Debt restructuring options_adani


Published on

  • Be the first to comment

  • Be the first to like this

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

Debt restructuring options_adani

  1. 1. A SUMMER PROJECT REPORT ON Debt restructuring options & Indian port sector. FOR ADANI PORTS LTD.
  3. 3. 2.OBJECTIVES OF PROJECT To study the Indian Infrastructure financing market. To study the Indian port sector . Understand the working and operations of GAPL To analyze different ways of substituting costly loans for other cheap debt instruments. To study the process of credit rating.
  4. 4. 3.INFRASTRUCTURE DEVELOPMENT FINANCING Introduction The availability of adequate infrastructure facilities is imperative for the overall economic development of the country. Infrastructure adequacy helps determine success in diversifying production, expanding trade, coping with population growth, reducing poverty and improving environmental conditions. Today, it is necessary to broaden one's concern from increasing the quantity of infrastructure stocks to improving the quality of infrastructure services. In recent years, there has been a revolution in thinking about that should be responsible for providing infrastructure stocks and services, and how these services should be delivered to the users. One of the bottlenecks in infrastructure development in India is the conflict arising out of the confusion over the government's role in being licensers for infrastructure development, an infrastructure developer and operator, and finally a regulator. A clear separation of these roles would be essential. To further aid this process, the financial, insurance and legal sectors would have to play a significant role. Provision of quality infrastructure services at reasonable cost, is a necessary condition for achieving sustained economic growth. In fact, one of the major challenges being faced by the Indian economy, as we enter the new millennium is to enhance infrastructure investment and to improve the delivery system and quality of services. There is a huge critical importance of the infrastructure sector and high priority for development of various infrastructure services such as power, telecommunications, seaports, airports, railways, roads etc. is being given these days. Investments in these sectors involve high risk, low return, and lumpiness of huge investment, high incremental capital/output ratio, long payback periods, and superior technology. These prerequisites pose a constraint on the Government's efficient delivery of quality infrastructure services. While
  5. 5. liberalizing the rules and procedures, the Government has created an environment conducive for private participation including foreign investment in infrastructure sector. A series of tax incentives and concessions have been announced, regulations and procedures have been simplified for enhancing competition in this sector. What is Infrastructure? As per India Infrastructure Report: "Infrastructure is generally defined as the physical framework of facilities through which goods and services are provided to public. Its linkages to the economy are multiple and complex, because it affects production and consumption directly, creates negative and positive spillover effects (externalities) and involves large flow of expenditure. Infrastructure contributes to economic development, both by increasing productivity and by providing amenities which enhance the quality of life. The services provided lead to growth in production in several ways: Infrastructure services are intermediate inputs to production and any reduction in these input costs raises the profitability of production, thus pertaining higher levels of output, income and or employment. These raise the productivity of other factors including labour and other capital. Infrastructure is thus often described as an "Unpaid Factor of Production", since its availability leads to higher obtainable from other capital and labour.
  6. 6. Why is Infrastructure Important? As per India Infrastructure Report: "The availability of adequate infrastructure facilities is imperative for the overall economic development of the country. Infrastructure adequacy helps determine reducing poverty and improving environmental conditions." "Research indicates that total infrastructure stocks increase by 1% with each 1% increment in per capita GDP." Key Issues in Infrastructure Development and Financing The Key issues in infrastructure development are: - Privatization The importance of privatization is because it brings along with it a) Additional resources and b) improved managerial efficiency in asset creation, asset utilization and customer service leading to better financial health, due to stake holding. Unbundling and Project Structuring Unbundling is a necessary condition before attracting private participation is unbundling the infrastructure into logical sub activities which can be privatized separately to enable private parties not to have to bite more than what they can chew. To enable unbundling necessary acts shall have to be overhauled. Regulatory reform would also be essential to provide increased autonomy, especially for capital investment, even as a precursor to unbundling. Another reason for regulatory reform is to exercise controls over implicit monopoly situations. Project Structuring is also a key issue as since projects have to be structured small enough to make them investment friendly, and at the same time "Commercial" viable.
