Mobilisation Advances from NHAI to Cushion Against Delays in Hybrid Annuity Projects; But Low Equity Weighs On

National Highways Authority of India's (NHAI; 'IND AAA'/Stable) payment of mobilisation advances to developers will provide a fillip to the construction pace of hybrid annuity model (HAM) projects, says India Ratings and Research (Ind-Ra). HAM was introduced to rejuvenate the road sector and lessen the equity burden on the already stressed developers. Lenders are gradually familiarising with this contract structure. Nevertheless, case-specific impediments such as aggressive bids and stressed sponsors among others continue to delay financial closure. At the same time, the agency feels low equity in HAM projects will weigh on funding decisions.

Construction funding accounts for 40% of the total cost in HAM projects and is released by the authority in five tranches linked to the milestones, while the balance (60%) is arranged by the concessionaire. The developer would fund not more than 25% of the non-authority component (60%), which necessitates raising debt. Therefore, the equity portion is narrowed to 15% of the project cost against the earlier set pattern of 20% or 25%.

Clause 23.8 of the HAM concession agreement delineates a provision to grant 10% of the project cost as a mobilisation advance to the concessionaire. To avail this facility, the concessionaire has to provide a bank guarantee for a value of 110% of the mobilisation advance to the authority. This will be set off proportionately against the construction period annuities. Although the net equity injection is only in the range of 2%-5%, the non-availability of funds is unlikely to hinder the construction progress. The project is likely to have sufficient funds because equity injections, mobilisation advances, debt drawdowns and timely grants would hasten the completion subject to the full availability of the land. Generally, these projects are executed by the in-house engineering, procurement & construction (EPC) companies. Therefore, the low equity component in the project with EPC margins being front ended, limits the incentive for the sponsors, an issue which continues to haunt some of the stressed toll projects.

Ind-Ra rated its first HAM Project Welspun Delhi Meerut Expressway Private Limited at 'IND A'/Stable in June 2017. The rating reflects the project's low revenue risk, fast pace of construction progress, favourable leverage and debt structure and comfortable debt service coverage ratios.

Of the 27 HAM projects bid up to December 2016, finances have been tied up for 60%. Lenders wary of funding HAM projects have gradually acclimatised to the contract structure especially the equity light model. Another 16 projects awarded later are yet to achieve financial closure. Amid lenders' cautious approach to infrastructure, a delay of about six months is usual and the agency believes that projects battling financial closure could be due to case-specific issues. Simultaneously, sponsor's experience, capabilities in executing projects on a timely basis and debt service coverage ratios are crucial in taking funding decisions.

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