New roads, old pain Highway building improves, but many projects still hobbling October 2016

Analytical contacts:

Sudip Sural Senior Director, CRISIL Ratings sudip.sural@crisil.com

Prasad Koparkar Senior Director, CRISIL Research prasad.koparkar@crisil.com

Sushmita Majumdar Director, CRISIL Ratings sushmita.majumdar@crisil.com

Ajay Srinivasan Director, CRISIL Research ajay.srinivasan@crisil.com

Hetal Gandhi Associate Director, CRISIL Research hetal.gandhi@crisil.com

Tanvi Shah Associate Director, CRISIL Ratings tanvi.shah@crisil.com

Pranavi Kulkarni Manager, CRISIL Ratings pranavi.kulkarni@crisil.com

Mekhala Leelasagar Manager, CRISIL Ratings mekhala.leelasagar@crisil.com

Priyanka Patawari Manager, CRISIL Ratings priyanka.patawari@crisil.com

Chrystal Noronha Analyst, CRISIL Research chrystal.noronha@crisil.com

3

Table of contents

Executive summary .............................................................................................................................................. 4 

Pace of highway construction set to double ........................................................................................................ 5 

Land acquisition worries subside ............................................................................................................... 6 

Execution gathers pace, to touch 11 km per day by fiscal 2018 ................................................................. 6 

Private participation to gather steam ......................................................................................................... 8 

Rising aggression in hybrid bids, but projects seem viable ........................................................................ 9 

Faster approvals, terminations begin to ease woes............................................................................................10 

The sponsor analysis framework .............................................................................................................. 11 

The execution-risk analysis framework .................................................................................................... 12 

Faster approvals for PCOD and terminations reduce high-risk projects .................................................. 13 

Viability analysis of projects ..................................................................................................................... 14 

Credit profile of operational BOT projects improving .........................................................................................16 

Positive impact of last year’s reforms ...................................................................................................... 18 

Will the hybrid annuity model be a game changer? .............................................................................................19 

Is this model better for developers versus BOT toll or annuity? ............................................................... 20 

The inherent risks ..................................................................................................................................... 20 

More hats in the ring, but aggression can backfire .................................................................................. 21 

4

Executive summary

CRISIL’s analysis of 85 under-construction and 104 operational BOT (build operate and transfer) and annuity projects awarded by the National Highways Authority of India (NHAI), which together span ~16,600 km, shows there has been a 13% reduction in high-risk projects over the past fiscal. These risks pertain to completion (for under-construction projects), and debt servicing ability (for operational ones).

Things also look much better in terms of pace of construction, which improved 40% from an average 4.3 km per day in fiscal 2015 to 6 km in fiscal 2016.

The material improvement in the pace of execution can be attributed to policy reforms by the NHAI and facilitations by the government, which are also reducing delays. Given this, we expect the average construction per day for NHAI projects to nearly double to more than 11 km by fiscal 2018.

The key policy reforms initiated include easing of the clearances process, ensuring 80% land acquisition before the award of project, premium rescheduling, allowing developers to fully exit operational road projects, and introduction of the hybrid annuity model. Given that these reforms are largely aimed at reducing risk, private participation is set to pick up.

Within the 85 under-construction BOT projects, there has been a 10% reduction; however, as much as 4,600 km of projects are still in the high-risk category because delays in land acquisition and approvals have increased costs by 20% or Rs 11,000 crore, and the financial health of sponsors remains weak. These stuck projects were largely awarded during fiscals 2009-2012 and the mitigation options for them include a one-time fund infusion through NHAI loans, and a change in sponsor.

Of the 4,600 km high-risk under-construction projects, 1,400 km has reached the provisional commercial operations date (PCOD) stage, but are still unviable due to cost overruns and weak sponsors. These projects need a whopping 60% revenue growth to meet debt service requirements. Refinancing, debt restructuring, premium deferment or acquisition by a stronger sponsor are the only solutions.

