Infrastructure development is critical for the overall economic growth of a country in the long term. Infrastructure assets are a unique asset class, highly capital intensive with long gestation period. One of the major challenges faced by the sector is in terms of financing. Typically, these assets require long term funding but in India primarily commercial bank loans with shorter tenors lead to an asset liability mismatch for the banks on one hand and debt servicing pressure on the projects in a shorter period than desired. The huge investment need of the sector cannot be met by the traditional financing channels alone and there is a need to explore alternate channels. The introduction of Infrastructure Investment Trusts (InvITs) by Securities Exchange Board of India (SEBI) through SEBI (Infrastructure Investment Trusts) Regulations 2014 and its subsequent amendments (last amended on May 04,2022) is an attempt to garner long term capital for the infrastructure sector. InvITs are an investment vehicle like mutual funds that allows developers to monetise revenue generating infrastructure assets and at the same time enable investors to invest in this class of assets. This benefits both the developers and the investors: developers are able to use thus released capital to invest in new projects or repay their debt and retail/ institutional investors are provided with liquidity as these maybe listed and traded on the stock exchanges.
What is an InvIT?
An InvIT is a collective investment scheme and is set up in the form of a trust that owns, operates, and invests in completed as well as under construction infrastructure projects. These assets can be from energy sector, telecom sector, transport sector etc. Generally, the infrastructure assets are held by the developers under Special Purpose Vehicles (SPVs). An InvIT allows multiple such assets to be pooled under one single entity, the trust which is governed by SEBI. The performance of InvITs primarily depends on how well its infrastructure holdings are performing. A unit of InvIT represents part ownership of the infrastructure assets held by the Trust. This entitles the unit holder(s) to receive a share of the income generated by the InvIT from its infrastructure holdings. Currently, distribution of 90% of net distributable cash flows (NDCF) is mandatory to the unit holders of a publicly listed InvIT. The public InvIT units are listed and traded on the stock exchange like equity stocks. The aggregate consolidated borrowings and deferred payments of the InvIT, net of cash and cash equivalents is restricted to 70% of the value of the InvIT assets. However, private InvITs (i.e., not listed on stock exchanges) are exempt from restrictions on leverage and mandatory distribution. Also, as per SEBI’s regulatory requirement, if the aggregate consolidated borrowing and deferred payment of the investment trust, net of cash and cash equivalents, exceeds 25% of the value of the assets, for any further borrowing, credit rating must be obtained from a registered credit rating agency. Further, if the leverage is beyond 49%, InvIT requires a credit rating of “AAA” for its consolidated borrowing and the proposed borrowing exceeding 49% and in addition, the InvIT must have a track record of minimum six distributions on a continuous basis.
Scope of Credit Rating of InvIT
Infomerics’ rating of InvITs is an opinion on the ability of the trust to make timely payment on its debt obligations. Infomerics does not rate the units of these trusts which are like shares of a company nor does the rating have any bearing on the market performance of the trust. The rating does not in any way signify or indicate the returns to unit holders nor does it signify any potential yield levels to unit holders, and therefore, the rating on the debt of InvIT should not be construed as a rating on InvIT’s units. The credit rating involves assessing the combined adequacy of cash flows to service its debt obligations after assessing the operational and financial risk profiles of the underlying portfolio of infrastructure assets. Infomerics considers consolidated debt on the books of the InvIT and its SPVs while arriving at the rating of the InvIT. The external debt could be either raised at the InvIT level or at the level of the SPVs. The InvIT could also guarantee the debt raised at the SPV which is included in the consolidated debt. The rating is also in no way a reflection on the credit worthiness of the individual assets/SPVs as these assets are part of a portfolio and evaluated as a pool.
Structure of InvIT
The InvIT is established as a Trust under Indian Trusts Act 1882 and registered with SEBI. It is designed as a tiered structure: a trustee, a sponsor, an investment manager, and a project manager (See diagram below). SEBI has laid down guidelines notifying as to which entity can qualify for each, in terms of experience in relevant areas, net worth, assets owned as well as each of their duties and responsibilities.
