Financial Express : Highways: Credit implications of BOT http://www.financialexpress.

com/printer/news/168670/

Close Window

Print Story

Highways: Credit implications of BOT

Posted online: May 14, 2006 at 0000 hrs

The increasing incidence of private sector participation in the highway sector projects exposes entities in the construction sector (Refer to box Rated portfolio in the highway sector) to
risks that have a direct bearing on their credit risk profiles. The increasing prevalence of Build-Operate-Transfer (BOT) projects, in contrast to the earlier system of cash contracts, gives
rise to a fresh set of funding, operations and maintenance, and revenue risks. This article sets out the agency’s approach in the context of various options available to players while
structuring their growth plans in the highways sector.

In general, the agency views annuity-based BOT projects more favourably than toll-based ones, since revenue risks in annuity-based projects are negligible. Similarly, entities that rely
more on equity to finance the project are generally better off than those, which rely extensively on debt.

Finally, the agency believes that a project finance structure is favourable for the sponsor: under such a structure, apart from the equity contribution, the risks associated with the SPV
performance are kept off the sponsor’s balance sheet.

Background: The shift to BOT

Until recently, most National Highway Development Programme (NHDP) projects were structured as cash contracts. Under a cash contract, the contractor builds the road and hands it
over to the nodal road agency; cash contracts constituted 77% of NHDP Phase 1 and 82% of Phase 2.

Going ahead, however, this pattern will change, since National Highways Authority of India (NHAI) contract awards from Phase 3A to Phase 7 are to
BOT projects: Past
be structured on BOT basis. The huge capital requirement, traffic risk, and design, construction and operation risks in BOT projects, can impact
players’ credit profiles. performance

As can be seen in the chart below, in a pure construction (or cash) contract, the risk to the executor is limited to construction risk, and lasts for the
duration of project implementation. Pre-NHDP projects
The experience on the Ministry
In BOT contracts, on the other hand, the executor is expected to build and operate the highway stretch over the concession period (typically of Surface Transport (MoST)
between 20 and 30 years), and transfer it to the road agency at the end of this period. projects was mixed. A few
Toll-based and annuity-based BOT projects such as Mumbai-Pune
Expressway and Narmada
BOT projects can be structured as toll-based or annuity-based projects. Under the annuity concept in India, the nodal road agency pays the Bridge Project were completed
concessionaire a fixed semi-annual payment over the concession period; the concessionaire, therefore, does not bear any traffic risk. On the other on schedule, and are operating
hand, in case of toll-based BOT projects, the concessionaire is left to recover the capital cost through collection of tolls. successfully. Nonetheless,
Mumbai-Pune Expressway,
This exposes the concessionaire to traffic risk, besides the construction risks that exist during the project implementation phase and operations and
Coimbatore Bypass and Noida
maintenance (O&M) risks in the operating phase.
Toll Bridge projects faced
Toll-based BOT schemes have typically been structured as BOT-cum-grant schemes. Such schemes entail financial constraints in the initial
Rated portfolio in the
partial funding of project cost through a non-refundable grant disbursed by the government/road agency. Such years of operation.

1 of 2 9/20/2009 2:20 AM
Financial Express : Highways: Credit implications of BOT http://www.financialexpress.com/printer/news/168670/

grants cover a maximum of 40% of the project cost: 25% is typically paid during construction, and 15%
highway sector This resulted from various
during the O&M period.
reasons- lower traffic volumes
The concessionaire, therefore, recovers the capital cost, minus the grant component , over the concession than originally estimated,
The agency has outstanding
period - a situation distinctly different from the cash contract model. This change in the business mix also existence of alternate untolled
rating on various entities
has implications for the nature of funds that can be deemed acceptable to maintain the credit ratings at routes leading to traffic
current levels. operating in the sector - players
diversion, user resistance to
like Larsen and Toubro Ltd
payment of tolls, and high
Going ahead, the government proposes to implement Phases 3 to 7 of NHDP projects (excluding Phase 4, (L&T, rated AAA/FAAA/Stable
gearing levels of the SPV or the
requiring Rs 400 billion investment; this phase is expected to be entirely annuity-based). These projects /P1+), Gammon India Ltd
will involve an investment of Rs 656 billion, and will be executed on BOT-toll basis (refer Table 1 below for (rated AA/Stable) and project implementing
the past performace of BOT projects). organisation
Nagarjuna Construction
Company Ltd (NCC, rated P1+) Post-NHDP projects
The agency believes that the increasing incidence of the riskier toll-based variant of BOT, and the Most NHDP BOT-toll projects
increased roles and responsibilities that a concessionaire is likely to be called upon to bear in future, will and nodal agency, National
awarded in Phase 1 have either
necessarily translate into higher risks; the higher risk will translate into an adverse impact on the credit risk Highway Authority of India
profile of the concessionaire. (NHAI, rated AAA/Stable) - just achieved completion or are
which are in the forefront of nearing completion. Hence, the
Funding risk project execution. performance of these projects
can only be evaluated in the
BOT projects require large capital investments. With a typical debt-equity ratio of 3:1, every Rs 10 billion future. However, in the case of
project requires Rs 2.5 billion of equity investments by the concessionaire(s). There have been several recent issues of Global Depository state-level toll based projects
Receipts (GDR) issues or foreign currency convertible (FCCB) offerings to fund these equity investments. GDRs result in an equity infusion into
(like Noida project,
the sponsor company, strengthening the company’s capital structure. Issuance of FCCB, however, often has the opposite effect:
Ahmedabad-Mehsana project,
The agency believes that the majority of FCCB issues are predominantly debt-like in nature. Thus, although FCCB issues infuse long-term funds Vadodara-Halol project),
to support future growth plans, the majority of them also lead to deterioration in the gearing and debt protection ratios of the issuer companies. performance has been
unsatisfactory as toll collections
The perils of recourse have been lower than expected.
BOT projects typically follow a project finance structure, with specific special purpose vehicles (SPVs) for their implementation. The sponsor
In the Durg Bypass (NHDP)
company’s contribution is therefore limited to its equity participation in the project. project, the actual toll
collections have only been 70%
The sponsor company also benefits from the Engineering Procurement and Construction (EPC) contract that is awarded to it by the SPV; this is of expected collections.
akin to the cash contracts that were awarded by NHAI in the early phases of the NHDP programme.

The SPV supplements its fund requirements by raising debt on the strength of its expected future cash flows. This results in a non-recourse structure; wherein the debt raised by the
SPV does not have recourse to the sponsor company’s balance sheet. The agency’s approach, at the time of profiling the credit risk of the parent company in such cases, will to be to
ascertain the return that the project will provide on the equity investment made by the sponsor company.

However, in instances where the sponsor company provides guarantees to the SPV, the non-recourse structure of the project is jeopardised. The agency’s approach while rating the
sponsor company in such cases is to consolidate the debt of the SPV with that of the sponsor company.

This can adversely impact the credit risk profile of the sponsor company, an impact that is particularly severe before the commencement of the project’s commercial operations: in
addition to the revenue risk of the SPV, the sponsor’s balance sheet has to bear the construction risk associated with the project.

Summary

The table below summarises the agency’s approach to the various scenarios / options that are available to construction companies in the Indian roads sector today.

2 of 2 9/20/2009 2:20 AM