Delays in clinching concession pact for road plans may put foreign lenders off

10/26/2015 Financial Express: Delays in clinching concession pact for road plans may put foreign lenders off

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Delays in clinching concession pact for road plans may putforeign lenders off

Rajalakshmi Deviprasad

MUMBAI, Oct 19:The model concession agreement report for highway projects is in the final stages ofcompletion. The National Highways Authority of India (NHAI), financial institutions like ICICI, IDBI,IDFC, experts in the ministry of surface transport (MoST) and sponsors and developers of road projectshave spent several months deliberating on the exhaustive report.

Price Waterhouse and Cameron & Mckenna prepared the report which lays down the terms of theconcession agreement, the financing pattern, an escrow cover and various force majeure conditions. Thereport has listed various forms of support measures like capital subsidy, revenue shortfall loan, stepinrights for lenders and 25 per cent weightage in annual toll adjustments for exchangerate risk.

The subsidy will be given for the construction phase and revenue shortfall loan to cover the gap betweentoll receipts and debtrepayment obligations. The NHAI will recover a portion of its debt through a fixedconcession fee after profits startaccruing to the concessionaire on an increasing scale.

This report will be issued at the prebid stage and bids for projects will be invited on the principle of leastsubsidy. The concession agreement will be signed by the NHAI and concessionaire, a limited liabilitycompany set up by the consortium that lands the project. As part of the concession agreement, theconcessionaire will construct, widen, operate and maintain the road on a build, operate and transfer(BOT) basis.

In the first phase, the project will involve widening of the road from two to four lanes. It will be furtherwidened to six lanes before the traffic reaches 60,000 passenger car units (PCUs) per day. Bothpromoters and lenders see this as a problem area. As traffic is the primary risk factor for lenders, they areunwilling to put money into the sixlane construction before the 60,000 PCUs perday norm is achieved.The sixlane obligation has put lenders in a quandary.

According to IDFC executive vicepresident YM Shivamurthy, "It isdifficult to appraise the project as oftoday." Even if the sixlane activity were to begin after the 60,000 PCUs per day traffic norm is reached,the concessionaire will need to finance this through additional debt. This would be difficult as theconcessionaire's only security cover receivables from the project has already been assigned to thefinanciers of the fourlane phase. The problem is compounded when there are two different sets oflenders for the two phases and, hence, the risk of providing them the same asset as security.

According to Shivmurthy, the NHAI should not insist on the sixlane obligation. The other solution, hesays, is to offer an exit option to the concessionaire when the sixlaning phase needs to begin.

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However, it does not solve the problem as the new concessionaire will not be able to raise the money forthe same reason. L&T Finance group head (project advisory services) Anindya Roychowdhury says thatthe NHAI and concessionaire could, jointly, institute an annuity fundat the onset of the concessionperiod. By the time the concessionaire needs to finance his expansion, the fund would have grown andhelp partfund the project and leverage costeffective debt.

A case in point is the Rs 630crore Noida Toll Bridge project where a sinking fund has been created andthe money invested in deep discount bonds. Income from the fund is being set off against depreciation inthe books resulting in higher profit in the initial years and therefore higher divdends. At the same time, itcreates a substantial fund at the end of the period. By the end of the concession period, the fund wouldhave grown enough to cover the entire initial capital cost of the project.

The definition of `debt due' is yet another area of conflict between the lenders and NHAI. The modelconcession document defines `debt due' as the "principal outstanding as of the transfer date but excludesany part of the principal that had fallen due for repayment one year prior to the termination date" and "allaccruedinterest up to the date preceding the transfer date but excluding any interest or charges that hadfallen due six months prior to the transfer date."

Lenders are unwilling to let go of the principal for one year and interest for six months. Says an IDBIsource, "Lenders want 100 per cent of the debt due less any insurance payments actually made." Theissue has largely remained unresolved. Domestic lenders argue that they are being fairly reasonablecompared to the stringent conditions laid down by international counterparts.

This is true as the latter will require 100 per cent of debt to be paid. This will not only include theoutstanding principal and interest but also penalty payment, fees and other expenses that are due to them.However, says a project company head, "It is unlikely that international lenders will come forward forroad projects. It has taken the government so long to come up with policy initiatives like the ModelConcession Agreement which is far from complete. Also, infrastructureprojects including roads getdelayed at the time of achieving financial close."

Assuming that much of what is called nonrecourse financing for road projects is going to be by domesticfinancial institutions, the Model Concession Agreement has several other sops for lenders like grants,favourable termination clauses and escrow cover. The government has also been generous with itsconcessions to the road sector.

