The problems with "takeout financing"

In its effort to boost infrastructure investments, the Government of India in its Union Budget 2009-10 has proposed that the India Infrastructure Finance Company Ltd (IIFCL) evolve a "takeout financing scheme" to facilitate incremental lending to infrastructure sector. Takeout financing is an example of off-balance sheet funding which involves securitising of infrastructure advances by primary financiers, especially banks, in favour of long-term financial institutions at a mutually agreed or market discovered price.

It is proposed that IIFCL will refinance upto 60% of commercial bank loans for PPP projects in critical sectors over the next fifteen to eighteen months. The IIFCL and Banks are now in a position to support projects involving total investment of Rs.1,00,000 crore.

However, arranging such finances is difficult in emerging markets like India where the long term debt market is extremely thin and the spreads on short and long term debts are considerable. In fact, the spread between one and ten year G-Secs is more than 300 basis points. Raising long term external loans is also unviable given the premium of more than 700 basis points over the LIBOR commanded by such loans.

I had blogged earlier about financing infrastructure by initially constructing the project with short-term bank loans (preferably raised by government agencies) and then swapping it with long tenor structured credit after the construction risk is off-loaded. The large construction risks, mostly outside the control of the private contractor (like site possession, right of way clearance, court litigation etc), have the effect of raising the cost of capital for financing such infrastructure projects. This model is the most efficient one since the government is both best positioned to bear the construction risks and to raise capital at the lowest cost.

In the circumstances, the more viable option is to finance the infrastructure asset by short term debt or by direct government backed debt. A pool of such infrastructure assets can then be bundled together, securitized and sold off as a tradable financial product. Their price and true cost of capital will be determined by the market. These tradebale assets would be similar to the infrastructure funds that are floated in the debt market to raise capital for creating specific infrastructure project assets. The Operation and Maintenance (O&M) of the assets can then be auctioned off to franchisees by competitive bidding, thereby helping consumers get the best deal in service pricing.

Update 1
My thanks to a comment by anon which has clarified on take-out financing. The above discussion was actually on a Businessline article which conveyed the impression of take-out financing as "securitising of infrastructure advances by primary financiers, especially banks, in favour of long-term financial institutions".

However, as the comment makes clear, take-out financing does not involve any securitization. Take-out financing seeks to overcome the asset-liability mismatches of commercial banks (which mobilize short-duration deposits and therefore cannot lend long-term) that prevents them lending long-term by a few banks joining together in a consortium manner to takeover a loan portfolio in turns. As Businessline again gives the example, "SBI, ICICI and IDBI can bankroll an infrastructure project requiring a ten-year loan by each one taking turns to lend for three years and four months each".

However, the discussion in the original holds in the context of any securitization of infrastructure assets or finances.