CRISIL’s analysis of the 104 operational projects also shows a significant 18% reduction in both length (to 2,700 km) and outstanding debt (to Rs 19,650 crore) of high-risk operational BOT projects compared with 2015. Consequently, 65% of the operational portfolio has a debt service coverage ratio of over 1 times compared with 55% a year back. This is largely due to healthy traffic growth, averaging over 12%, and reforms like the 100% exit clause in projects and NHAI premium deferment. Refinancing of debt by low cost longer tenure loans has also played a large role in credit improvement of these projects.

CRISIL estimates that over the next two years, stronger developers will be able to raise funds for their under-construction portfolio through stake sales in their operational portfolio and from investment trusts. However, weaker developers still face a funding gap of Rs 6,300 crore, equivalent to around three-fourth of funds required for their existing portfolio.

CRISIL believes the hybrid annuity model has a lot of potential since the developer is fully insulated from traffic risk and partly from inflation and interest rate risks. The award of projects through this mode would kickstart private sector participation, as 60% of the funding for these projects has to be arranged by the developer

However, bidding aggression, both on project cost, and operations and maintenance parameters, and funding mix for hybrid annuity projects needs to be closely monitored. Our assessment indicates that around one-quarter of the projects awarded so far could face challenges in debt servicing.

5

Pace of highway construction set to double

Aggressive bidding coupled with time and cost overruns had significantly impacted private investments in the roads sector since fiscal 2013. However, over the past 24 months, a slew of reforms initiated by the government and the National Highways Authority of India (NHAI) have focused on resolving concerns and improving investor confidence. Consequently, there has been a material improvement in the awarding, and pace of execution, of projects, and a reduction in delays in projects awarded post fiscal 2012.

The key reforms initiated include:

Premium rescheduling for managing cash flow mismatches for BOT toll projects

100% exit for developers from BOT projects after 2 years of completion

Introduction of the hybrid annuity model

Payment of 75% of the arbitration claims prior to final settlement by government agencies in instances where the initial ruling is in favour of the concessionaire/contractor

Introduction of new funding avenues such as investment trusts (InVITs)

Impact of key policy initiatives

Source: CRISIL Research

6

Land acquisition worries subside

Another area where the impact of reforms has been visible is land acquisition, which has impacted the viability of several projects in the past. Our analysis of 40 projects tendered out by NHAI during the course of calendar years 2015 and 2016 indicates that a large portion of land was already in place at the time of tendering. For 40 projects analysed, 90-95% of the land required was at 3D stage and around 85% had reached 3G stage* at the time of tendering. Further, forest clearances were required for less than 10% of the projects.

Our interactions with financiers as well as developers confirms their comfort if a considerable amount of land required for a project is at 3D/3G stage of acquisition before bidding. Financiers cautiously define critical stretches within projects, and now insist on 80-100% land acquisition in critical stretches at the time of financial closure.

*3D stage indicates land title vesting with the central government subsequent to the publication of a notification to acquire land in the

official gazette, while the 3G stage indicates that compensation payable has been determined

Percentage of land acquired at the time of floating tenders

Source: NHAI, CRISIL Research

Execution gathers pace, to touch 11 km per day by fiscal 2018

The speed of execution of NHAI projects improved 40% from an average 4.3 km per day in fiscal 2015 to 6 km in fiscal 2016. We expect this number to nearly double to over 11 km by fiscal 2018, propelled partly by execution of engineering, procurement, construction (EPC) projects awarded during in the past three fiscals.

However, even in the case of BOT and stuck projects, we are beginning to see positive movement. For example, 15 NHAI projects were completed in the first four months of the current fiscal of which 7 were BOT toll projects and 4 were awarded prior to 2009.

