AT last, even the critics of Finance Minister Yashwant Sinha are agreed that he's gung-ho about infrastructure development. And the runaway success of the Resurgent India Bonds, the over $4 billion proceeds of which are going to fund core sector projects, is not the only reason for it. More important is the first Take-out Finance deal of Rs 400 crore signed in Mumbai last week by the Infrastructure Development Corporation of India (IDFC), and the State Bank of India.
IDFC was set up in June 1997 at the initiative of former finance minister P. Chidambaram, but its initial equity allotment to 17 shareholders could be completed only after a year, in March 1998. Referring to this in his budget speech on June 1, Sinha informed Parliament that "the IDFC has tied up its paid-up equity capital of Rs 1,000 crore, including equity participation of Rs 400 crore by nine foreign investors, and has now commenced operation." Says a foreign banker: "Yashwant Sinha has got things moving in the right direction. It is on his prodding that IDFC took the first step in encouraging infrastructure financing. It could be coincidental but still, you can't deny him the credit for prioritising infrastructure financing, which is where all previous governments' intentions and announcements had hit the wall."
Financing of long-gestation infrastructure projects has long been a ticklish issue for project promoters as well as financial institutions. Says M.S. Verma, chairman of SBI: "Most banks and financial institutions were hampered by stipulations on asset-liability mismatch, capital adequacy ratio and exposure norms, from comfortably financing infrastructure projects whose gestation periods could range from a minimum of five years to 25 years." Agrees Deepak Parekh, chairman of IDFC: "Last year, Rs 22,000 crore of loans had been sanctioned for infrastructure development. Only Rs 6,500 crore were actually disbursed."
Indeed, banks have found it increasingly difficult to lend money for a period of over five years. Infrastructure development, one of the top priorities for growth, will require the flow of significant resources over the next decade. The complexity of the investments and their long duration will require the creation of innovative instruments which spread out the risk judiciously among many participants. It is this ability to design instruments best suited to the risk profile of projects and then to allocate the risks to those best able to assume them that will determine the extent to which the specific issues in infrastructure financing will be addressed.
While financial institutions and a few large banks such as SBI are increasingly focusing their resources on infrastructure finance, many other banks are not able to participate in this competitive field due to lack of large fund requirements, the high level of appraisal skills required, long tenure of loans, maturity mismatches, etc.
Says Parekh: "The traditional sources of project funding, comprising long-term loans from financial institutions and equity offerings in the capital market, are inadequate to match the risk-return profile and pay-back periods of infrastructure projects. The term lending institutions in India typically extend loans for seven to 10 years, while infrastructure projects will require tenures of 10-15 years." Even SBI, which has over a period of time acquired the requisite skills and experience in appraising infrastructure projects, would need to recycle funds to make long-term funds available for financing many more such projects.
The current agreement IDFC has entered into with SBI involves a Rs 400-crore Takeout Finance deal with a five-year tenure, which will provide a liquidity support to SBI for long-term core sector projects. Explains Verma: "What this basically means is that SBI today can fund a project worth Rs 1,000 crore (considering a 40:60 debt-equity ratio, the loan will be worth Rs 400 crore). After five years, if the bank needs liquidity, it can still withdraw the Rs 400 crore from IDFC. This is mainly to ensure that a bank lending large amounts for long-gestation infrastructure projects is not short of liquidity at any given point of time."
The amount of the take-out finance deal is earmarked for three projects—Bharti Telenet Ltd, the financing of the Narmada Bridge in Gujarat, and the Coimbatore bypass in Tamil Nadu. In both the Narmada Bridge and the Coimbatore bypass projects being undertaken by Larsen & Toubro, the debt funds would be initially provided by SBI for five years at the end of which the bank has the option to either continue or call back the principal. IDFC at that point would "take out" SBI for the principal amount of the loan.
The project companies therefore are able to avail longer tenure funds of over 10 years. In this structure both IDFC and SBI participate in the credit risk for the principal and interest respectively. Says Verma: "The Take-out Financing Agreement would be a tripartite agreement between IDFC, SBI (or a participating bank) and the project company. It would be structured as part of the overall joint documentation with the other lenders in the project. Suitable covenants would be incorporated in the other financing documents for the project to give effect to the provisions of the Takeout Agreement."
The take-out financing structure is a new and innovative instrument, being tried in India for the first time. Both IDFC and SBI are putting in place a mechanism which will facilitate a much greater flow of resources to infrastructure projects in a manner which ensures that the structures adopted are closely related to the inherent risks and cash flow profiles of investment capital from the commercial banks to infrastructure projects—a very large and untapped potential—so that the comparative advantages of all participants are satisfied.
ACCORDING to Verma, over the next five years, SBI expects the liquidity support from IDFC to go up to Rs 5,000 crore. "This will be a support for the Rs 18,000 crore of loans that have been targeted by the bank for core sector projects," says he. Adds Parekh: "IDFC has also earmarked Rs 250 crore as take-out finance for other banks in the current year. We are negotiating with the Unit Trust of India for a take-out financing deal."
In essence, this structure would invite banks to participate in infrastructure financing for a specific term and at a preferred risk profile that suits their own appetite, with IDFC standing behind the structure and willing to "take out" the obligation after a specified period. This ensures that the project achieves its goal of long-term funding though the participants in the loan would change as the project progresses. This structure has a number of possibilities: banks can assume full credit risk in the initial period of a project (typically the highest risks and consequent returns), partial or no credit risk with the variable being the pricing. IDFC could not offer both "take out" as well as liquidity support to the participating banks.
But IDFC will undertake a thorough appraisal of the project to understand the risks involved and to recommend the most efficient structure from the point of view of both project sponsors as well as lenders. In a take-out financing deal, a financial intermediary with short-term liabilities creates a long-term asset. Aftera specified period, the long-term assetis transferred to the book of a long-term player.
IDFC has been established with a singular aim: to lead private capital to commercially viable infrastructure projects in India. The corporation is in the process of developing both instruments and techniques to achieve this aim. Infrastructure projects, especially those in the private domain, will require efficient financial structuring to meet the long term and back-ended cash flow profiles.
In the absence of specially designed instruments, these characteristics would preclude the effective participation of the banks which typically have a shorter time preference owing to their liability profiles. Further, as long as necessary appraisal skills and detailed knowledge of functioning of infrastructure markets are being developed, many banks may not be willing to participate in infrastructure financing.
Says Parekh: "Only 35 per cent of our lending is direct. Rest of our activities will include guarantees, market-making and subordinating debt (see chart). I only hope that a greater portion of the Rs 90,000-crore banking sector deposits could be brought into infrastructure projects."
Banking analysts are also expecting that a substantial portion of the money from the Resurgent India Bonds will be channelled through IDFC and other banks to get infrastructure development moving. And this time, hopefully, in earnest.
