Criteria For Rating Of Entities In Infrastructure Sector
7th October 2019 (Version 3)

The Infrastructure sector includes segments such as construction of roads, bridges, irrigation projects,power projects - generation, transmission and distribution, ports, airports, and other such projects of social importance such as waste management. Typically in frastructure projects differ from regular projects in terms of their large investment, long gestation periods, strategic importance and significant entry barriers.

Types of Infrastructure Projects:

Government Projects: Government projects include ports, irrigation projects of strategic importance undertaken by the government.

PPP (Public Private Partnership) Projects: These are projects undertaken in Special Purpose Vehicles format (SPVs) in which the government and private parties hold stakes.

Private Projects: These are projects promoted by private entrepreneurs. 

Generally, infrastructure projects are executed through Special Purpose Vehicles floated by the promoters/sponsors. These SPVs could be either wholly owned by the promoter or jointly with other stakeholders like Government/private equity investors. The SPV structure helps in ring-fencing the cash flows and assets of the project from the promoter's balance sheet. Debt is usually raised in the SPV against the strength of the cash flows. These cash flows could be toll charges for a toll-way company, transmission charges for a power transmission company or user development fees/rentals generated by an airport. Operational cash flows are generally collected in a separate account (Escrow Account) and a waterfall mechanism would be in place to decide priority of payments.

While each segment in the sector has its unique characteristics, there are certain factors which are common to most of the infrastructure projects. Acuité believes that focusing on thesekey factors common to most projects provides an appropriate evaluation of the risk profile of the project. This document details some of these common parameters and their importance from a credit rating standpoint. 

The rating framework for infrastructure entities takes into account the Business Risk, Financial Risk and Management Risk. Given below are the factors examined under each of these:

BUSINESS RISK

Business risks associated with infrastructure entities can be bifurcated into two categories - risks associated with the project until commissioning and commercial operations thereafter

  • Risks associated with the project prior to commissioning
  • Funding Risk:

    Funding Risk analysis entails an evaluation of the financial closure of the project - both from an equity and debtperspective.The equity portion is to be brought in by the promoter/sponsor and also supplemented by private equity investors and public offerings. The debt portion is usually raised from domestic banks, financial institutions, NBFCs, and international lenders such as multi-lateral institutions. Most infrastructure projects involve a consortium/syndicate of lenders. Besides, regular funding in the form of rupee/foreign currency term loans, Rupee-denominated bonds, External Commercial Borrowings (ECBs) etc., other avenues such as mezzanine debt and the like are the other avenues of funding available to the infrastructure players. 

    Infrastructure projects are generally long duration projects with long gestation periods. Hence, the funding profile of such a project has to be long term in nature, in order to align cash flows with debt servicing commitments. Acuité takes into account the maturity profile of debt while arriving at funding risk assessment.

    Infrastructure projections are prone to time and cost overruns. Hence, the ability of the promoter/sponsor to infuse additional funds is a key factor that influences the funding risk assessment. 

    Execution Risk:

    Acuité factors in the following while assessing Execution Risk:

    • Type of Project: Acuité examines the nature of the project being undertaken - Greenfield project/ Expansion project etc. A greenfield project entails higher level of risk compared to a brownfield project.
    • Regulatory approvals: The timely receipt of approvals from various government departments/ regulatory agencies is a critical factor influencing execution risk.In case of road projects, delays in approvalslike ‘Right of Way'may impact the timely execution.
    • Requisite raw material, labour, utilities:Acuité examines the tie-ups for uninterrupted supply of key inputs. For instance, coal supply linkages would be a critical aspect examined by Acuité while rating a coal-based power generation company.
    • Dependency on overseas vendors: Dependence on overseas vendors for capital equipment/raw material  
    • Reputation: Reputation of key vendors on timely delivery of equipment/track record with regard to after sales servicing is crucial. For instance, solar panels are one of the key equipmentin solar energy projects. Tie up with an established vendor with track record of timely delivery, performance and after sales delivery will imply lower execution risk.
    • Terrain of the project: Terrain of the project andavailability ofsocial infrastructure also play a vital role in execution risk. For instance, projects located in areas prone to natural calamities/events like floods, earthquakes will have typicallyhigher execution risk.