Sponsors are people who promote and refer to any organisation or a corporate entity with a capital of Rs 100 crore, which establishes the InvIT and in case of PPP projects, could be the base developer. The sponsor sets up the InvIT and appoints the trustee. The sponsor shall transfer its ownership of the infrastructure assets to the InvIT.
The trustee shall hold the InvITs assets on behalf of the InvIT for the benefit of the unitholders. The trustee appoints an investment manager and project manager and oversees the activities of the investment manager and the project manager. The trustee cannot be an associate of the sponsor or the investment manager.
The investment manager is an entity that is responsible for actual investment, divestment, and related investment decisions of the InvIT. The trustee enters into an investment management agreement with the investment manager on behalf of the InvIT.
The project manager primarily undertakes the operations and maintenance of the InvIT assets. It is also responsible for project execution and completion of projects on time.
Refer to Annexure 1 for current regulatory framework on InvITs.
Diagram of Structure of InvIT
The credit rating of borrowings of an InvIT primarily involves assessing the credit quality of the underlying asset portfolio, the cash flow coverage, leverage, financial flexibility, and the management risk. The credit rating reflects the combined strength of the InvITs assets/SPVs cash flows to meet debt obligations in a timely manner. The ratings approach is similar to that of rating debt in a corporate. Infomerics applies the ‘Rating Criteria for Infrastructure Sector’ while assessing the homogeneous or heterogeneous assets/SPVs of the trust.
Portfolio Credit Quality:
The most important driver for assessment of the business risk profile of the InvIT is the assessment of the underlying infrastructure assets or SPVs. The cashflows available at the InvIT level are a consolidation/ pooling of the cash flows available from each of the assets/SPVs for servicing the debt obligation of the InvIT. Therefore, it is important that cash flow adequacy at individual asset level is assessed. The credit quality of the assets in the portfolio are assessed using the sector specific criteria applicable to the entity. In case of homogeneous assets, for example assets in power transmission business rating criteria applicable to power transmission projects will be applicable and accordingly the cash flows will be pooled together. In case of heterogeneous assets, each asset/SPV will be assessed separately using sector specific rating criteria for each.
The assessment of infrastructure assets primarily covers revenue risk, operating risk, counterparty credit risk, regulatory risk and any project execution risks with reference to under construction projects. Stresses to revenue due to changes in demand supply situation, renegotiating of contracts (PPAs), higher operating costs, repricing of input risks (fuel supply) are analyzed. The assets adherence to the performance parameters and the experience and track record of the O&M contractor is assessed. Another key parameter is the financial health of the counterparties in terms of timely payment of dues. Diversification of counterparties and presence of reserves like debt service reserves, O&M reserves etc. add some comfort. Generally, a stable and well-developed regulatory framework in case of infrastructure assets provide for predictability of cash flows as the tariffs are governed by the concession agreements. Here the timely issue of tariff orders and timely compensations due to changes in the terms of the concession agreements are important in assessing regulatory risk.
Majority of the assets under the InvIT are expected to be operational and generally a track record of their performance would have been established. For example, record of traffic movement would have been established in case of toll roads, airports, and ports. In case of power generation assets, performance parameters like plant availability and plant load factors and adequate availability of fuel and power evacuation would have been established. For power transmission assets availability of the assets would have been established. For projects under construction timely and within budget completion risk is assessed, experience and track record of the EPC contractor is assessed. Independent experts’ reports are relied upon to understand the demand potential for example traffic studies in terms of toll roads.
The portfolio credit quality at the InvIT level could be higher than the credit quality of the individual assets in the pool. This emanates from possible diversification benefits across geographies, multiple counterparties, a mix of revenue models and that of technologies. For example, a well-diversified proportion of solar and wind project across states, or a mix of toll and annuity-based road projects. Thus, the cash flows at the InvIT level can exhibit less volatility as compared to the cash flows at the individual asset/SPV level. Hence a well-diversified asset base with strong cash flows, low receivables concentration will be looked at favourably.
The rating normally corresponds to the current portfolio and may factor any planned additions in its analysis. However, any unplanned addition or divestment will trigger a rating review of the InvIT. Infomerics would review the rating of the InvIT each time a new asset is added or divested from the portfolio and if there is any deviation from the stated investment philosophy of the InvIT. The new addition would be assessed both at the individual level and at the consolidated level and if there are any deviations from the stated investment philosophy it may impact the rating of the InvIT.