CRISIL also analysed disaggregated data on execution for all projects awarded by the NHAI during in fiscals 2013, 2014 and 2015 at 8, 12, 18, and 30 months after awarding. Here too, the prognosis is encouraging with close to 25% execution taking place 12 months after projects were awarded in fiscal 2015. The pace of execution of BOT projects awarded in fiscal 2013 has also ramped up to around 40%, 30 months since.

While the situation appears to be improving, there are still several BOT projects awarded between fiscals 2010 and 2012 that continue to be delayed, and are consequently viewed as high-risk projects (details on Page 12).

92%88%

95%

83%

Average 3(D) completed Average 3(G) completed

Tenders in 2015 (18 tenders) Tenders in 2016 (22 tenders)

7

Annual highway construction

Pace of execution improves

Source: CRISIL Research, NHAI

22072481

1628 1576

2196

3040

4242

2011-12 2012-13 2013-14 2014-15 2015-16 2016-17P 2017-18P

NHAI Execution

Km

2%

9%

5%3%

18%

24%

3%

39%41%

2012-13 2013-14 2014-15

8 months post awarding 12 months 18 months 30 months

8

Private participation to gather steam

Given that reforms initiated are largely aimed at reducing risk, private participation is set to pick up. Higher private sector participation – in terms of willingness to arrange financing – is evident in the increasing bidding interest in projects being awarded on the hybrid annuity model. As of August 2016, 27 projects totaling 1,500 km have been awarded on this model, and another 2,000 km are expected to be awarded in the second half of this fiscal.

Under this model, the developer has to bring in 60% of the funding for a project (with the NHAI contributing the rest). Further, the developer is fully insulated from traffic risks and partly from inflation and interest-rate risks.

CRISIL expects NHAI to award close to 11,000 km of road projects over the course of the current fiscal and the next, of which ~50% would be on the hybrid annuity model. This represents a distinct shift from the previous two fiscals, wherein three-quarters of the ~7,200 km awarded were on EPC basis, wherein the entire financing had to be arranged by the NHAI.

As execution of hybrid annuity projects starts gaining traction during the next fiscal and beyond, we expect a gradual pick-up in the private sector investments flowing on the ground, thereby increasing the share of private sector in the sectoral investment mix.

Highway project awards indicate a sharp uptick in investment commitment by private sector…

…execution to follow, gradual pick-up in private investments on the cards

Note: awarding in percentage of value terms

33%

76% 55%

67%

24%

45%

FY13 - FY14E FY15 - FY16E FY17 - FY18PPublic Private

30%60%

58%70%40%

42%

FY13 - FY14E FY15 - FY16E FY17 - FY18P

Public Private

Rs 480 bn

Rs 1100 bn

Rs 470 bn

9

Rising aggression in hybrid bids, but projects seem viable

There has been a significant increase in competition for road projects. For EPC projects awarded by the NHAI, there are around 15 bidders per project, and the number increases to as much as 30 for some small projects. Furthermore, the projects are also being bid out at a fine cost (median cost is around 5% lower than the NHAI benchmark cost), and the gap between the L1 and L2 bidder is minuscule.

Even for hybrid annuity projects, competition is on the rise, as indicated from our assessment of 21 out of 27 projects awarded between January and August 2016.

Competitive intensity across hybrid annuity projects

Source: CRISIL Research

0%

5%

10%

15%

20%

25%

30%

0

2

4

6

8

10

Jan-Feb 2016 Mar-Apr 2016 May-Jun 2016 Jul-Aug 2016

Nos

.

Median number of biddersMedian gap b/w L2 and L1 as a proportion of L1 (Bid price)Median of (L1 excluding O&M/NHAI benchmark cost-1)

10

Faster approvals, terminations begin to ease woes

An analysis of 85 under-construction projects awarded by the NHAI on BOT model shows there has been a 10% reduction in projects with high execution risk. That’s because of faster approvals for provisional commercial operations date (PCOD), terminations, and construction progress.

We assessed execution risk of under-construction projects using two yardsticks – construction risk and sponsor risk and found that timely equity infusion and support from sponsor are critical to complete projects in a timely manner.

