Financing of Infrastructure Project

Concepts & RBI Guideline

1. Special Purpose Vehicle.2. Tradational financing.3. With Recourse, Non Recourse, Limited recourse

(Features).4. Prudential Exposure Norms.5. Asset liability management.6. Administrative arrangement.7. Take-out financing.8. Liquidity support from IDFC.9. Security Structures of SPVs.10. Trust and Retention arrangement (TRA).11. Guarantees12. Inter-Institutional Guarantees

13. Financing Promoters Equity.14. Appraisals15. Mode of Infra Financing – BOT etc16. PPP Projects17. Lead Bank18. Long Term Debt19. Private Sector Co20. Public Sector Co21. Project Company22. Project Term23. Total Project Cost

1. SPECIAL PURPOSE VEHICLES : (SPVS) Registered under CO’s Act 1956. Specially undertaking infra projects. Not act merely as a financial Intermediary. Bankruptcy of financial difficulties of parents /

sponsor should not affect of the financial health of SPV.

De-risk own balance sheet From high project leverage.

Creates an exit option for equity investors. Tax Structuring.

Lenders – Legal & Structural Separation (Bankruptcy).

Ring fencing From Sponsors cash Flows . Focused entity with a limited purpose ( Cash Flow

protection). Restrict additional debt issuances.

Traditional Financing

Conventional direct financing on balance sheet support.

Financing of Capital expenditure Retained earning + Long term finance. Debt / Loan. Full recourse Lender’s look to firms entire asset portfolio, cash

flow Loan service.

Project Financing

With recourse – to sponsors Non recourse – Recourse only to project cash flows

& project assets. Limited recourse – Recourse to sponsors under

certain defined circumstances. (Sponsor support obligation)

Sponsor group commits to provide standby support has crystallized prior to financial closers

In the event of any cost overruns in the project , it is met from such standby support.

Infra projects are characterized by large size, huge Capital Cost, long gestation and extended pay back period and high leverage ratios.

The approach is to properly identify and allocate various elements of the projects risk to the entities participating in the projects.

Prudential Exposure Norms.

Regulatory Norms fixed by RBI Better Risk Management Avoidance of concentration of Credit risk

Infra others Single borrower 20 15 Group of borrowers 50 40 Banks Capital Funds – Capital + Reserves Not applicable in the case of public sector

units

Computation of exposure

Fund based, non fund based, Loan against FDs, Derivatives, Investments.

Asset liability management.

Long term financing of projects Asset liability mismatch Not in Conformity with the maturity profile of a

banks liabilities. Adhere to ALM Guidelines of RBI to avoid

Liquidity mismatches

Administrative Arrangements.

Timely & adequate availability of credit is the Pre-requisite

Banks to avoid delay Procedure for approval of Loan Proposals. Institute a suitable monitoring mechanism for

reviewing application pending beyond the specified period.

Multiplicity of appraisal Broadly accept technical parameters laid

down by leading public financial institution. Ongoing monitoring of the project

implementation. Credit disbursed is utilized for the purpose for

which it was sanctioned.

Take-out financing arrangement Mechanism to avoid asset-liability maturity

mismatches / liquidity.

Banks have arrangement with IDFC or any other FI.

Transfer the outstanding in Banks Books on a predetermined basis.

IDFC/SBI devised different take out financing structure

These products addresses liquidity, asset liability mismatches, limited availability of project appraisal skills.

Developed a model agreement.

Liquidity support from IDFC.

Alternative to take out financing IDFC would commit, at the point of sanction,

to refinance the entire outstanding Loan (Principal +int) or part after an agreed period.

Credit risk on the project will be of Bank IDFC will take credit risk on the Bank. Interest rate depend upon the risk Perception

of the BK by the IDFC

Security Structure of SPVs.

Security Structure generally more stringent than the normal project.

Security package - registered mortgage hypothecation of assets pledge of sponsors holding in SPVs.

Project Contracts / Documents – assigned in favor of lending institutions

Charge on the future receivables.

Trust and Retention arrangement (TRA) Independent agent acting on behalf of

security trustee will appropriate all cash flows.

This is then allocated in a pre-determined manner to various requirements including debt servicing.

Residual Cash flow is available to the project company.

Guarantees

Payment risk in some infra projects is further mitigated by way of guarantee from the State or Central Govt.

Inter – institutional Guarantees

Banks are precluded from issuing guarantees favor of other Banks/ lending institution for the loans extended by the latter for infra .

Primary lender in expected to assume the credit risk and funding is not allowed not applicable to FIS

No General relaxation Keeping in view of the

a) Special features of lending

b) high degree of appraisal skills on the part of the lenders

c) availability of resources of a maturity matching with the project period

Banks are permitted to issue guarantee favoring other lending institutions provided bank issuing guarantees

Takes a funded shares in the project at least to the extent of 5 percent of the project cost and undertake normal credit appraisal, monitoring and follow up all the project.

Financing Promoters equity The promoters contribution towards equity

capital of the a company should come from their own resources.

Banks should not normally grant advance to take up shares of other companies

An exception may be made to this policy for financing the acquisition of promotors share is an existing Company engaged in Infra project subject to following condition.

1. Bank facilities is only for acquisition of shares of existing company providing Infra facilities.

2. Existing promoters (foreign & domestic ) voluntarily disinvest their majority shares in compliances with SEBI guide.

3. Companies to which loan are extended should have a satisfactory net worth

4. Company financed and promoters should not be defaulter to banks/FS

5. In order to ensure the borrower has substantial stoke in the Infra company, bank fiancé should be restricted to 50% of the finance required.

