Absence of adequate major maintenance reserve (MMR) for BOT road projects exposes lenders to default risk, says ICRA in its latest study on Indian Road Sector. ICRA’s assessment of Major Maintenance costs across several national highway (NH) projects reveals that the median cost per lane km was Rs. 1.8 million. In ICRA’s view, if the lenders do not enforce creation of MMR immediately on commissioning of projects and instead allow tail periods to shrink through loan top-ups at the time of the first MM, then they could be either exposed to default risk or be totally dependent on sponsors infusing the requisite funds for subsequent MM and in some cases for debt servicing.
MM is the largest expense item during the operations phase of a BOT road project, with each MM cycle involving expenditure of about 12% of initial construction cost. As per ICRA estimates, the total estimated expenditure towards MM during the project life could be as high as 60% of the initial construction cost, as a BOT project goes through three to five MM cycles depending on the length of the concession period.
According to ICRA’s study on 15 NH road projects commissioned between 2005 and 2009 suggests that, in 60% of the operational BOT projects, a major maintenance reserve (MMR) was not created, whereas in the remaining 40%, it was not adequate to fund the MM cost. Although the common loan agreements stipulate the creation of an MMR; lenders/banks have not been proactive in enforcing the same, thereby allowing temporary surpluses if any to leak out of the SPVs. Adherence to MMR creation is relatively higher in case of debt raised in the form of bonds/NCDs.
According to Mr. Rohit Inamdar, Senior Vice-President, ICRA, “In the absence of adequate MMR, the road SPVs are either dependent on the sponsors for fund infusion or have to fall back on its tail period to raise additional debt. Therefore, the credit profile of most operational BOT projects are crucially linked to sponsors’ ability and willingness to fund MM cost and the sufficiency of tail period. However, presence of a financially strong sponsor need not necessarily mean assured fund support for the MM expense. In the absence of explicit support (guarantees/letters of comfort/ shortfall undertakings), the sponsors’ willingness to support the operational projects would be determined by strength of project cash flows and duration of the tail period. Increased leveraging could weaken the credit profile of SPVs and diminish sponsors’ interest.”
ICRA also compared MM cost per million standard axles (MSA) for various projects as the comparison on per lane km basis does not capture the volume and mix of traffic. Even in MSA terms, the variation in MM cost was wide enough to consider it as the key sensitive factor and a critical determinant of credit quality of operational BOT projects. The median MM cost per MSA was Rs.6.0 million. In case of the projects with high MM cost per MSA, the MM activity was delayed resulting in accelerated wear and tear.
Mr. Inamdar, added, “While high growth in commercial traffic boosts toll collections, it also increases the MM frequency and pushes operations and maintenance (O&M) and MM costs upwards due to higher and faster wear and tear. In case of annuity projects, higher-than-estimated growth in commercial traffic could stretch the cash flows even further as the O&M and periodic maintenance costs will increase without any increase in revenues. Therefore, timely and adequate routine and periodic maintenance are critical for debt servicing and creation of adequately-funded MM reserves, deserve immediate attention from sponsors and lenders.”
Sharp pickup in NH project awards, execution
Concerted efforts made to address execution bottlenecks have yielded positive results, reflected in the 39% increase in the pace of NH execution with the execution rate reaching 5.39 km/day during April 2015-February 2016 versus 3.87 km/day during April 2014-February 2015. The execution during 11M FY2016 was at 1,800 km – higher than the execution achieved during 12M of FY2015 (1,500 km) and FY2014 (1,779 km). Similarly, NHAI awards increased by 60% during 11MFY2016 to 3,457 km compared to 2,155 km in 11MFY2015; awards picked up pace as the developer’s interest was rekindled due to speedy approvals and better Right of Way (RoW) availability.
After initial teething problems with no bids for the first project under the Hybrid Annuity Model (HAM) mode and modest participation (average of three bids for the first few projects) during January-March 2016, NHAI’s aggressive promotion of the HAM model, through awareness campaigns to lenders and developers has yielded positive results. Some of the more recent bids have witnessed good participation (as high as 9-10 bidders per project).
NHAI’s ambitious FY2017 target
The Ministry of Road Transport and Highways (MoRTH) plans to increase both awards and execution in FY2017 by 2.5 times, from that of the FY2016 levels; for NHAI, the targets are more steep with target execution of 8000 km (@21.92 km/day) and target awards at 15,000 km. The target for FY2017 is almost four times higher than what was achieved during FY2016. In the case of NH projects, the maximum length awarded since FY2010 was 6,491 km (adjusted for cancellations, net awards stood at 3,303 km) in FY 2012 and peak execution stood at 7.41 km/day in FY2013. When compared to peak execution and gross awards in the last seven years, the execution target for FY2017 is around 3x and the awards target is 2.3x.
NH projects under implementation as on February 2016 stood at 9,575 km (of these, construction is yet to commence on 6263 km). Even if one assumes construction to commence on the entire 9,575 km, the maximum achievable target would be 3,200 km, which is 8.76 km/day (assuming a construction period of three years). Around Rs. 440 billion is allocated by NHAI towards construction for FY2017, which could support 4,600-5,000 km (almost 60% of targeted 8,000 km) of construction, assuming an EPC:BOT mix of 80:20. On the awards front, the awards peaked during FY2011-FY2012, primarily on account of support from the private sector, which is not the case now, given the leveraged balance sheets and stretched liquidity of most developers and cautious approach of lenders towards the infrastructure sector.
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