreamed and acceptable credit enhancement product to ensure that the bonds subscribed to by IDFs have an AA rating and that the bonds issued by IDFs also have an AA rating to ensure that pension and insurance funds invest in IDF papers.
Taken as a whole, we are of the view that banks, IDFs, and an institutionalised credit enhancement mechanism can play a mutually supportive role. Banks provide the financing for project construction as they are best placed to take construction risk. Next IDFs take out banks by subscribing to project bond issuances and the project pre-pay bank loans, thereby enabling banks to manage ALM risk and lend to new Greenfield projects. Insurance and pension funds subscribe to IDF bond issuances which are then channelled to for investment in infrastructure project bonds. The credit enhancement mechanism plays a role in enabling investments in IDF bonds and bond investment by IDFs.
The above emphasis on tapping insurance and pension funds is critical as infrastructure projects would require upwards of 15 year money. This assumes that IDFs subscribe to 15 year project bonds of SPVs that have entered a 25-30 year concession, and which are issued after a 3-4 year construction period, followed by 1-2 year operation period, still leaving a significant post-debt repayment tail. In this scenario, retail investors, particularly IDFs â€“ MF would be unwilling to invest in any paper with maturity beyond a seven-year horizon and IDFs are mandated to issue paper with a minimum maturity of five years. The IDFs would have to address this asset liability mismatch and focus their fund raising entirely to insurance and pension funds. However, it should be kept in mind that these funds also have a cap on what percentage of their total investible corpus they can invest in mutual funds.