  7. 7. Project Appraisal and Financing The key issue here is one of appraising the project against future cash flows rather than an asset base or collaterals. Various forms of revenue, control over revenue and risk guarantees would also be related concerns. A vital banking infrastructure to complement all this would be essential. Project Implementation Speed of project implementation would be imperatives, in the context of environmental and other regulatory issues. Classification of Infrastructure Sector Infrastructure is classified as: - *Economic Infrastructure which includes transportation (Roadways, railways, airways and other water transportation); Power Generation, transmission and distribution; telecommunications; port handling facilities; water supply and sewage disposal; urban mass transportation systems and other urban infrastructure (housing, etc) and irrigation. *Social Infrastructure which includes medical, educational and other primary services. Features of Infrastructure Projects in India Characteristics of Infrastructure Projects: 1. Multiple level project Risks: Infrastructure Financing involves risk participation at multiple levels and is complex to understand for individual investors. The nature of Project risk in various stages is volatile, it is the highest in the pre-commissioning stage and is sought to be mitigated through contractual framework which is concession driven or provides guaranteed returns. These guarantees and concessions are typically
  8. 8. extended by Government and Quasi-government organization (Municipal Corporations, PSU, etc) and thus minimizing financial risk. 2. Unconventional Asset Cover: Infrastructure Projects are typified by unconventional asset structure. As an illustration, the assets of an infrastructure project could comprise. a. Roads or a bridge or Flyovers b. Jetties, Container Terminals, Loading-Unloading Bay, Storage Tanks in the Port Infrastructure Projects c. Oil well or a coal mine-drills, rigs, etc d. Water Treatment Plant (ETP) These assets are not amenable to resale or reapplication and hence are unacceptable as security cover to conventional lenders. Furthermore, the step-in rights to lenders are non-existent since such projects are awarded on basis of concession and are on a Build Operate and Transfer basis (BOT) with the "Ownership" of such assets rests with the State of Central Government or Quasi Government Organization. Challenges in Infrastructure Financing Infrastructure projects are typically: 1. Long tenure projects and involving 2. High capital outlay and back-ended returns. Therefore such projects require long tenure funds i.e. in excess of 10 years. In the Indian context the availability of such funds is restrictive since Indian Financial Institutions/Banks are often constrained by: a. Preferred investment horizon of 7-10 years to avoid major asset/liability mismatches. b. Exposure norms and risk weightage on exposures for projects
  9. 9. Fiscal Incentives for Investment in Infrastructure Projects The Government of India has sought to alleviate some of these concerns/issues by providing certain fiscal incentives, concessions and policy reforms. Some of these reforms have been: a. Income Tax exemptions under Section 10 (23)(g) for interest and capital gains income earned for infrastructure projects b. Income Tax exemptions under Section 54 (EA/EB) for capital gains which can be reinvested in infrastructure project companies c. Deduction under Section 88 for investment in infrastructure projects - Deduction available for individual investors. d. Exemption from Minimum Alternative Tax e. Concessional import duties and port charges for project-related imports. f. Increased limits for External Commercial Borrowings. g. Five year tax holiday to be claimed within 12 years of operation. For the balance years, a 30% exemption is available. Characteristics of Infrastructure Projects Infrastructure Projects are typified by unconventional asset structure - Roads, Bridges, Jetties, Container Terminals, oil/mine drills, water treatment plant - investment not amenable to resale or reapplication - Unacceptable security cover - Step- in rights to lenders inadequate - Lack of implementation expertise Project risk in various stages of the project life cycle: - Highest pre-commissioning stage - would involve higher cost of funds, partly offset by benefits of Section 10 (23)(g) - Risk upon commissioning - diminished From the Financiers' Perspective: - Long tenure borrowing in the form of loan - lack of exit options - Sponsor to carry risk till the end - Lender's risk partly mitigated
  10. 10. The use of Credit Derivative Structures can also be given a thought while structuring the transaction structure for financing the Infrastructure Projects. Risk Assessment of Private Infrastructure Projects Project Sponsor/Infrastructure Company bears considerable risks. The following are the major risks beared by the these companies: 1. Implementation Risk: This is the risk in the pre-commissioning stage which covers Project Design, Project Configurations, Equipment Procurements and timely completion of the Project.. 2. Operational Risk: This is also one of the major risk beared by the Infrastructure Company / Project Sponsors. This covers Operation and Maintenance requiring Engineering / Logistics Expertise. 3. Financial Risk: Financial risk takes place when Implementation Risk and Operational Risk are partly mitigated. The result of this risk makes the problems of Financial Closure of the Project Impossible. This risk is mitigated by achieving necessary financial closure of the Project in the Implementation Stage. 4. Revenue Risk: Revenue Risk takes place when the project cash flows does not achieves the standards of worst possible case revenues. This is partly mitigated through Concession Agreement, Take or Pay, Guarantees.
