Infra sector sponsors try bonds backed by credit enhancements

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Mumbai: A handful of bond deals involving credit enhancements are helping sponsors of infrastructure projects repay costly bank loans and instead borrow from the bond market at a cheaper rate.

Over the past eight months, companies such as Tata Realty and Infrastructure Ltd (TRIL), Sterlite Grid Power Ventures Ltd and Hindustan Powerprojects Pvt. Ltd have raised money through bonds backed by credit enhancements.

Credit enhancements are essentially credit guarantees offered by a third party, India Infrastructure Finance Co. Ltd (IIFCL) or banks. They are also offered through structures that set aside a certain part of the funds raised into a reserve which can be used to pay interest in case of erratic cash flows.

Hindustan Powerprojects privately placed bonds after receiving an external credit enhancement from IIFCL. The enhancement for Sterlite Grid Power Ventures issuance came from banks.

Others, such as Hindalco Industries Ltd and Century Textiles and Industries Ltd, are also in talks for such credit enhancements, two bankers privy to the developments said on condition of anonymity.

Emails sent on 11 March to Hindalco and Century Textiles did not receive any response.

The motive behind a credit enhancement is to upgrade the rating of the issuer and the issuance. Typically, most projects, after they are completed and begin operations, are rated BBB-. This is the lowest investment grade rating and not high enough to attract investment from long-term investors such as insurance companies and provident funds owing to regulations that allow them to invest only in instruments rated AA and above.

“The market for below AA+ rated corporates is very limited and the cost benefit is also very low in comparison to loans,” said Ajay Manglunia, executive vice- president of fixed income at Edelweiss Securities Capital.

For instance, a 10-year AAA-rated corporate bond’s yield is around 8.5% while that on an AA-rated bond is over 9.5%. Bonds rated below AA do not get any interest, bankers said.

“Why most projects do not get a high rating as AA or AAA is because while the construction-related risks are behind them, what drives the rating is the adequacy of the cash flow to meet payment obligations. Typically this cushion is not very high for the projects, especially in the initial phase,” said Pawan Agrawal, chief analytical officer at Crisil Ratings.

This is where structures such as credit enhancements help.

For instance, TRIL, the special purpose vehicle for the construction of the Pune-Solapur toll road, raised Rs.1,000 crore through bonds after getting an upgrade in its rating to A+.

Besides the parentage of the Tata group, bankers created three reserves and added what is know as a “cash-trapping clause” that prevents the company from using a part of the funds set aside as a reserve. This cushion took the rating of the bond up by a notch, said the first of the bankers cited earlier. TRIL did not reply to an email sent on 11 March.

In a bond sale by East-North Interconnection Co. Ltd, a subsidiary of power transmission firm Sterlite Grid Power Ventures, bankers used the fact that it gets regular cash flows from Power Grid Corp. of India Ltd to push the rating of the bond up to AAA (structured obligation). The issue was rated by Crisil.

The company’s website says it raised about Rs.900 crore through the bond issue in January, selling bonds with a 17.5-year tenor in three parts, with the yield ranging between 8.8% and 9.25%. “This was used to repay a bank loan that had an interest rate of 10%. So there was a saving of nearly 100 basis points for the company,” said the first banker. A basis point is one-hundredth of a percentage point.

To be sure, such deals are still a rarity. “The cost of getting a credit enhancement is the deciding factor. Sometimes, investors tell us to give a higher yield on the bond that is rated probably A or below rather than charge some basis points for offering credit enhancement,” said the second banker.

However, bankers expect an increase in such deals given the urgency to unlock bank funds from infrastructure projects.

The Reserve Bank of India has indicated that project financing should move to the bond market. To this effect, the government entrusted IIFCL to provide credit enhancements and help companies access the bond market. IIFCL hopes deals will pick up in the coming months.

“We have a number of deals in the pipeline wherein we would be able to give credit enhancements to issuers,” said an official at the company, requesting anonymity.

Under the credit enhancement scheme, IIFCL has so far offered enhancements for two bond issuances with an aggregate size of about Rs.800 crore.

The government also announced that Life Insurance Corp. of India would offer credit enhancement through guarantees to infrastructure bonds and further deepen the bond market.