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Traditionally, the bulk of infrastructure financing in India has come from the banks. However, asset-liability mismatches and rising bad loans have limited the ability of lenders to fund the country’s humongous infrastructure funding requirement – estimated at Rs 43 trillion in the five years through 2022.
Therefore, an active corporate bond market is imperative, but conspicuous by its absence, leaving debt-laden developers with few options to refinance projects and recycle their locked-in capital.
This is where InvITs can help. An InvIT is a trust registered with the Securities and Exchange Board of India (Sebi) and listed on the Indian stock exchange. It acquires the initial asset portfolio of a sponsor/ developer and issues units in lieu. The sponsor, in turn, puts up part of the units as offer for sale (OFS) during listing. In India, two InvITs are already trading on the exchanges and at least three more are in the pipeline.
Business trusts abroad work like InvITs and have seen considerable success in Asia, especially Singapore. They typically target infrastructure, healthcare, retail, and information technology sectors. Regulations governing Indian InvITs are similar to those for the business trusts, but offer additional benefits such as tax advantage, lower voting requirement, and gearing limits.
InvITs offer multiple benefits to infrastructure developers stuck with high leverage and unfinished projects. OFS unlocks their invested capital, and also recovers unsecured loans they may have given to Special Purpose Vehicles (SPVs) to fund past time and cost overruns. That, in turn, enables them to deleverage their holding companies and even to bid for new projects.
Developers can also prepay bank debt in their special purpose vehicles (SPVs) with the initial public offer proceeds. In the absence of external debt servicing, cash flows generated by project SPVs thus get enhanced. They get to retain control over their assets as project managers and those with a ready pipeline of projects can even time the market for stake dilution in the InvIT.
Infrastructure assets in sectors with long concession periods and predictable cash flows are ideal candidates for InvITs, such as toll roads and power transmission projects. As for investors, InvITs ensure steady, tax-efficient returns over protracted investment horizons of 20-30 years, given mandatory payouts, third-party valuation every six months, and liquidity. Indeed, the tax-exempt status of Indian InvITs, coupled with zero dividend distribution tax, provides a yield upside of 2.5%, which improves their attractiveness.
The debt structure of InvITs and their underlying SPVs can have a bearing on overall yields. For a given level of external SPV leverage, the overall cash yield increases with an increase in the interest rate charged on InvIT loans given to the SPVs. That, along with appropriate structuring of principal repayments on such InvIT loans, can potentiallymaximise cash up-streaming and, in turn, influence yields.
Also, there is greater comfort compared with a direct exposure to infrastructure assets, given the cap on aggregate gearing levels, stipulated minimum sponsor holding in the trust, independent valuation of the assets, trustee-monitored transparency, and stringent compliance and disclosure requirements. Additionally, there is safety, with strong governance, concession agreement safeguards, and predominance of operational assets.
All this gives InvITs an edge over traditional debt and equity investments, though these are better suited for institutional investors such as pension and insurance funds who can evaluate performance and cash-flow related risks in the underlying infrastructure assets, compared with retail investors.
For all that, investments in InvITs have their own share of risks. Exposure to cash flow risks in the underlying SPVs can affect distribution/ payouts, as also future capital value.
The investor also faces risks of early termination of concession agreement, or a decline in toll revenue, which may reduce distributable cash flows from the specific SPV. Risks could also be regulatory in nature, such as delayed receipt of compensation in case of termination.
Therefore, the quality of assets will determine the quality of the underlying cash flow and, in turn, the trust’s business-risk profile. Timely addition of new projects is also essential, as not having assets in the InvIT for six months can lead to delisting, and eventually, winding up.
The two listed InvITs have used the funds garnered to repay existing debt and deleverage. While both are currently trading below their issue prices, these are early days to judge them.
Investor interest is expected to increase once the InvITs make their first cash distribution and the sponsors demonstrate their ability to identify and add the right kind of assets over time. Robust management, strong governance and continuous addition of good quality assets will determine the yields generated, and eventually determine investor interest in this instrument.
By Sudip Sural, Senior Director – Infra & Public Finance, CRISIL Infrastructure Advisory