The stock market in general and banks, realty stocks & shares of infrastructure finance companies in particular reacted sharply to the draft proposal of the Reserve Bank of India (RBI) that suggested tighter project financing norms of banks to project financing. The Indian real estate projects already weathering headwinds to attract project finance immediately swung into cost & benefit analysis. Though most of the leading developers were cautious in giving critical reactions, privately they all maintained that the RBI should have rather looked into the funding gap of the viable under construction real estate projects with cash receivables in the pipeline. A Track2Realty analysis.
What is RBI draft finance norms?
The Reserve Bank of India in its proposal to tighten project financing has released a draft framework for banks & lenders who finance real estate & infrastructure projects. The draft framework aims to tighten project financing, as it recommends an increased standard asset provisioning of up to 5% on loans. The proposal, as and when implemented, would result in an additional provisioning of 0.5-3% of banks net worth.
At present, standard asset provisioning of real estate stands at 0.4%. This is applicable to all scheduled commercial banks, NBFCs (Non-Banking Financial Corporations, urban co-operative banks and other financial institutions.
The draft guidelines have suggested that once the project reaches the operational phase, the 5% provisions can be reduced to 2.5% of the funded outstanding. It can be further reduced to 1% of the funded outstanding provided that the project has a positive net operating cash flow that is sufficient to cover current repayment obligation to all lenders.
What is project finance?
Project finance is the funding of the given single project through either debt or equity. The means to repayment is the cash flow generated by the project. It is a loan structure that relies primarily on the cash flow for repayment and the project’s assets are more often than not used as collateral in project financing by the lenders.
The RBI guideline has emphasised that all mandatory pre-requisites, including encumbrance free land, legal and regulatory clearances, should be in place before financial closure. However, for infrastructure projects under PPP (Public Private Participation), a minimum 50% land availability can be considered by lenders to achieve financial closure.
Why is real estate worried with the draft finance norms?
Many within the built environment of the Indian real estate believe the RBI’s hawkish stance at this moment is unwarranted. They also believe there should be different benchmarks for long-term infrastructure projects and real estate projects. Their worry emanates with the following apprehensions:
Delay in loan sanctioning
Borrowing cost to rise
Increase in interest cost
Additional burden to be passed on to buyers
Banks/NBFCs with no expertise in project financing may lost interest in this segment
Profitability of banks & financial institutions to hit
Minimum aggregate exposure norms limit opportunities of smaller banks & NBFCs
Kiran Chonkar, Partner, Corporate Finance and Investment Banking, BDO India says typically most projects have a sizable gestation period before they are able to start their commercial operations and ramp up the operations to be able to self-service the project loan obligations. Financiers to safeguard their interests and mitigate the project risk normally take charge on all project assets, pledge of project SPV shares, corporate guarantee from parent company, create a debt service reserve account and create other contractual comforts as a part of their security package.
“The Reserve Bank of India (RBI) stipulates strict guidelines pertaining to provisioning for Banks/NBFCs in case the Date of Commercial Operations (DCCO) gets delayed beyond a notified timeframe for projects under construction to mitigate the additional risk arising out of the delay in start of operations. Additionally, there are prudent guidelines for standard provisioning for loans & advances. In such a scenario, levying a 5% provisioning for projects under construction seems to be a bit beyond reasonable credit-risk caution and almost borders on signalling a trust deficit on credit appraisal process of project financing banks and institutions,” says Chonkar.
And it is not just the real estate projects that would take a hit. Even with the large infrastructure projects the proposed RBI regulations will have practical challenges in implementing as the maximum moratorium period allowed is six months, thereby providing no headroom in case of delays in annuity receipt.
Vinay Kumar G, Vice President and Sector Head – Corporate Ratings, ICRA Limited believes for a Hybrid Annuity Mode (HAM) road project of NHAI, the annuity becomes due for payment after 180 days of COD (commercial operations date), and the authority (NHAI) has 15 days for making the annuity payment as per the concession agreement. To address these timelines, HAM project sanctions generally have seven months (or higher) repayment moratorium from the COD date which provides a cushion of more than one month in case of administrative delays in annuity receipt, if any.
“The operational period for a HAM project is 15 years and sanctions generally have 13.5-14 years as repayment period translating to repayment tenor at above 90% of the economic life of the project. The revised regulations specify the repayment tenor, including the moratorium period not to exceed 85% of the economic life of the project, and would require revision in sanction terms for new HAM projects to align with the modified regulations. Given the compressed timelines for repayment, it is likely to increase the equity requirements for the developers to maintain similar credit profiles, he says”.
Riddhi Saha, a Chartered Accountant, believes the RBI’s hawkish stand has more to do with trust deficit than credit-risk balancing. According to her, at a time when the NPAs (Non-Performing Assets) of banks & financial institutions have reduced and asset quality improved, there is no immediate driving factor for such a hawkish stand.
“India is not China, neither with its credit exposure to real estate or infrastructure. More importantly, most of the leading & listed players in the space have a healthy balance sheet. I personally see no reason why the norms would be suddenly tightened to derail the growth. Does RBI feel there is a bubble in the making?” questions Saha.
IIFL Securities in a report has estimated that additional provisioning requirements would hit 0.5-3% of banks’ net worth and hurt CET1 (Common Equity Tier 1) ratio by 7-30 basis points (bps). CET 1 ratio is a measurement of a bank’s core equity capital, compared with its risk-weighted assets. It shows a bank’s ability to withstand any financial stress. One basis point is one-hundredth of a percentage point.
Another report by JM Financial says a significant increase in provisioning requirement will result in lower returns for lenders in project finance and reduce incremental appetite for such exposures, if implemented in current form.
In a nutshell, while project financing in India has always been critical with many projects stuck up due to non-availability of finance and/or funding gap, the draft guidelines on project financing has made the built environment all the more apprehensive. Beyond the cost & benefit analysis of the projects and the lenders, there is a general consensus that the draft guidelines in its present form doesn’t augur well for the ecosystem.
Ravi Sinha
#RaviTrack2Media
Ravi Sinha is a journalist with over two decades of cross-discipline media exposure. He is the CEO of real estate thinktank group Track2Realty. He has been writing extensively on the real estate sector for more than a decade now. Evaluation of real estate brand performance is his core domain expertise and he has immense insight into consumers’ psychograph. He has conceptualised Track2Realty BrandXReport as India’s 1st & only objective & non-paid brand rating journal that is industry-accepted benchmark of brand equity & ranking of the Indian real estate companies.
Track2Realty is an independent media group managed by a consortium of journalists. Starting as the first e-newspaper in the Indian real estate sector in 2011, the group has today evolved as a think-tank on the sector with specialized research reports and rating & ranking. We are editorially independent and free from commercial bias and/or influenced by investors or shareholders. Our editorial team has no clash of interest in practicing high quality journalism that is free, frank & fearless.
Subscribe our YouTube Channel @ https://bit.ly/2tDugGl
