Infrastructure debt funds (IDFs) are likely to reduce banks' exposure to the sector but improved risk appetite of investors and availability of secondary bond markets will be crucial to create an enabling environment for the success of this source of funding, says a report.
As per India Ratings, IDFs are intended to moderate banks' over exposure to the infra sector and lessen their burden but certain structural adjustments, improved investors' risk appetite and availability of active secondary bond markets are needed to create an enabling environment for IDF.
Though IDFs have gradually gained traction in refinancing infrastructure loans, some features deter the effectiveness in the process, it said.
"The conundrum stems from the existing lenders' preference for IDF mutual funds and investors' choice for IDF non-banking financial companies," it said.
While existing lenders prefer IDF MFs due to their desire to retain operational projects that generate cash flow adequate for debt service rather than under-construction, low interest rate of IDF NBFCs attracts project companies.
Also, a certain regulation restricts investments only in operational projects for IDF NBFC hence existing lenders' preference is IDF MF, the report said.
On entry, IDF NBFC demands super seniority rights on the termination payments which lenders may not be willing to relinquish after having endured the construction and delay risks.
According to the agency, these risks are generally high in a project life-cycle and given IDF NBFCs' exposure ceilings of around 85 per cent of the project debt on investments, any concessionaire default would be fully protected by the termination payments, which is generally 90 per cent of the original debt.
"IDF NBFCs regulation stipulates fund capitalisation. Consequently, a few projects' debt service default may not significantly impair investment returns. Investments were restricted to operational projects, resulting in a low portfolio risk.
"Whereas, IDF MF investments in under construction or diverse projects heighten the default risk and any risk is directly passed through. Thus domestic and foreign pension funds would embrace IDF NBFC," India Ratings said.
It further said that unless the functions of availability of longer-term funds at lower costs and the effective transfer of risks take place simultaneously, the mission of IDFs would not be met, it said.
"An active secondary bond is necessary to perform the 'transfer-of-risks' function effectively. The mission of forming IDFs will be achieved only if an appetite is created for various risk categories across the sector. This is necessary to create a secondary-debt market for infrastructure assets," the agency said.
