India Ratings and Research (Fitch Group): Pooled Structures and InvITs to Boost Market Access for Developers
Mumbai: Nuanced structures in pooling of assets such as obligor/co-obligor or Infrastructure Investment Trust (InvIT) would propel refinancing of the infrastructure assets, says India Ratings and Research (Ind-Ra).
In FY19, Ind-Ra rated issuers opted for pooled structures, including InvIT and raised INR70.63 billion, up 32% yoy. The agency expects about INR210 billion (INR100 billion in obligor/co-obligor and INR110 billion in InvITs) of potential transactions under the contemporary pooling model in the next 18 to 24 months.
Given the growing portfolio of many developers, the usage of such structures would sharply increase in the coming years, as asset pooling not only offers geographical diversification but also enables in blending different categories of assets within a segment such as wind and solar or toll and annuities. As asset vintage increases, operational parameters strengthen the predictability of cash flows. At the same time, multiple variants are emerging in the obligor/co-obligor structure and not all of them will be approached similarly. Therefore, cash flow consolidation is a function of debt structural features and differences between the structures make few stronger than the others. Nonetheless, the majority of obligor/co-obligor structures warrant cash flow consolidation. Ind-Ra will evaluate intricacies of the structure, waterfall mechanism and covenant testing to decide the consolidation aspect.
Under the obligor/co-obligor structure the cumulative debt of a pool (i.e. a group of SPVs or assets) would be serviced out of the pool participants. The debt structure defines the constituent entities as obligors and co-obligors to one another. If the cash flows of one or more of the individual entities are insufficient to meet their respective debt servicing requirements, the surplus cash flows of the remaining co-obligor(s) can be used to meet the shortfall. The agency also sees InvIT as an extension of pooling model operating under a regulated vehicle. Ind-Ra currently rates a number of obligor/co-obligor structures and two InvITs in the infrastructure space.
For some structures, Ind-Ra consolidates the cash flows of all co-obligors and evaluates the consolidated financial performance of the entire pool of assets. While other asset pools are structured in a way that each co-obligor is rated individually and the rating of the generally weaker projects is set as a benchmark to arrive at the rating of the entire pool of SPVs.
Structure Decoding Essential for Pooling: A common loan agreement with a joint and several obligation to meet debt service is structurally strong as it binds all pool participants, thereby favouring cash flow pooling. Cross guarantees between the borrowers is another mechanism that ensures joint obligation of all the co-obligors for the cumulative debt. On the other hand, a cross default clause between the participants is considered relatively weaker as the clause invocation is at the discretion of the lenders and the cross default by itself does not ensure pooling, unless reinforced by the loan agreements of the other co-obligors and the cash flow waterfall mechanism. To clarify this further, the presence of a cross default provision does not automatically mean that the cash flows are fungible enough among the participants of the pool.
Perils of Waterfall Mechanism Assessment Critical: To decide the consolidation of cash flows for co-obligors, it is vital to understand the cash flow waterfall mechanism. Should an agreement entail a common escrow or common debt service account, the cash flow pooling is essential. In some structures, funds are available to co-obligors from the surplus account after all respective escrow sub-accounts of individual co-obligors are fully funded. This creates uncertainty and is almost equivalent to a restricted payment, except for the testing of financial covenants. In this case, again cross default clause is the connecting thread which is discretionary and could expose the structure to the weakest entity default unless the structure allows free flow of funds frequently.
Financial Covenants and Distribution: If financial covenants are tested at the pool level before distribution, the document limits the release of cash until the pool participants’ debt servicing is complete. This enables even the weaker entities to timely meet their debt servicing obligations. On the contrary, individual covenants and separate distributions could allow sponsors to take out cash from the SPVs before meeting any possible shortfall of other co-obligors, and thus weaken the pooling structure. The presence of individual covenants and restrictions would restrain cash movements between participants, leading to the unavailability of cash with co-obligors.
InvITs: While evaluating InvITs, Ind-Ra pools the cash flows of the underlying infrastructure assets. The debt of an InvIT fund is serviced by the interest and principal payments of internal debt from InvIT to underlying SPVs and dividends from the underlying vehicles. Although, an InvIT fund is not obligated to timely service debt of all the SPVs under its fold, it manages fund transfer between SPVs. In certain cases InvITs provide legal undertakings. The InvIT cash flow waterfall and the covenants mandate debt servicing as a priority over the distribution of surplus to investors. Ind-Ra, therefore, believes timely debt servicing would be ensured by InvIT funds. Nevertheless, ratings of the SPVs will be based on their own credit profiles, as there is no obligor/co-obligor structure. Given there is no contractual pooling structure, the InvIT structure is relatively weaker than the regular obligor/co-obligor structure. However, the overall InvIT structure’s stipulation of leverage below a particular threshold props up the debt service coverage and favours higher ratings. On the other hand, the rating of the InvIT could be constrained if it has mutual default clauses with its constituent SPVs’ external debt, which are considered relatively weaker.
Risk Profile Diversification: The pooling of different SPVs helps in diversifying the risks faced by a project. A pool of projects located across different regions having power purchase agreements with multiple counterparties helps in mitigating the counterparty concentration and supply risks associated with individual projects to some extent. A pool of SPVs diversified on the basis of location, counterparty and equipment suppliers is stronger than those with similar attributes.
Instances from Ind-Ra Portfolio: Ind-Ra has rated the bank facilities borrowed collectively by five Mytrah SPVs, Bindu Vayu Urja Pvt Ltd (‘IND A(SO)’/Stable), Mytrah Vayu (Pennar) Private Limited (‘IND A(SO)’/Stable), Mytrah Vayu (Krishna) Private Limited (‘IND A(SO)’/Stable), Mytrah Vayu Urja Pvt Ltd and Mytrah Vayu Manjira Pvt Ltd based on the obligor co-obligor approach. All the SPVs are jointly and severally liable for the cumulative debt. The cash flows are consolidated before debt servicing, and financial covenants are tested on the combined cash flows of all the SPVs. These clauses make this one of the stronger obligor/co-obligor structures rated by Ind-Ra.
Another transaction involving the diversified pool of Parampujya Solar Energy Private Limited (‘Provisional IND AA(SO)’/Stable), Prayatna Developers Private Limited (‘Provisional IND AA(SO)’/Stable) and Adani Green Energy (UP) Limited (‘Provisional IND AA(SO)’/Stable), referred to as the restricted group 1 (RG1), was rated on a combined cash flow basis. Cross guarantees between the three participants, presence of a cross default clause and consolidated covenant testing bind the RG1 to meet debt servicing obligations. The underlying obligor and co-obligor structure clearly lists the mechanism for money transfer to co-obligors in the event of insufficient funds in their respective trust and retention accounts and any cash out flows from the RG1 towards distribution to subordinated debtholders, dividend payments and others are subject to the meeting of the restrictive covenants at the consolidated level.
Some other structures allowing fungibility of cash among SPVs only from surplus as per the cash flow waterfall and having a cross-default clause between all the SPVs have been rated based on the lowest rated entity of the pool.
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About India Ratings and Research: India Ratings and Research (Ind-Ra) is India’s most respected credit rating agency committed to providing India’s credit markets accurate, timely and prospective credit opinions. Built on a foundation of independent thinking, rigorous analytics, and an open and balanced approach towards credit research, Ind-Ra has grown rapidly during the past decade, gaining significant market presence in India’s fixed income market.
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