Takeout Financing Scheme

The much-awaited take-out financing products from India Infrastructure Finance Co (IIFCL) have recently started picking up.

On October 12, 2010 Finance Minister Pranab Mukherjee said that:

“Development of adequate and quality infrastructure was a major priority for the government to achieve sustainable and inclusive economic growth and make India a globally competitive economy”

The above remarks were made by Finance Minister when he was speaking after signing of an agreement between Union Bank of India (UBI) and India Infrastructure Finance Company Ltd (IIFCL) in respect of some identified projects as part of the first ever major initiative under takeout finance scheme.

The objective of this article is to understand the basics of Takeout Financing.

We all know that Infrastructure projects have a very long gestation period, sometimes more than 20 years. These projects involve a heavy investment and the repayment period for the loans taken on these projects is very long, generally 8 to 10 years.

So in long term infrastructure finance there are two main factors:

• Huge amount is involved.
• Long gestation period.
• Huge Risk, which is higher in the beginning (construction phase) and comparatively lower in later (operation Phase).

In India, the Banks have cannot go beyond an exposure limit, which refers to limits for arrangements for providing funds or credit including loans and advances, debt and equity securities, loan substitute securities, and financial leases. This exposure limit is fixed by the Reserve Bank of India.

Keeping in view the above factors, Infrastructure Financing in India has the following limitations

1. The Banks have usually smaller balance sheets, as compared to the size of the Infrastructure Projects. The exposure limit prescribed by the RBI can easily breached by two or three large projects.
2. The Commercial banks usually provide short term finance, the Financial Institutions such as Insurance Firms and pension Funds provide long term finance, but they are subject to control by the IRDA and other regulators.
3. A loan should have liabilities of the matching maturity. For example, the commercial banks may have fixed deposits etc. for a period of around 5-7 years , but the infrastructure projects need a loan for a period which is almost double than this period. This is called “Asset Liability Mismatch“.

Takeout financing is a way around the above limitations.

We know that Financing generally has two parties:

1. Project Company : Which needs to borrow for its project
2. Lending Company: Which may be a commercial bank as well as FI (Financial Institution) : which lends to the above project company

But in Take Out Financing, there are Three parties:

1. Project Company
2. Lending Company (which may be a commercial bank as well as FI (Financial Institution)
3. A taking over institution (Which may be a leading Bank, Consortium of banks or Financial Institution) In India IIFCL is a Taking Over institution.

The job of the third party mentioned above (IIFCL or other FI) is to enter into an agreement which makes a provision that the Lending Company will transfer the part/ whole of the outstanding to the taking over institution on a predetermined basis. This means that the loan provided by the leading bank / consortium of banks to the project company are taken over after a certain period by the taking over institution. This saves the lending firm from a possibility of default and Asset Liability Mismatch or ALM considerations.

In the Union Budget 2009-10, the Finance Minister Pranab Mukherjee had made this statement:

To stimulate the public investment in Infrastructure, we had set up the Indian Infrastructure Finance Company Ltd (It was established in 1956)
as a special purpose vehicle for providing long term financial assistance to the infrastructure projects. We will ensure that IIFCL is given greater flexibility to aggressively fulfill its mandate. Takeout financing is an accepted international practice of releasing long-term funds for financing infrastructure projects. It can be used to effectively address Asset-Liability mismatch of commercial banks arising out of financing infrastructure projects and also to free up capital for financing new projects. IIFCL would, in consultation with banks, evolve a takeout financing scheme, which could facilitate incremental lending to the infrastructure sector.

As a follow up to the above, the Take Out Financing Scheme was launched and it came into existence from April 16, 2010.

The Objectives are:

1. Boost the availability of longer tenure debt finance for infrastructure projects.
2. To address sectoral / group / entity exposure issues and asset-liability mismatch concerns of Lenders, who are providing debt financing to infrastructure projects.
3. To expand sources of finance for infrastructure projects by facilitating participation of new entities i.e. medium / small sized banks, insurance companies and pension funds.

The Projects:

The IIFCL extends the Takeout Financing scheme for the following kind of projects:

1. Road and bridges, railways, seaports, airports, inland waterways and other transportation projects;
2. Power Projects
3. Urban transport, water supply, sewage, solid waste management and other physical infrastructure in urban areas;
4. Gas pipelines projects
5. Infrastructure projects in Special Economic Zones
6. International convention centers and other tourism infrastructure projects

Extent of Takeout Financing:

The IIFCL provides the takeout financing to individual Lender(s) to the extent of 100% of the residual amount of the loan on the Scheduled Date of Occurrence of Takeout. In the case of Lead Bank, IIFCL provides takeout finance to the extent of 75% of residual amount of loan. However, the total Takeout Amount cannot exceed 50% of the total residual loan of the infrastructure project on the Scheduled Date of Occurrence of Takeout.

Agreement:

IIFCL, the identified Lender(s) and the Borrower enter into a tripartite agreement i.e. Takeout Agreement pursuant to the Takeout Finance Scheme. The Scheduled Date of Occurrence of Takeout is 1 year after the scheduled Commercial Operation Date (COD) of the project. In case, the COD gets changed with the concurrence of the Lenders, the Scheduled Date of Occurrence of Takeout is changed accordingly.

Tenure of the take out amount:

The tenor of the Takeout Amount with IIFCL shall be up to 15 years. The amortization schedule of taken out loan by IIFCL will be structured to ensure that the last loan repayment is not scheduled beyond 80% of the Project Term.

Why Takeout Financing is a Viable Option
for Infrastructure Finance?

In the above discussion we can understand that Take out financing is a viable option for long term high value projects financing. It involves selling the loan portfolio at a premium or discount depending on market condition and the risk perception of the investor. Apart from this, most Indian Banks and FIs are in public sector and they are answerable to Parliament through CAG (Comptroller and Auditor General) and subject to scrutiny / vigilance by CVC (Central Vigilance Commission) , so financing the high risk projects invites the twin swords of CWG and CVC to them. Take out financing helps them to save themselves from these swords.

Infrastructure in 12th Five year Plan:

Please note that during the Eleventh Five Year Plan (2007-12), estimated investment requirements of the infrastructure sector was 514 billion dollars. In the 12th Plan period, infrastructure investment of one trillion dollars has been envisaged.

First major Takeout Finance Agreement:

IIFCL, on October 12, 2010 has issued the sanction letters for the first takeout finance transaction to UBI involving taking out of over Rs.1500 crore in 7 different projects from power and road sector