India Ratings and Research (Ind-Ra) opines road projects which are to be commissioned on the hybrid annuity model (HAM) in FY22 could refinance Rs 175 billion of their existing debt during the year. The study includes the entire gamut of HAM projects (64 projects including 13 projects already operational) with a debt size of around Rs 325 billion. The refinance potential has shrunk to Rs 175 billion due to the limited headroom available between the total project cost against the bid project cost.

Given the predictive nature of revenue and expenses, HAM projects are preferred by long-term investors and capital market investors. Ind-Ra is the first rating agency to rate the first capital market transaction for a HAM project by GR Group for its SPV Varanasi Sangam Expressway (IND AAA/Stable). The debt structure has addressed the cashflow mismatch by linking interest rate to repo rates, thereby providing a natural hedge. Ind-Ra sees an increasing number of projects to be refinanced through bonds, especially sponsored by a strong sponsor. 

Ind-Ra considers the credit profile of the operations and maintenance (O&M) contractor, adequacy of O&M and major maintenance costs important for the ratings. Also, any undertakings from project sponsor(s) to address the weakness of the project structure is evaluated during the rating exercise; hence, the sponsor’s credit profile is also a key rating factor.

Ind-Ra expects an increasing number of projects, once operational, would refinance through bonds or rupee term loan if bank rates remain low to revive growth in the economy. The steady decline in bank rate to 4.25% per annum in May 2020, which has since been stable, from 6.75% per annum in January 2019 and inadequate interest rate transmission have impacted the cash flow cushion of operational HAM projects. Therefore, both debt service coverage ratios (DSCR) and equity returns have diminished.

A downward interest rate scenario is negative for HAM projects, as the annuities remain linked to interest rates even in a 100% rate transmission scenario. The impact manifolds when the rate transmission is inadequate. The impact on DSCR and equity returns is 0.01x and 110bp, respectively, when the bank rate falls by 100bp and transmission rate is 100%; however, the impact increases to 0.04x and 206bp, respectively, if the transmission rate is 40%.

Projects funded at a total project cost (TPC) in the range of 80% to 90% of the bid project cost (BPC) have a healthy DSCR, as per Ind-Ra study. Whereas, the projects funded at BPC with low O&M revenue have a muted DSCR, limiting refinancing potential.

Ind-Ra's evaluation reveals that 29 of the 64 projects have quoted a low O&M revenue and TPC is more than 90% of BPC. This leaves minimum room for the sponsor to take out returns during the operating period.

Ind-Ra opines that amid the current low interest regime with low bank rates, projects with TPC in the range of 80% to 90% of BPC and projects where TPC is beyond 90% of BPC with adequate O&M revenue to be the appropriate for refinancing. Impact on DSCR and internal rate of return (IRR) is pronounced as the gap between TPC and BPC gets narrower.