Construction risk analysis framework

* Despite delays in construction, 32 projects of 3403 km have been categorized under low risk as they have achieved PCOD Source: NHAI, company reports & CRISIL estimates

CRISIL’s framework to analyse construction risk takes into account progress achieved by these 85 projects till date and hence the expected time overrun1 before achieving their commercial operation date (COD). Based on this, the projects have been classified into three categories:

1. High construction risk: These include projects where execution so far has been less than 30% or between 30-70%, and which are expected to face a time overrun of over 18 months, and therefore carry high construction risk. As a result, their ability to meet the COD is uncertain.

2. Moderate construction risk: Such projects have been sub-divided into three buckets:

i. Projects with an expected time overrun of more than 18 months but where construction progress is more than 70%. So, despite the significant time overrun expected, these projects can achieve a PCOD and start operations once construction is 75% complete in the continuous project stretch.

1 Time overrun is the difference between the original expected COD and CRISIL’s estimate.

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ii. Those with an expected time overrun of 6-18 months and where construction progress is 30-70%. Such projects can still achieve PCOD if the time overrun is not very significant.

iii. Those with minimal expected time overrun of up to 6 months but with very little progress in construction. Such projects are at a nascent stage and could face issues that delay implementation and completion thereby resulting in tome and cost overrun.

3. Low construction risk: Such projects have low expected time overruns and have also seen substantial progress (more than 70%) in construction. Many of these projects can achieve PCOD once they construct 75% of a continuous project stretch. The remaining projects are also expected to achieve COD with limited delays. Furthermore, despite delays in construction, projects that have achieved PCOD have been categorised under low risk as project construction risk is mitigated to a large extent.

The sponsor analysis framework

We analysed 13 large developers on ability to infuse funds into under-construction projects and support cost-overruns, and to meet cash flow mismatches in case of shortfall in operational projects. The wherewithal of one sponsor that is a holding company of special purpose vehicles (SPVs), was analysed based on the split in portfolio between under-construction and operational projects.

These sponsors have been classified into strong and weak based on their standalone gearing, the mix of under-construction and operational projects in portfolio, quantum of equity infusion and support required to fund cost overruns in under-construction projects, and cash flow mismatches in operational projects expected over the next two years.

Sponsor risk assessment framework

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While sponsors with low gearing have sound financial health, those with a high proportion of operational projects in portfolio have greater financial flexibility to raise funds from divestment and securitisation. These two aspects have been looked at in conjunction with the funding requirement of sponsors for the next two years in order to determine their ability to support projects. Stake sales in some projects in fiscal 2016 have helped one sponsor deleverage balance sheet and improve the financial risk profile.

Our analysis shows sponsors require Rs 13,200 crore of equity commitments in under-construction projects over the next two years to ensure they are completed on schedule. Stronger sponsors have access to fund-raising avenues such as infrastructure investment trusts (InvITs) and Initial Public Offerings (IPOs) to meet commitments unlike their weaker counterparts.

InvITs to help strong sponsors overcome funding gap; weak ones continue to struggle

Furthermore, strong sponsors having a healthy portfolio of operational assets can infuse an additional Rs 2,140 crore from the surplus in their operational portfolio and close to Rs 2900 cr in the next few years in light of the recently introduced reforms that permit 100% exit from projects two years after the COD. Such sponsors can also look at diluting stake in operational projects and tap the capital market to raise additional monies. But timeliness, attractive valuations and appropriate closures will be critical. In contrast, funding avenues for weak sponsors remain limited and they are today staring at a funding gap of about Rs 6,300 crore.

The execution-risk analysis framework

Superimposing the sponsor risk framework over the high, moderate and low construction risk of under-construction projects, we conclude that 36% of under-construction BOT road projects - spanning 3,200 km with a sanctioned debt of Rs 29,000 crore - are at very high or high risk of not being completed. The cost overrun for these projects is estimated to be around Rs 11,000 crore and it will keep mounting with further delays in completion.

