The current levels of stress have been harsh on the road sector as a whole, indicating that there could be further deterioration in credit quality. While describing the current concerns of the toll roads sector, R Venkataraman believes the various steps taken by NHAI may not greatly help the ailing sector.
There is a negative outlook for toll roads currently for reasons affecting their potential credit quality. Generally, ratings of toll road projects are at lower levels because these risks have already been factored into the ratings to a large extent. However, the current levels of stress have been too harsh on the sector as a whole, indicating that there could be further deterioration in their credit quality.
Elongated construction schedules due to delay in handover of land by National Highways Authority of India (NHAI) is seen to be the main concern for projects under construction. Lower-than-expected traffic and revenue and high interest rates are risks faced by operational projects. These concerns along with weaknesses in financial structuring have aggravated the risk profile of the road projects.
Given the weak financial structures and exacerbation of project risks, demands for promoters´ (sponsors) resources are likely to increase. In a harsh economic environment, where the credit quality of many sponsors are under pressure and when they face challenges in raising equity as well as in effecting sale of distressed assets, their ability and willingness to support projects are coming under strain. This trend is forcing developers to selectively support projects that have a long term economic value in contrast to their earlier strategy of attempting to preserve vital bank relationships by propping up all projects.
A large number of operating road assets is under tremendous stress exhibited by their inability to meet their respective debt service in a timely manner. Project companies/developers are approaching the lenders to restructure the debt. For the financial restructuring to be effective, the debt amortisation will have to be reworked based on a realistic estimate of traffic/revenues and also have to make use of the longer tail (period between the last amortisation date of the loan according to the initial terms and the expiry of the concession). Postponement of principal amortisation alone without actually extending the debt tenor may not actually help and in some cases may only end up in postponing the payment default. More importantly, enforcement of covenants in the financing documents will instill greater degree of financial discipline.
In the absence of a vibrant equity market, ceased private-equity interest, slowing bank lending and the dire need to maintain liquidity, the promoters are forced to place additional debt burden on the operational toll roads which are not spectacular in performance; but are just in line with initial expectations. Annuity-based projects, which generally have much lower debt-service coverage levels than toll roads at the similar rating levels (because of lower revenue risk) are also being subjected to additional gearing. In these projects, even a slight rise in prices of inputs would trigger an increase in the operation and maintenance costs constraining the cash available for debt payments. To add to these woes, the rupee depreciation is expected to adversely impact the projects having unhedged external commercial borrowings (ECB) as a sign¡ficant component in the total debt.
Future of PPP in toll roads
The lack of interest from private sector is evident from the tardy response to NHAI bids. In FY12-13, only 9 out of 22 projects attracted successful bids and this trend continues even during the current year. Faced with this challenge, NHAI is moving away from the build-operate-transfer (BOT) to engineering-procurement-construction (EPC) mode, which is like a construction contract.
The 12th Plan target for the road (NHDP) sector suggests an investment requirement of around Rs 1.8 lakh crore by the private sector, which accounts for around 47 per cent of the total projected investments. Clearly, in order to achieve these targets, an enabling investment climate is a pre-requisite. However, the extant sluggishness and waning private-sector interest does not indicate a progressive trend. Given the current situation, NHAI is also considering operate-maintain-transfer (OMT) route in certain cases, which means that NHAI will construct the road and bid it out to the private sector for its operation and maintenance. This remains to be tested.
The developers ascribe the ´lack of interest´ to reasons including the delay in handover of land - as a consequence having to face prolonged construction period and delays in achievement of commercial operations date (COD). This results in locking up high cost of capital.
It is worth mentioning here that in our rated list of projects, not a single instance of construction delay has been attributed to the concessionaire. The delays in achieving COD have been caused mainly because of delay in handover of the required land and right of way to the concessionaire by the grantor.
Tight exit norms (it has reportedly been relaxed now) and much lower revenues than expected with a huge revenue share/premium are also quoted to be the reasons for the declining interest. For example, in our portfolio of rated projects, the toll revenue under performance ranges from 5 per cent to even as high as 35-40 per cent, which forces the developers to reconsider their investments in road projects.
Also, there are issues related to mismatch in toll revenues and debt amortisation - where the toll revenues would pertain only to the completed portion as against the full project stretch, but the debt amortisation will have to be for the full loan amount, irrespective of the quantum of drawdown.
For example, if the grantor determines that partial commercial operations could be awarded (along with proportional tolling rights for completed portion) due to the expectation of prolonged delays in handing over the remaining land; yet, in accordance with the existing arrangements, the debt amortisation will have to be for the full loan amount as per the loan agreement. Else, it could be deemed as default according to the financing documents. So, the project company is forced to apply for restructuring of debt because the revenues from partial tolling may not be adequate to meet maintenance expenses and debt service.
Given the multiple risks faced by the project sponsors, it appears that the private sector interest is gradually diminishing in the sector.
The situation is quite paradoxical. In one way, there is a huge demand for infrastructure. The demand for infrastructure is telling, which the successive plans is endeavouring to address. On the other hand, however, the investors have lost the appetite to invest in the sector. The investments have yielded sub-standard returns.
Revenue underperformance in toll roads Toll revenue underperformance consists of two parts. The first part is underperformance in traffic which is because of the lower level of economic activity than what was projected. The second part is due to over-estimation of traffic and annual growth rate of traffic at the time of bidding. Absence of historical traffic data have, in a way contributed to the aggressive bidding by the bidders, although I would not agree that it is the only reason for aggressive bidding.
Inflation and toll roads
According to the concession agreements, the annual increase in toll rate is either fully or partially linked to annual inflation. In a way, the high inflation over the recent years has played a positive effect on the toll revenues. The high inflation rates have marginally off-set the adverse impact of a severe traffic underperformance in toll roads.
Financing toll roads
Banks are the largest lenders to the toll road projects. Ideally, a substantial share of this must have been financed by longer term fixed rate instruments. I am not too sure if the existing bank loans could be effectively structured to make use of the long tail available. While the banks offer loans for a door-to-door tenor of 12-13 years, it has all attributes of shorter and medium term loans; annually resettable interest rates, lower moratorium period, quarterly amortisation which does not match with the concession tenor etc. The absence of a vibrant fixed income market clearly inhibits infra¡structure financing.
For the financing to be effective, the debt should almost match the concession tenor to ease the pressure on cash flows. By definition, infrastructure projects have longer gestation and it is not a good idea to pay off the capital within a few years by compressing the cash flows and forcing the lenders to assume operational risks which is disproportionate to their returns. In economies like Australia, the debt matches the period of concession; in fact there is a substantial refinancing risk built into the project. This eases the operational cash flows and the potential liquidity squeeze in the ramp up phases. In the US, there are revenue bonds that finance these assets.
The 100 per cent stake sale, which is now allowed by NHAI, may facilitate consolidation to some extent, but not too sure if it will help the ailing sector.