  11. 11. 4. INDIAN PORT SECTOR India has 13 major ports and 139 intermediate and minor ports (at present, however, only 40 are active), and 30 cater to the Andaman and Nicobar and Lakshadeep and Minicoy Archipelagos along its 5560 km coastline. The Indian ports handled traffic of 368.96 million tones in fiscal 2000-01 and the total traffic handled at Indian ports has grown at a compounded annual growth rate of 9.03% p.a during the period 1991-92 to 2000-01. in fiscal 2001, the major 13 ports accounted for 280.96 million tones (76.15%) of the cargo, while the minor ports (primarily from Gujarat), accounted for the balance. The minor ports during the same period have shown a faster growth of around 24.95% p.a, primarily due to increased congestion at major ports, an increased development in shore-based industries and initiatives by state governments in developing the ports within their jurisdiction. Indian ports suffer from low labour productivity and low equipment efficiency levels adversely affecting their operating performance. The main factors contributing to the low productivity of Indian ports are: Operations constraints such as frequent breakdown of cargo handling equipment Inadequate dredging and container handling facility Inadequate and non-optimal deployment of port equipment Lack of proper co-ordination in the entire logistics chain
  12. 12. The major operating parameters related to the port operations are Turnaround Time: Time between a ship arriving at a port and sailing back. Pre-berthing Time: Time between a ship arriving at a port and getting berthed. Idle Time: Time during which the loading/unloading operations are not being performed on the ship when the ship is berthed. Idle Time to Total Time at berth: The ratio of the total idle time of the ship and the total time for which it was on the berth. Idle Time to Total Time at Port: The ratio of the total idle time of the ship and the total time for which it was on port. Average Output per ship berth day: The ratio between total output from the ship and the total number of days of occupation of a berth by the ship. Gujarat Port Sector Gujarat, situated on the west coast of India, is a principal maritime state endowed with several strategic port locations. The state has a 1600 km long coastline (which is a third of the total Indian coastline) and has a large potential cargo market comprising the northern, western and central Indian states. Of the 41 ports in Gujarat, Kandla is the only major port. The 11 intermediate and 29 minor ports fall within the jurisdiction of GMB(Gujarat Maritime Board). GMB has been proactive in terms of encouraging private sector participation in port developments. Out of the 10 identified probable site locations by GMB, port with private sector participation have commenced operations at Mundra and Pipavav.
  13. 13. BOOT Guidelines Under the port policy, GoG announced the Build-Own-Operate-Transfer (BOOT) Guidelines in July 1997 to serve as framework for involvement of private sector in the construction and operation of the 10 identified green field projects, including the Mundra port. Under the BOOT principles, the ports are to be developed as commercially viable entities capable of operating without government support and the responsibility of financing the port will rest with the developer. The government will grant license/concession to the private developer to Build-Own- Operate and manage the port facilities for a specific period and permit the developer to create mortgage/hypothecation of the real estate as security for lenders to the project to be limited to the BOOT period. The ownership of the land and waterfront will vest with the government. The acquisition of land for the project will be the responsibility of the GoG/GMB. The land will be allotted on lease to the developer for a term concurrent with the term of the concession agreement. In order to facilitate the development of the port, the government intends initiating concomitant development of road and rail corridors and industrial parks. The road and rail linkages from the port to the nearest highway/railhead will be structured as separate BOT packages and the port developer will have the first preference of undertaking such development. The ownership rights of developer would include the right to mortgage, hypothecate or to execute such covenants as may be required for effectively vesting a charge on the port assets in favor of a lender to the project and the right to sell, convey or transfer to another party, the right title and interest and concession vested in the developer, on the request of lender to the project, subject to contractual agreements. The lender in consultation with GMB will select the new developer and if necessary the terms and conditions of the concession agreement may be re-negotiated. The developer may operate the port as a full service or as landlord port. The GoG/GMB will permit subleasing of facilities or subcontracting of services provided the developer continues to remain responsible to the GoG for due performance under the contracted terms and conditions. The duration of the BOOT package would be 30 years and can be considered for period greater than
  14. 14. 30 years for projects will entail sizeable capital investment on account of site- specific marine conditions and back-up infrastructure such as road/rail linkages. Private sector can be involved in several ways including extending of resources, providing state-of-the-art technology at project management and maintenance levels. Besides, public-private partnership can be developed on models like build-operate-transfer (BOT), build-operate-own-transfer (BOOT), build-operate- lease-transfer (BOLT) and design-build-finance- operate-transfer (DBFOT) models. The country is yet to adopt full-fledged private sector participation models.