47292140

28895820 6120

8432

1075 1038

-6318-5000

0

5000

10000

15000

Equity and supportrequired for

projects

Surplus inoperational

Stake sale inoperational

projects

Additional fundfrom IPO/InvIT

Deficit with weaksponsors

Rs.

in c

rore

Deficit with strong sponsors

Strong sponsors Weak sponsorsxx

13

36% under-construction projects at high execution risk

These projects, now starved for funds, are backed by financially weak sponsors, have high or moderate construction risk, and had won projects between fiscals 2010 and 2012 through aggressive bidding.

They would be served well through NHAI loans (for projects more than 50% complete) and changes in policy that enable exit of weak sponsors in under-construction projects.

Faster approvals for PCOD and terminations reduce high-risk projects

High Risk

14

Projects with high construction risk reduced by ~500 km in fiscal 2016 on account of significant progress achieved on projects and delayed termination mainly because of right-of-way (ROW) issues. Furthermore, delays in project execution due to land acquisition and weak financial health of sponsors resulted in movement of some projects from the low risk bucket to moderate risk bucket.

Sponsor support in terms of timely equity infusion and funding of cost overruns is critical for under-construction projects. But for a large percentage of projects, sponsors are too weak financially to ensure timely support.

Given the government’s thrust on the roads and highways sector, expediting clearances and addressing land acquisition-related woes in a time-bound manner could help revive slow-moving projects.

Viability analysis of projects

CRISIL also analysed the viability of under-construction projects that have recently achieved PCOD by assessing the revenue they require based on project cost, operating expenses, debt obligation and premium payout. This showed ~15 projects spanning 1,400 km (14 toll and one annuity) backed by weak sponsors are facing viability issues.

60% traffic growth required for delayed projects with PCOD to become viable

32000

(20,000)

500017000

30000

-30000

-20000

-10000

0

10000

20000

30000

40000

Revenue/day/km Operatingexpense/day/km

Debt serviceobligation/day/km

Premiumpayout/day/km

Shortfall/day/km

in R

s.

6% 6%11%

13% 12%

63%

0%

10%

20%

30%

40%

50%

60%

70%

2013 2014 2015 2016 2017

Toll revenue growth of ~60% required to meet shortfall as against expected growth of 12% in fiscal 2017

15

Out of a total 36 projects that have achieved PCOD, about 20 spanning 1,855 km are unviable on a standalone basis. Inordinate delays in completion led to significant cost overruns and higher debt contracted, which ultimately impacted viability. The revenue growth required in these projects to meet shortfall in operational cash flows is as high as ~60% against expected growth of 12% in fiscal 2017.

Many of these projects were bid aggressively at high premiums, which add to the agony of weak sponsors reeling under elevated debt due to cost overruns. Not surprisingly, we have seen premium deferments in a few operational and under-construction projects.

Overall, under-construction BOT projects spanning 4,600 km with a sanctioned debt of Rs 41,350 crore are at risk today. This is lower than last fiscal, and the improvement was largely driven by faster clearances leading to healthy progress in implementation, completions, and terminations.

CRISIL believes low-cost refinancing, debt restructuring, premium deferment, project acquisition by strong sponsors are some of the options before high-risk projects. The facilitation of these through reforms and policy push could bring under-construction BOT projects up to speed.

16

Credit profile of operational BOT projects improving

Healthy pick-up in traffic despite near-zero toll rate hikes has supported cash flows and hence improved the debt service ability of operational BOT projects. In the past few years, their sponsors have faced liquidity crunch because of lower than estimated traffic and modest inflation-linked toll-rate hikes. However, the successful implementation of reforms and improvement in commercial traffic riding on economic growth has changed the script for operational projects.

