Tuesday, March 9, 2010

Financing newly created infrastructure assets

Here is the problem facing a local government agency in a major Indian city. It has constructed a massive road project with funding from a hybrid of loan from an external funding agency and a 15 year annuity-based BOT. It was proposed to re-pay the loan and make the annuity payments from a bouquet of revenue stream inflows that would come in once the road is constructed. Reputed consultants who had structured the financing arrangements, in keeping with their pro-cyclical outlook, had based their assumptions of revenue streams on the booming property prices (when the construction started). Shortly after the project achieved financial closure and construction started, the real estate market crashed leaving most, if not all the revenue stream assumptions in shambles. Now with the project completed, the repayments having come due, the already distressed local government is clueless to repay the loans. The state government is even bigger mess to bailout the project.

So what is the way out? Here are three possible alternatives

1. The first and simplest alternative would be to re-visit the revenue streams and examine the possibility of restructuring them in light of the changed circumstances and squeeze out all possible value from them. However, the existing revenue streams alone will surely not yield adequate returns to finance the payments due.

2. The more promising and efficient alternative would involve ring fencing the asset, in this case the road, with all its linkages, into a project entity. The entity can then be registered as a special purpose vehicle (SPV) and the newly created asset (which would not have been created without the borrowing liability) transferred to the entity. This asset can then be leveraged to raise capital by issuing long term debt instruments. If the project asset happens to have some brand value (as this road incidentally has), then it may even be possible to leverage this value to optimally market its debt instruments.

3. Restructure the debt by tapping into the various infrastructure financing options which the Government of India announced recently. The recent Union Budget increased the allocation for Indian Infrastructure Finance Company Ltd (IIFCL) to raise tax-free bonds to both directly finance and re-finance infrastructure projects. The disbursements by IIFCL are expected to touch Rs 9000 Cr by the end of fiscal 2010-11 and Rs 20,000 Cr by March 2011.

The takeout financing scheme announced last year and estimated to finance Rs 25,000 Cr in infrastructure investments over the next three years is the other alternative. Under takeout financing, the short to medium-term loans granted by banks can be taken-out after a hsort duration (3-5 years) from the originating banks' books by either long-term infrastructure financing institutions or a consortium of other banks. Another financing option from the Government of India is to avail the viability gap funding(VGF) mechanism for infrastructure projects.

The local government agency has no choice but to seek between the last two broad alternatives, and adopt whichever is the cheapest. Or adopt a hybrid of both. The repayment will have to involve identifying and structuring all possible road-linked revenue streams - toll collections, impact fees (due to local development and levied on registration/property taxes), advertisement rights, commercial development of related land and so on. Incidentally, the crisis does present an opportunity for the local government agency to push through the difficult measures like tolling, impact fees etc. It will also have to be based on medium-term assumptions of normalcy returning to the property markets. The VGF can be sourced to meet a share of the deficit.

After restructuring based on these revenue streams and the VGF funding, any remaining short fall can be met with a commitment for back-loaded government budgetary support. In other words, the commercial revenue streams, internal local government agency resources (escrowing some source), and VGF will form the upfront repayment sources, and the government support will kick-in in only the later half. The advantage with this arrangement is three-fold

1. Roping in the state government will enahance the credibility of the funding model and facilitate achievement of a better financing deal at possibly cheaper rates.

2. This will avoid the cash-strapped government having to step in with any budgetary support immediately.

3. Finally, there is the strong possibility of newer revenue channels emerging and existing streams becoming more vibrant, thereby providng additional revenue sources and minimizing or even eliminating the need for any government budgetary assistance.

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