  15. 15. 5. GUJARAT ADANI PORTS LTD. Introduction Gujarat Adani Port Ltd (GAPL), a company promoted by Adani Port Ltd (APL) in the joint sector with the Gujarat Port Infrastructure and Development Company Limited (GPIDCL), is undertaking the development of Mundra Port located at Navinal Island, Village Mundra, dist Kachch. Promoters Gujarat Adani Port Ltd (GAPL) is a company incorporated on 26th May 1998 and promoted by Ahmedabad based Adani Group and Government of Gujarat through Gujarat Port Infrastructure Development Company Ltd (GPIDCL) for the development of Mundra port as per the port policy and BOOT guidelines of the GoG. Board of Directors: 1. Balwant singh Chairman Secretary, Port and Fisheries Department, GoG 2. Gautam S. Adani Managing Director 3. P. N. Roy Chaudhury, IAS Director Managing Director, GPIDCL 4. Rajesh S. Adani Director 5. K.N. Venkatasubramaniam Independent Director 6. K.N. Shelat Director Industry Commissioner, GoG
  16. 16. Business Development With a view to giving a focused thrust to the overall development of the port, an exercises has been carried out by GAPL to identify bulk customers who would like to have an alternative port. GAPL has developed and is in the process of developing the services and facilities in tune with the requirements of bulk users of the port facilities. Product Customer POL IOC,Caltex,IBP,Swiss Singapore(Jayshree),Ruchi Petrochemicals Asian Paints, Nirma, C.J.Shah, Crescent, Hareshkumar Edible Oil Andre, Cargill, Ruchi, Soya, Liberty, B.Arunkumar Shadiram, Godrej, Wilmar. Castrol Oil Hindustan lever, Minal, M.lakhamshi DOC, rice Peter Cremer, A.C.Toefer, Gee Premji, Cargill, Nidera Ruchi, Shivnath Rai, Priyanka, L&T, KB overseas Satnam overseas. Coal Emirates Trading Agency, Glencore, Binani Cement Laxmi cement, Esteco, Gee Premji, Hindustan Zinc. Minerals Ashapura Trimax, Gimpex, GMDC Salt Friends, Bharat Salt & Chemical Industries Timber Sentrans, Glory, Gupta Global Steel Shah Alloys, Tisco Sulphur Swiss Singapore, GSFC, Emmsons, Rama Phospate, Nirma Fertilizers ETA, GSFC, SPIC, IPL, NFL, STC, MMTC, KRIBHCO, MFL, Indo gulf fertilizers, ICI, GNFC, Zuari, Chmbal Fertilisers Observations 1.Mundra port has handled more than 700 vessels till 15th September,2002, carrying about 9.5 million tones of cargo. The connectivity of railway(in November, 2001) further boosted the strategic importance of Mundra. The deep draft and the connectivity of the port to the hinterland has culminated in attracting HPCL and IOCL to establish crude oil handling facilities on the port. In addition, the port has encouraged creation of other industrial
  17. 17. activities like largest single location edible oil refinery in the country viz. Adani Wilmar Ltd at Mundra. 2.GAPL is contemplating enhancing the business flow in Mundra through various strategic initiatives, which interalia, include re-positioning the business of port-port related activities and container terminal business. Revenue Realizations: - The main heads of revenue in GAPL is as under 1. Marine Income 2. Royalty Income 3. Lease Rent Income 4. Development Charges 5. Railway Income 6. Sharing of Container Revenue Marine Income Port dues and pilot age charges (USD/GRT) 0.57(0.17+0.38) Berth hire charges (USD/GRT/day) 0.15
  18. 18. Wharfage Charges Sr. no Comodity Wharfage Rate (Rs./T) 1Dry Cargo A Coal 30.00 B Fertiliser 35.00 C FRM 35.00 D DOC 20.00 E Salt 20.00 F Alumina 50.00 G Iron and Steel 55.00 H Timber 35.00 I Food grains (rice) 35.00 J Ores and Minerals 25.00 K Others 35.00 L Edible Oil 35.00 M Oils 35.00 N Chemicals 50.00 O POL-products 50.00 *Due to confidentiality clause of company other details were not shared. Details of Loan Funds GAPL has availed loan from various Banks and Institutions to the extent of approximately Rs.500 crores and proposed to make the repayment of approximately Rs.250 crores. In view of the said repayment, GAPL has reduced its interest expenses on long-term loan, which is very important in Infrastructure project due to their capital-intensive nature. This has resulted substantial saving in interest cost in future and thereby increasing the profitability. With this background GAPL is looking for various alternative option to reduce its cost of loan funds.