For the first time, a capital subsidy will be given for the construction phase. It shall not exceed either 25per cent of the total project cost or 50 per cent of the total equity whichever is lower. Also, a revenueshortfall loan will be given to cover the gap between toll receipts and debt repayment obligations.

Termination payment in case of various types of force majeure events is generous. In nonpolitical forcemajeure events, the payment will be equal to the debt due less insurance claims. In the case of politicalforce majeure, the payment will be equal to the total debt due plus 125 percent of the subordinated loanplus 175 per cent of the equity actually spent on the project.

Says Roychowdhury, "It is a positive step by the government. Its decision to compensate the lender up to100 per cent of debt for political force majeure situations (acknowledging the fact that thesponsors/lenders should not be held responsibile for such an event), while restricting the compensation to75 per cent for apolitical events like an act of god is perhaps based on the rationale that since thegovernment also cannot in anyway be held responsible for such an event is all but fair that, while theybear the brunt of the compensation (75 per cent), at least 25 per cent should be borne by the lenders."

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anindyaroychowdhury

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This is not an unreasonable argument. In a noninfrastructure project, the only way a lender can recoverhis money is through insurance claims (for force majeure events) and through a protracted legal route(for nonforce majeure defaults). While lenders believe that funding infrastructure projects is moreriskydue to the absence of adequate asset cover, what they have in return is a more direct recourse a directcharge, through the escrow account, on the entire income! This is not there in a noninfrastructureproject, where the primary security is the asset (the plant & equipment).

So, while there are minuses in infrastructure lending, there are as many comforts for the lenders. Somegenuine concerns, however, remain. The construction period risk has not been incorporated in the modelagreement. If the concessionaire defaults in the construction period, there is no provision in theconcession agreement for the lenders of the project. Further, in the case of default by the concessionaire,although the lenders have been given `stepin' rights, they cannot operate the facility themselves. Lenderswill merely replace the existing concessionaire by giving a substitution notice. It is unclear who willoperate the road during this notice period.

International lenders will also want the 25 per cent weightageto the change in the dollarrupee exchangerate in the annual adjustment of the toll structure to be changed to an international currency of theirchoice. Lenders and project promoters argue that there is no provision for an annual adjustment in tolls ifthe entire debt is financed by domestic institutions.

It seems impractical to tie 25 per cent to the foreign currency without considering the source offinancing. Does this mean that, if a promoter does not go in for forex funding, he loses out on this 25 percent benefit? In the power sector, where 100 per cent passthrough (to consumers) on exchange risk hasbeen allowed to the promoters, it has been seen that there has been little incentive to reduce forex risk.Further, provision for an annual increase in toll should be translated into actual increases. In the case ofthe Rau Pitampur road project, increases were not effected every year and this has thrown the entireproject out of gear.

One step that is seen by both lenders and promoters asretrogate is the reduction of the wholesale priceindex (WPI) weightage in annual toll adjustments. While the model fixes the WPI weightage at 50 percent, previous projects like the Narmada road project or Coimbatore Bypass had 100 per cent weightageassigned to the WPI. All the cash inflows and outflows will be operated through an escrow account. Theconcession agreement lists the priority of the various outflows. Lenders want the second claim on escrowreceivables to be given to them.

However, NHAI seems reluctant to do so, a puzzling reaction as all they get from the project is a nominalconcession fee which starts accruing to them after the first seven years. Up until the seventh year, it is anominal Re 1 per year, after which it is fees realisable for 5000 PCUs per day for the eight year and 6000PCUs per day after the ninth year. Infact, lenders and promoters are unanimous in their view that theconcession fee should be projectspecific and cannot be fixed in the model agreement.

There are otherconditions in the agreement that need some rethinking. For instance, there is a clause thatsays that if the government, before the completion of nine years from the onset of the project, allows anadditional tollway on the highway, then it would grant the concessionaire an extension of the concessionperiod. This is given so that the concessionaire recovers the loss in revenue.

However, says Roy Chowdhury, "If the additional tollway charges a lower toll, the concessionaire willget a substantially reduced traffic on his route. An extension of the concession period may still notcompensate for the loss of revenue." He suggests a direct monthly compensation to the concessionaire inthe form of cash compensation. A loss of profit insurance could be taken out at the onset.

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There are other grey areas. The document has set a lockin period for the promoters' equity at 51 per centduring the construction period and 33 per cent during the balance of the concession period. Promotersfind the latter conditionrestrictive. Further, local traffic has been exempt from tolls. Promoters say thatthe proportion of local traffic in the total is not avalable and could determine the receivables of theproject. There is also the possibility that the traffic growth leading to the necessity of the sixlaning couldcome predominantly from the local traffic.

Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.

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Delays in clinching concession pact for road plans may put foreign lenders off