The financial risk assessment involves Infomerics evaluating the stability and adequacy of cash flows, debt service coverage metrics, overall leverage, financial flexibility, in the form of headroom for further borrowing and liquidity of the InvIT.
InvIT Regulations allow InvITs to raise debt at InvIT level or at the SPV level. Hence there could be external debt only at InvIT level, or only at SPV level or at both InvIT and SPV levels. At first cash flows of individual SPVs after meeting their operational expenses are assessed that can be up streamed to the InvIT. Then all such cashflows of SPVs are consolidated to arrive at the cash flows of the InvIT. The adequacy of such cash flows is evaluated for meeting InvITs expenses and debt obligations. This is applicable when there is no external debt at SPV level. Even if there is external debt at any SPV level and such debt does not have restrictive covenants in terms of up streaming of cash flows to InvIT similar approach is followed. If there are any restrictive covenants only surplus cash flows after servicing debt obligations of that SPVs available are consolidated for the cash flows of the InvIT. The debt service coverage ratio both at the InvIT level and at the SPV level is evaluated based on the available cash flows. Creation of debt service reserve account and O&M reserve account in the structure provide an additional comfort.
The aggregate debt, including those in the SPVs is considered in arriving at the gearing levels of the InvIT. In terms of infrastructure assets, a high financial leverage can be offset to an extent by long maturity profile of debts, lower cost of debt and financial flexibility available in terms of getting debt refinanced. Also, and more importantly the low volatility in earnings exhibited by infrastructure assets offset and thereby permit usage of higher leverage in these assets. Funding and pricing risks are also factored in, in case of debt of an SPV facing project execution risk. The extent of distress support that may be provided by the InvIT to a relatively weaker SPV is also factored in. Further in case of InvITs the leverage restrictions and requirements at various levels of leverage are detailed in the SEBI guidelines. Also, an InvIT may choose to repay the external debt at the SPV levels as the debt at the InvIT level will be economical based on the consolidated cash flows from a diversified asset base. Unencumbered cash balances, undrawn lines of credit at consolidated level further provide liquidity support in times of temporary cash flow mismatches.
Projects that have been operational for a few years would have stabilized and there would be predictability on their cash flows. An InvIT with assets generating stable cash flows (for example in passive assets such as transmission assets and annuity road projects) would be looked at more favorably than active assets such as thermal power plants.
The foreign exchange variation risk is also assessed in case of unhedged foreign currency borrowings. Adjustments to interest rate assumptions are factored in the sensitivity analysis while calculating the available cash flows of the SPVs. Any financial implications of contingent liabilities and off-balance sheet exposure of the SPVs and the InvIT are also evaluated.
The assessment of management risk is an important part of the debt rating exercise. The experience and track record of the trustee, investment manager and project manager are of key importance. It is reviewed how similar investment and project execution tasks especially of under construction projects have been handled by the investment manager and project manager respectively in the past. A detailed discussion with the management is done to understand the issuer’s investment policy, leveraging policy and return policy. Also, Infomerics evaluates credit profile and track record of the sponsor. A strong sponsor may lend financial flexibility in terms of refinancing debt and may also attract equity investments in the fund based on its past track record or being part of a strong group. Generally, the sponsor may also be involved in the O&M of the assets. Thus, a strong operational track record and financial profile of the sponsor does add some comfort while assessing the credit profile of the InvIT.
InvITs are investment vehicles that invest in infrastructure assets. They are governed by SEBI guidelines. There are laid guidelines on listing, distribution of cash flows, leverage, and investment. Infomerics rating of the InvIT is an opinion on the ability of the trust to make timely payments on its debt obligations. This opinion is based on the detailed assessment of the underlying quality of asset portfolio, cash flow and its adequacy, cash flow coverage, financial flexibility, and management expertise.
Current Regulatory Framework
SEBI has laid down the framework for setting up InvITs in India and has specified eligibility criteria for various parties to the InvITs.
1. Structure of InvIT
2. Eligibility Criteria for Various Parties
3. Distribution Requirements
4. Borrowing Restrictions
5. Valuation of Assets