The construction risk transfer through takeout financing

I had blogged earlier about how infrastructure financing can be made more attractive for investors by a two-step financing pattern. This would involve separating the construction activity and its attendant risks from the project life-cycle costs and financing the two separately.

This approach assumes importance in view of the considerable construction risks associated with many infrastructure projects in India, which in turn increases the financing cost and therefore raises doubts about its financial viability. The broad strategy would therefore be to finance the construction with short-term loans, preferably raised by the government (since government is best able to bear the common site-clearance related construction risks) and then swap the loan with long-term bonds once the construction is completed and construction risk has been off-loaded.

In this context, the recent announcement on liberalised takeout financing conditions by the state-owned India Infrastructure Finance Company Ltd (IIFCL) assumes significance. The IIFCL plans to take over projects immediately after their commercial operation date (COD) from the original financiers (mainly banks) and pass on interest rate concessions to project developers. As part of this, a lender financing the infrastructure project can enter into an arrangement with IIFCL for transferring to the latter the outstanding in respect of such financing in its books on a pre-determined basis.

Takeout financing is attractive to banks as it addresses sectoral/group exposure issues and asset-liability mismatch concerns (banks give most of their loans as short-term ones, 3-5 years). Interest rates on the loan taken out by IIFCL is likely to be an estimated 75-200 basis points lower than the original project loan. The project developer would benefit from this reduction in cost of capital. The IIFCL has so far inked takeout financing agreements aggregating about Rs 3,100 crore with a host of banks, including Union Bank of India (Rs 1,020 crore), Central Bank of India (Rs 1,000 crore); Punjab National Bank (Rs 180 crore), and Punjab National Bank (Rs 600 crore).

This intermediation role by the IIFCL will align the incentives of all project parties to commission the project within time and access the take-out loan swap at the much lower cost of capital.