Leading domestic credit rating agency Icra, which has a tie-up with global player Moody’s, has warned of rising risks arising from double-leveraging by private sector entities in the infrastructure space, saying such multiple ways of fund-raising increase lenders’ risks.
Noting that PPP model is gaining ground in the infra space, Icra says many developers, who are implementing projects through project-specific special purpose vehicles (SPVs) in the road, power, port, and airport sectors, raise funds through multiple ways.
Double-leveraging typically refers to a situation where a bank holding company conducts a debt offering to acquire a large equity stake in a subsidiary bank, mostly debt-based capital. Ideally, dividends earned on the subsidiary’s stock are used to finance the holding company’s interest payments.
In the present context, double-leveraging means when a holding company acts as an indirect workaround entity or an operating entity to raise debt-based capital for its SPV.
Companies over-leverage when fresh investments are hard to come by and they have to meet their equity commitments.
Such situations are forcing the developers to resort to structures and practises that are resulting in excessive leveraging, thereby significantly increasing the risk exposure of lenders towards infrastructure assets even though the projects themselves may be funded in debt: equity ratio of 75:25, says Icra.
Generally in the infra space, SPVs of a group are housed either in a single holding company or in several sector-specific holding companies. While the primary objective of a holding company is to consolidate the group’s holdings in various infrastructure projects at a single entity level, some holding company are also serve as operating entities, it says.
“While infra assets are generally required to have an equity contribution of around 25-30 per cent from the developer, the increasing trend of raising debt at the holding company level and infusing it as equity in SPVs is resulting in high leveraging of these assets,” says Icra.
“Many of the developers are raising funds at the holding company level, which are then routed in the form of equity to the SPVs implementing various infra assets.
“The funds in the holding company are raised by several means, including direct equity infusion by promoters, PE funds like structured debt with buyback clauses, guaranteed returns as also increasingly via debt, which many a time lead to double-leveraging,” says an Icra report.
According to Icra, double-leveraging also happens when a developer enters into an EPC contract with the SPVs and pump back profits from this to partly fund the equity contributions to be made by the contractors in the SPVs.
Refinancing/securitisation of project revenues, which is popular now, is yet another way of over leveraging, wherein a company deploys the surplus funds generated through securitisation of future cash flows into other projects, it says.
The problem with this is that, says Icra, “it can result in reduction of the developer’s effective financial commitment in the projects and consequent increase in the lender’s exposure to project risks“.
“Such activities by the developers,” warns Icra, “increases the risks that are borne by the lenders. This also enables promoters to bid aggressively for new projects, as their own exposure to the asset is relatively limited.”
Further, it adds, double-leveraging also exposes the holding company to high refinancing risks, particularly when the holding company has limited standalone operations and the returns in the form of dividends from equity investments are limited given the long gestation period associated with infrastructure projects.
A high leveraging ratio combined with limited expected future cash flows from subsidiaries could be a major cause of concern for the debt investor, the agency added.