6. Finance extended should be against the security of the assets of the borrowing company or the assets of the acquired company and not against the shares of that company the company being acquired

7. Shares of the borrower Co/ Co being acquired may be accepted as additional security and not as primary security.

8. Banks to ensure stipulated margin at all time.

9. The tenor the bank loans may not be long than 7 years. But Banks Board can make exception

10. The financing would be subject to compliance with statutory requirements under section-19(2) of the Banking Regulation Act 1949.

11. Banks financing acquisition of equity shares by promoters should be within the regulatory ceiling of 5% capital market exposures in relation to its total outstanding advances as on March 31st of the previous year

Appraisal

Govt. owned entities, Banks/FI’s should undertake due diligence on the viability of the project.

Should ensure that the individual components of financing and returns on the project are well defined and assessed.

State Govt guarantee/ Any reported arrangement with RBI or any Bank for

servicing the loan (standing instruction ) may not be taken as of substitute for satisfactory credit appraisal.

Appraisal requirements should not be diluted. Financing Infra project through SPV, call for

appraisal skills on the part of lending agencies .

Appraisal requires-

a) Identification of various project risks

b) Evaluation of risk mitigation through appraisal of project contracts.

c) Evaluation of credit worthiness of the contracting entities, their abilities to fulfill contractual obligations.

Banks/ FIs may consider constituting screening committees/ special cells for appraisal of credit proposal and monitoring the progress/performance of the projects.

Often size of the funding requirement would necessitate joint financing by banks/ FIs or by more than one Bank under consortium or syndication arrangements.

Participating Banks/FIs may for the propose of their own assessment refer to the appraisal report prepared by the lead Bank/FI or have the project appraisal jointly.

Modes of Infra Financing

a) BOT – Build, operate & transfer

b) BOLT – Build, operate, lease and transfer

c) BOOT – Build, own, operate & transfer

d) BOO – Build, own & operate

e) BOOS – Build, own, operate & sell

Build Operate Transfer (BOT)

BOT is a type of project financing. BOT is relatively new approach to infra development, which enables direct private sector investment in large scale infra project

The theory of BOT is as follows

1. Build – a private company (or consortium) agrees with a govt. to invest in a public Infra project. The Co then secure their own finance to construct the project

2. Operate – the private developer then owns, maintains & manages the facility for a agreed concession period and recoups their investment through charges or tolls.

3. Transfer – after the concessionary period the Co transfers ownership & operation of the facility to the Govt. or relevant state authority.

The major parties to BOT projects will usually include

1. Govt. agency – Govt. dept or statutory authority is a pivotal party

Grant the sponsor the concession that is the right to build, own and operate the facility.

Grant a long term lease or sell the site to the sponsor. Govt. co-operation is critical in large projects –

approvals, authorizations, consents for the construction & operation of the project.

Govt. agency is normally the primary party. It will initiate the project, conduct the tendering process, and evaluations of tenders and will grant the sponsor the concession & where necessary the off take agreement.

2. Sponsor- Usually a consortium of interested groups - typically a

consortium group, an operator, a financing institution which in response to the invitation by the Govt. prepare the proposal to construct, operate, & finance the particular project

a) Construction contractor

b) Operation & maintenance contractor

c) Financier

d) Others – insurers, equipment suppliers and design consultant lawyers & tax advisers

Advantages of BOT

1. Govt. get benefit of private sector to mobilize finances and use the best management skills in the construction operation and maintenance.

2. Private participation also ensures efficiency and quality by using the best equipment.

3. Projects are conducted in a fully competitive bidding situation & are thus completed at the lowest possible cost.

Public Private Partnership (PPP) Project Means a project based on a contract or

concession agreement between the govt. or statutory entity on the one side and a Private company on the other side, for delivering an infrastructure service on payment of user charges.

Lending to PPP Projects

A project awarded to a private sector company for development, financing, construction, maintenance and operation through public private partnership.

In case of PPP project, the private sector co shall be selected through a transparent and open competition bidding process.

PPP projects based on standardized model documents duly approved by the respective govt. would preferred. Stand alone document may be subjected to detailed scrutiny.

Lead Bank

Financial institution (FI) that is funding the Infra project by providing debt to an extent not less than 25% (twenty five percent) of the total project debt and designated as such by an inter institutional group or consortium of financial institution.

Long Term Debt

Means the debt provided by the consortium banks to the project company where the average maturity for repayment exceeds 10 years.

Private Sector Company

Means a company in which 51% or more of the subscribed and paid –up equity is owned and controlled by private entities.

Public Sector Company

Means a company in which 51% or more of the subscribed and paid-up equity is owned and controlled by the central or a state govt. jointly or severally and includes any undertaking designated as such by the dept of public enterprises and companies in which majority stake is held by public sector companies other than financial institution.

Project Company

Means the company which is implementing the infra project.

Project Term Means the duration of the contract or

concession agreement for a PPP project.

Total Project Cost

Means a) As estimated by the govt. / statutory entity that

owns the project

b) As sanctioned by the lead bank

c) As actually expended But does not include the cost of land

increased by the govt. / statutory entity.

Financial Parameters

1. Debt Equity Ratio

2.5:1 to 4:1 in exception cases

2. Promoters contributionNot less than 15% of the project cost

3. Fixed asset coverage ratio 1.25 and above

4. Overall Debt service coverage Rationot less than 1.50-2.0

Interest = Earning before Interest &tax

coverage average expenses

5. Internal Rate of Return

(Post Tax)

4% over the estimated

cost of funds