While toll rate hikes have kept pace with the Wholesale Price Index (WPI)-based inflation, traffic has started to outpace economic growth recently. Toll rate hikes have been modest in fiscal 2016 because of low annual variation and negative WPI inflation to which they are linked. Traffic growth, on the other hand, has picked up along with the economy and faster growth in consumption-linked sectors. CRISIL believes healthy traffic growth will continue to support revenue and credit profile of operational projects over the medium term.

Healthy traffic growth expected to sustain and support toll revenue in the near term

6.2% 5.6%

11.2%

12.9%12.0% 12.0%

5.2%4.2% 3.6%

-0.1%

2.5%2.5%1.0%

1.3%

7.5%

13.0%

9.5%9.5%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

2013 2014 2015 2016 2017E 2018E

% growth revenues % toll rate hike % traffic growth

7.5%

4.8%

5.5%

-2.4%

2%2%

5.60%

6.60%7.20% 7.60% 7.60% 7.70%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

2013 2014 2015 2016 2017E 2018E

% inflation % GDP growth

17

We analysed 104 operational BOT projects (74 toll-based and 30 annuity-based) with total outstanding debt of ~Rs 46,950 crore. It showed 28 projects spanning 2,700 km with debt outstanding of Rs 19,650 crore at risk. That means 35% of the projects are at risk this year compared with 45% last year. The improvement was driven by reforms and a pick-up in traffic.

The credit risk in these project stems from the inadequacy of standalone cash flows in meeting debt obligations in the near term. Furthermore, sponsors of these projects do not display adequate financial flexibility to provide timely support to meet debt servicing obligations.

A major challenge for operational toll-based highways is the large variation in base traffic estimates made at the time of awarding projects and actual traffic after commissioning. This has impacted toll collection and therefore debt servicing ability.

Annuity projects, on the other hand, continue to perform well with most of them meeting their debt servicing obligations on a standalone basis. Maintenance of highways and timely as well as full receipt of annuity from the NHAI continues to be the key monitorable.

CRISIL has classified these projects into low, moderate and high-risk categories based on their ability to service debt on a standalone basis, and sponsor wherewithal:

High risk: Such projects have inadequate cash flows to service debt obligations in the medium term on a standalone basis, and are backed by financially weak sponsors. A dozen operational BOT toll projects with a debt of Rs 9,515 crore and two BOT annuity projects with a debt of Rs 285 crore fall in this category.

Moderate risk: Such projects have inadequate cash flows to service debt obligations in the medium term on a standalone basis, but have financially strong sponsors. There are 14 operational BOT toll projects with a debt of Rs 9,850 crore in this category. No annuity-based project is in this category. Timely support from sponsors to help meet cash-flow mismatches is crucial here.

Low risk: Such projects are viable and have sufficient cash flows to meet debt obligations on a standalone basis. 48 operational BOT toll projects with debt of Rs 17,190 crore and 28 BOT annuity projects with a debt of Rs 10,110 crore fall in this category.

Risk classification of operational BOT toll projects

Source: NHAI, Company reports & CRISIL estimates

Strong  

Adequate debt servicing capability5,080 km

Debt outstanding Rs 27,300 crore

High risk1,250 km

Debt outstanding Rs 9,800 crore

Moderate Risk (Sponsor support is key)

1,450 kmDebt outstanding Rs 9,850 crore

Wea

kS

pons

ors

DSCR < 1 DSCR > 1

DSCR Level

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Positive impact of last year’s reforms

In October 2015, we had underscored how, of all the policy reforms announced for operational projects, the removal of restriction on exit clause was likely to have the maximum impact. This afforded change in management and improved access to better refinancing terms. Four projects that were dubbed high risk are now in the low-risk category with new managements stepping in and wrangling favourable terms on refinancing. Four others were also refinanced at a lower cost, which improved their debt servicing ability and hence credit profiles.

In addition, the government has approved partial deferment of premium payment for projects that were bid at a high premium and are facing difficulties in honouring debt obligations. This has turned a high-risk project into a low risk one.