    Technology Risk:

    Acuité examines the following aspects:

    • Nature of technology (new or conventional)
    • Extent of technological change in the sector
    • Availability of ongoing technological support

    Past track record of the technology provider

    Legal Risk:

    Whileinfrastructure projects are mostly implemented by the Central/State Government, a large number of projects take the public-private partnership(PPP) mode. The PPP model envisages financial /nonfinancial/fiscal support from the government. Given the implications of the model, Acuité evaluates the roles and responsibilities envisaged in the partnership, rights, as well as the financial implications arising out of the agreements and contracts entered into between the parties.

  • Risks associated with the project after Commercial operations
  • Offtake Risk

    Offtake risk assessment entails a study of the adequacy of operating cash flows vis-a-vis debt servicing commitments.The following aspects will be examined:

    • Revenue generation, volumes, tariffs (proposed as well for the future and escalation if any)
    • Utility of infrastructure to users and the alternatives/substitutes available
    • The ability and willingness of users to pay and their economic conditions
    • Competition in the market
    • Government/tariff regulations.Robustness of the revenue collection mechanisms, revenue leakage and mitigation measures
    • Political risk in tariff fixation and its revision

    Operating Risk: 

    Generally the infrastructure facilities once developed, require ongoing maintenance. For instance the toll-way developer is responsible for timely maintenance of the toll road which is assessed under Operating Risk. In case of wind energy projects, usually the original EPC contractor handles the operations and maintenance. The lack of proper maintenance on the part of the EPC contractor for say a Solar Energy project may impact the future plant lead factor (PLF) of the project. The following are the factorsevaluated with regard to operation and maintenance of infrastructure projects:

    • The facilities not meeting the standards set and user dissatisfaction and impact on the revenue generation.
    • Maintenance of safety standards, not meeting the quality requirement and resultant damages if any, claims and impact on revenue.
    • Some of the examples in this regard include frequent non availability of power from generating stations, problems of distribution including low voltage, non-availability of berths in docks resulting in demurrages, non-availability of one/two lanes an expressway due to poor road quality and subsequent repairs.

    Based on the specific characteristics of the concerned infrastructure projects, Acuité evaluates the risks associated with operations, the impact on revenue generation and debt servicing capabilities.

    Counterparty Risk:

    A key risk to be noted in an infrastructure project is the credit quality of the counterparty. A strong counterparty like NHAI or Government of India will significantly mitigate counterpartyrisk inherent in a project. However, in the event of a relatively weaker counterparty - for instance aState Electricity Distribution Company (Discom)- the counterparty risk is significantly elevated due to higher possibility of delays/defaults in payments or legal issues. A strong counterparty to a project increases the ability to raise funds at favourable pricing.   

    Risk arising out of Force Majeure Condition:

    Force Majeure conditions arise due to earthquakes, fire, damages during construction/operations which can have an adverse impact on the project. Acuité ascertains whether adequate insurance cover exists to cover such unforeseen losses. Besides, emphasis is also laid on the provisions in the legal agreement on termination of the contract between the sponsor and the purchaser and compensation for the same. 

    Credit Enhancement Assessment:

    Generally, the lenders to Infrastructure Projects stipulate covenants such as guarantees from promoter entities enjoying high investment grade rating and/or maintenance of adequatesafeguards by way of DSRA (Debt Service Reserve Account), Escrow Account etc. In such cases Acuité may adequately factor in the credit enhancement while considering the rating.  

    FINANCIAL RISK

    The financial risk analysis of an infra project takes into account the following factors:

    • Reasonability of the assumptions underlying the  cash flow  projection
    • The base case cash generation capacity of the project and its adequacy to meet the debt obligations.The debt coverage metrics such as interest coverage, debt service coverage ratio, ratio of net cash accruals to total debt are also evaluated. In case of infra projects involving foreign currency debt, risks such as currency movements, hedging etc. are considered.

    A sensitivity of the debt coverage metrics is carried out to assess the debt servicing ability under various conditions of stress. The financial risk analysis of infrastructure projects focusses more on the cash generation potential and promoter's support in case of need.

    MANAGEMENT RISK

    The factors considered include:

    • Track record of management with banks/financial institutions/capital markets. Relationships with banks/institutions from a future fundraising perspective
    • Experience and track record of management with regard to implementation and successful operation of similar projects
    • Stated/Implied stance of management on commitment to the project
    • In case of more than one promoter, Acuité will examine the likelihood of ongoing financial support from each. In case of private equity investors, the expectations on exit and its impact on the project will be examined
    • The ability to anticipate, withstand and manage challenges arising during the implementation of the infra project with long gestation and operating periods for repayments.

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