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RBI suggests enhancing credit for infra bonds

LiveMint logoLiveMint 20-05-2014 Joel Rebello

Mumbai: The Reserve Bank of India (RBI) has proposed to allow banks to offer partial credit enhancement to project-specific infrastructure bonds, in order to increase access to funds and reduce the cost of funding such projects.

In draft norms released on Tuesday, RBI said loans from banks can enhance the credit profile of an infrastructure project by a maximum of two notches as banks will be allowed to lend as much as 20% of the bond issue value, lowering the risk for investors. Better ratings of such bonds will make it more attractive to long-term investors and reduce the issuer’s interest costs.

“The credit enhancement provided by banks will be able to provide such bonds with partial credit enhancement in the form of a subordinated instrument—either a loan or contingent facility—to support senior project bonds issued by the firms/special purpose vehicles (SPVs) and thereby improve their credit rating,” RBI said in draft guidelines released on Tuesday.

In simple words, banks can now offer either a loan or a non funded guarantee to a project, which will act as a second tier of protection to investors looking to buy the bond.

Ratings of projects backed by banks in such a way can be enhanced by a “maximum” of two notches like from AA- to AA+, RBI said. However, the bank’s credit rating will not be extended to the infrastructure project, RBI said.

Importantly, such backing by banks will rank ahead of equity in terms of repayment priority by the borrower. “These act as ‘first loss piece’ and improve the credit quality of the senior bond,” RBI said.

N.S. Venkatesh, treasurer at IDBI Bank Ltd, said credit enhancement will help in funding of infrastructure projects.

“SPVs are constrained by cash flows and, hence, bonds issued by them generally have lower ratings. If a bank gives credit enhancement to a project, bonds issued by the SPV gets automatically rated higher because in case of a default, the investor gets partially refunded by the bank,” he said.

Besides a direct loan to the project, banks can also provide “non-funded” support through an “irrevocable and revolving contingent credit line”.

“In the event that the project runs into difficulties and the credit line is drawn, the bank will inject funds under the facility which will create a mezzanine instrument broadly similar to funded credit facility,” RBI said, adding that this will only happen when project risk occurs, not before.

The loan or line of credit can only be provided to companies or SPVs who run infrastructure projects. Further, the credit rating with and without the enhancement should be disclosed, RBI said.

Banks have also been forbidden from investing in bonds in which they have provided a credit enhancement, or even giving any other credit facility to the specific project. Banks must also have a board approved policy for such instruments in place, RBI said.

Venkatesh of IDBI said high credit ratings will likely attract foreign investors as many of these bonds could now attract investment grade ratings.

“This will address the liquidity constraints as promoters will not be dependent on bank funding, but will be able to access foreign funds if bonds are rated higher,” he added.

Currently, foreign investors can buy $5 billion worth of credit-enhanced bonds out of the total $51 billion limit for corporate bonds.

RBI has asked for suggestions on the draft guidelines by 30 June.

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