CRISIL had also mentioned that the gains from the Reserve Bank of India’s 5:25 scheme will be limited since most operational highways had shorter concession periods. Not surprisingly, no project has qualified under this scheme yet.

Movement of projects to low risk bucket due to improved debt servicing capability

With improvement in traffic and implementation of reforms, the removal of restriction on exit clause and premium deferment, 12 formerly high risk projects with debt of Rs 5,930 crore are now expected to become viable. However, for those at risk, timely support from sponsors remains crucial to meet operating expenses and debt obligations.

CRISIL believes successful implementation of reforms, especially the 100% exit clause and refinancing thereafter, can further improve and strengthen the credit profiles of operational BOT projects. This will also help road developers raise funds and ease their financial position to some extent.

19

Will the hybrid annuity model be a game changer?

Developer participation in the BOT model of road construction has reduced with the average number of bids from 25 in fiscal 2011 to 6 in 2016. That’s because of the stretched financials of developers and their limited capacity to take up new projects.

The NHAI introduced the hybrid annuity model to encourage private participation. The model reduces upfront equity infusion required by developers because 40% of the project cost is funded by the NHAI. The authority will also provide fixed annuity payouts and cover operating as well as interest costs during the operational phase, which further reduced the risk for developers.

With a target of 3,000 km to be awarded on hybrid annuity basis in fiscal 2017, this model will cumulatively reduce the public funding requirement by Rs 18,000 crore compared with the EPC model. Simultaneously, for the developer, the equity requirement would reduce by 40% to Rs 5,400 crore compared with Rs 9,000 crore in BOT toll or annuity models for the same length.

Hybrid annuity business model suits the risk appetite of private players

In the construction phase, with the NHAI funding 40% of the project cost, the equity infusion requirement and the debt burden of stretched developers will reduce. In the operational phase, developers will have steady cash flows through annuity receipts, interest income on balance annuity payments, and operation and maintenance (O&M) cost payout. While the total annuity payout would be adjusted one time for inflation after the construction period, the payout for O&M cost will be adjusted for inflation annually.

Reduces upfront equity infusion requirement, while increasing NHAI funding

Construction phase: Project cost funding Operational phase: Cash flows

Debt

Equity

Payments linked to project milestone (8%

for each milestone)

NHAI funding 40% of project cost

18%

42%

Developer funding – 60% of project cost

NHAI to fund remaining 60% of project cost in the form of annuityAnnuity inflow every six months – adjusted for inflation index

Inflows Outflows

Annuity

Interest on balance annuity payments @bank rate +3%pa

Difference due to inflation on O&M bids

O&M payments

Routine O&M cost

Administration costs

Debt servicing obligation

Major maintenance cost

• Bidding amount by developers to include– Project cost (bid project cost)– Maintenance cost (routine O&M + major maintenance cost)

• All payments to developers will be adjusted to inflation index (WPI) from the date of project award

20

Is this model better for developers versus BOT toll or annuity?

While the higher return on investment is what drew developers to the BOT models, the risks associated with land acquisition, and hence delays in construction and variability in traffic during the operational phase, hit the sponsors hard. Hybrid annuity has limited downside for developers compared with BOT, but the returns are limited, too. The annuity amount will be adjusted to inflation upon completion of construction. Also, maintenance payments will be linked to inflation annually. Both these factors are positive for hybrid annuity project developers compared with the BOT annuity model where the major maintenance cost is open to inflationary impact, while the annuity inflow is fixed.

Besides positive developments on funding and operating costs in the hybrid annuity model, the NHAI has also addressed some issues that plagued BOT projects mainly with respect to timely availability of right of way and requisite approvals. As for right of way, the NHAI will be handing over 80% of continuous stretches before signing the concession agreement. The remaining would be given within 180 days failing which, that portion will be removed from the scope of work of the NHAI. If there are delays from the NHAI in providing clearances that, in turn, delays project execution, it will lead to the extension of the concession period in proportion to the delay. Furthermore, a part of the NHAI’s own funds will get blocked if there is a delay in construction because it is financing 40% of the project cost.

