India Ratings and Research (Ind-Ra) believes that the proposed changes in the concession agreement of build–operate–transfer (BOT) projects such as non-issuances of work orders until 90% land acquisition, descoping provisions akin to hybrid annuity model (HAM) projects, and transfer of projects after lenders’ approval are positive moves. However, they are unlikely to garner increased private attention, given traffic risks and termination payment issues remain unaddressed.
Attempts to Mitigate Land Acquisition and Approval Issues: Delays in land acquisition and approvals have led to significant delays in project completion and have been the prime reason for significant cost overruns. Addressing these issues by adopting the practices implemented in HAM projects could reduce some of the key risks faced by the developers. Also, the revised concession agreement could delink operations and construction period, as implemented in HAM projects, which would provide certainty of the toll collection period.
Endeavour to Fast Track Dispute Resolution and Transfer Stuck Projects: Arbitration processes for the settlement of developer claims in case of foreclosure have been dragged for years, leading to significant lock-up of developers’ funds. The inclusion of a dispute resolution board and timely redressal within 90 days are welcome steps. Also, the provision to substitute the concessionaire in case of a likely financial default would help reduce the stuck projects. However, the fast track resolution of arbitration awards remains a challenge, as the decision of dispute resolution board remains recommendatory in nature and courts remain the arbitration authority for dispute resolution for claims above INR250 million in case the parties do not agree on dispute resolution board for arbitration.
Traffic Risks Remain Unaddressed; Periodic Traffic Density Reviews & Innovative Debt Structures key to Revival: Developers and lenders are likely to remain wary of investing in BOT projects, given the high-risk factors associated with estimating base year toll collection and changing traffic flows on account of new roads coming up nearby. There have been instances wherein there was over 50% gap in actual toll collection and appraised toll collection at the time of bid, leading to loan defaults. Ind-Ra believes adopting structures prevalent in various geographies could mitigate the risk. Ind-Ra has earlier analysed the various project concession structures that are used in road projects across geographies. This includes a structure based on periodic traffic density reviews, as followed in the US and Latin America wherein flexible term concessions are used in some toll road projects, with the concession term linked to the total aggregate revenue of a project. This helps in reaching a predefined net present value based threshold that would assure developers with a minimum floor return, which could enable a revival of the segment.
Ind-Ra believes that the tweaking of concession periods would expose projects to either refinancing risks in case of extension of the concession period or tail risks in case of curtailment of the concession period, as the financial closure is accompanied with a defined repayment schedule in line with the original concession period. However, the same could be again mitigated by using innovative debt structures such as flexi-repayment structures with long tenor debts, deferrable principal repayments and prepayment options linked to traffic performance. Ind-Ra has also rated projects with a floor coupon rate having a fixed target annualised yield wherein the unpaid coupon is cumulated and compounded to provide target yields.
Unchanged Termination Provisions could lead to Under-Recovery for Lenders: In the erstwhile BOT toll concessions, termination payments were linked to National Highway Authority of India (‘IND AAA’/Stable’) project costs which were generally substantially lower than the actual project costs, leading to a high under-recovery for debt and equity during termination. Ind-Ra believes revisiting provisions of termination payment in accordance with the provisions associated with HAM and toll-operate-transfer model would better protect lenders in case of eventualities and is likely to garner increased private attention.
Source of Capital could Constraint Large Awards: Ind-Ra opines that given the large size of BOT projects starting from INR10 billion, limited risk appetite of developers and at least 30% equity requirement compared to the limited equity required in EPC and HAM projects would keep the bidding competition limited. Furthermore, the muted growth in bank credit in the road sector at 2.15% over the past five years reflects the limited appetite from banks. Furthermore, most of the NPAs in the sector has been on account of cost overruns and inaccurate traffic projections.
National Infrastructure Plan Hinges on Private Participation; HAM Remains Preferred Mode: The government has unveiled its ambitious National Infrastructure Pipeline, under which it will develop additional 67,000km of national highways in the next five years at an estimated cost of INR19.6 trillion. The private players are likely to fund 22% of the overall costs. Ind-Ra estimates the overall private investment in the segment remains below 20%. However, the project awards in the HAM mode since FY17 are likely to push the private investment above 20% in the near term, as the construction activity picks up pace across these projects. In FY18, of the overall 7,397km awarded by NHAI, around 3,397km was under HAM, 3,791km under EPC and only 209km under BOT. However, the projects awarded through HAM slowed down to around 880km in FY19 of the overall 2,222km of total projects awarded.
Ind-Ra believes HAM would remain the preferred mode of private investments for the sector, with the investor sentiment remaining muted for the pre-qualification bids invited by NHAI in September 2019 for BOT projects and the subsequent extensions of the bid submission deadline. However, the pace of project awards in the mode depends on NHAI’s ability to mitigate its cash flow mismatches.