The inherent risks

While the model seems robust to address gaps in the previous BOT models, it is still exposed to the following risks during the construction and operational phases.

Aggression in bidding which lowers project cost would expose the developer to cost overruns. Weaker sponsors may find it a task to bring in equity to meet these. Also, cost overruns would mean further stress on the project as inflows through annuity is fixed. This will lead to a stressed situation for some projects in terms of debt servicing. Cash flows consists of semi-annual fixed annuity payout, interest income on the balance annuity pay out, and annual operations and maintenance cost payout adjusted for inflation. Thus, cash flows will be sensitive to interest rates over the tenure of the concession period as well as to inflation during the construction phase.

21

More hats in the ring, but aggression can backfire

Given the slow movement in the award of BOT toll and annuity projects, we are seeing some aggression in hybrid annuity projects with some mid-sized and small developers also taking up projects. CRISIL analysed the hybrid annuity projects awarded till date and found that around one-quarter of the projects could face challenges in debt servicing.

There has been an increase in the average number of bidders from 3 earlier to 10 now. Bids, in some projects, have been aggressive compared with the NHAI’s own base project cost and normative operations and maintenance costs for road stretches.

Bid characteristics of few projects

Though the equity requirement has reduced, these mid-sized and small developers’ ability to get the required equity money in a timely manner will remain the key monitorable. Also their ability to provide financial support in case of cost overruns and cash flow mismatches could hamper execution and hence viability. Beyond that, risks pertaining to delays in clearance and higher leverage will persist even in this model.

Overall, the hybrid annuity model seems to be an attractive option for developers though there could be risks emerging from aggressive bidding. Furthermore, implementation of reforms as regards land acquisition and approvals will play a key role till projects under this model are commissioned. Till then, developers should stay cautious during bidding to avoid bruising their financials, as it had happened between fiscals 2010 and 2012.

0

0.5

1

1.5

2

2.5

0

20

40

60

80

100

120

140

Project 1 Project 2 Project 3 Project 4 Project 5 Project 6 Project 7 Project 8

Nor

mat

ive

O&

M

Pro

ject

cos

t to

base

100

Bidder project cost NHAI project cost Normative O&M Bidder O&M

Viable Unviable

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CRISIL Limited: CRISIL House, Central Avenue, Hiranandani Business Park, Powai, Mumbai – 400076. India

Phone: + 91 22 3342 3000 | Fax: + 91 22 3342 3001 | www.crisil.com

About CRISIL Limited CRISIL is a global analytical company providing ratings, research, and risk and policy advisory services.

We are India's leading ratings agency. We are also the foremost provider of high-end research to the world's largest banks and leading corporations. With sustainable competitive advantage arising from our strong brand, unmatched credibility, market leadership across businesses, and large customer base, we deliver analysis, opinions, and solutions that make markets function better.

Our defining trait is our ability to convert data and information into expert judgments and forecasts across a wide range of domains, with deep expertise and complete objectivity.

At the core of our credibility, built up assiduously over the years, are our values: Integrity, Excellence, Accountability, Teamwork and Respect

CRISIL is majority owned by S&P Global Inc., a leading provider of transparent and independent ratings, benchmarks, analytics and data to the capital and commodity markets worldwide.

CRISIL Privacy Notice CRISIL respects your privacy. We use your contact information, such as your name, address, and email id, to fulfil your request and service your account and to provide you with additional information from CRISIL and other parts of S&P Global Inc. and its subsidiaries (collectively, the “Company”) you may find of interest.

For further information, or to let us know your preferences with respect to receiving marketing materials, please visit www.crisil.com/privacy. You can view the Company’s Customer Privacy at https://www.spglobal.com/privacy

Last updated: April 2016