  19. 19. Corporate Debt Restructuring aims to support continuing economic recovery by enabling viable debtors to continue business operations and promoting fair and equitable debt repayment to creditors. The company is looking for new alternatives to raise cheaper fund to replace their existing debt so what I have done is spotted four alternatives for infrastructure financing and looked at their advantages, disadvantages and suitability to company and suggested it to company and the four alternatives are 1. Issuing Corporate Bond 2. Securitisation of Future Cash Flow 3. Funding through Private Insurance Sector 4. Mezzanine Finance I tried to cover all related aspect of each alternative and tried to see that it is feasible for the company to explore this alternative but due to time constraint and technicalities of port sector and confidentiality clause some information might not be presented by me in this report.
  20. 20. 6. CORPORATE BOND The first option for Debt Restructuring is issuing Bond in this alternative I have given details of different types of bond that company can issue in future, recent market trend by example of recent bond issues by some companies, credit rating process and in annexure SEBI guidelines for debt issuance and credit rating symbols of different agencies. According to Mr Pratip Kar of the Securities and Exchange Board of India (SEBI), ``Infrastructure financing is predominantly a structured debt finance and places a higher burden on the capital market to raise debt resources. A vibrant bond market thus becomes a necessary condition for infrastructure financing.'' Though infrastructure projects are capital-intensive with long gestation periods, infrastructure bonds being low-risk guaranteed or secured debt, fetching a return of 11-14 per cent, are an attractive investment proposition. Thanks to the various tax exemptions, the FIs are able to earn a better spread by lending to infrastructure companies, through such bonds. Clearly, a vibrant debt market which allows full play to investors -- institutional and retail -- to lend and borrow and employ a variety of trading strategies is just as necessary for speedy development of infrastructure. Tax incentives are not enough. Bond Bond refers to a security issued by a company, financial institution or government, which offers regular or fixed payment of interest in return for borrowed money for a certain period.
  21. 21. Different types of bonds that are useful for infrastructure projects 1.Assumed bond 2.Callable bond 3.Combination bond 4.Consolidated bond 5.Convertible bond 6.Dual currency bond 7.Dollar bond 8.Eurobond 9.Guaranteed bond 10.Income bond 11.Junk bond 12.Mortgage bond 13.Secured bond 14.Surety bond 15.Zero-coupon bond Recent Corporate Bond Issues Name Of the Issuing Company Total Issue Size(Rs cr) Instrumen t Rating Rating Agency Coupon Tenor(in yrs) Put/Call Option Open Date Close Date GMIDC 349NCD 11.00, 11.25, 11.50% 7, 10 & 12 5, 7 & 10 respectivel y Mar 4 2003 May 2 2003
  22. 22. respectivel y Gujarat Electricity Board 350NCD 11.00, 11.25, 11.50% respectivel y 7, 10 & 12 5, 8 &10 Mar 3 2003 May 31 2003 MKVDC 300NCD BB(So) CARE 11.00, 11.25, 11.50% respectivel y 7, 10 & 12 5, 7 &10 Feb 27 2003 Apr 30 2003 Maharashtra Patbandhar e Vittiya 350 + GS 150 NCD BBB(So) CARE 11.00, 11.25, 11.50% respectivel y 7, 10 & 12 5, 7 &10 Feb 18 2003 Apr 25 2003 Larsen & Toubro Ltd 35FRB AA+ CRISIL NSE Mibor + 110 bps 1.04 1 Apr 1 2003 Apr 1 2003 IndusInd Bank 35.5 Tier II Bonds 8% 5.25 Mar 31 2003 L&T Holdings Limited 30NCD AA+(SO) CRISIL 8% 5 Mar 31 2003 L&T Holdings Limited 20NCD AA+(SO) CRISIL 7.85% 3 Mar 31 2003 Konkan Irrigation Developmen t Corp 60 + GS 29.5 NCD BB(So) CARE 11.00, 11.25, 11.50% respectivel y 7, 10 & 12 5, 7 &10 Feb 26 2003 Mar 31 2003
  23. 23. Vidarbha Irrigation Developmen t Corporation (VIDC) 400 + GS 105 NCD 11.00, 11.25, 11.50% respectivel y 7, 10 & 12 5, 7 &10 Mar 6 2003 Mar 31 2003 IDBI Bank 45 Tier II Bonds 8.40% 7.25 Mar 31 2003 Indian Railways Finance Corporation (IRFC) 77 Tax-Free NCD AAA CRISIL 5.20% 5 Mar 31 2003 Indian Railways Finance Corporation (IRFC) 255 Taxable NCD AAA CRISIL 6.98% 10 Mar 31 2003 Dena Bank 60 + GS 40 Tier II Bonds Unrated 7% 5.25 Mar 25 2003 Mar 29 2003 Bank of Maharashtra 50 + GS 50 Tier II Bonds Unrated 7% 5.25 Mar 20 2003 Mar 29 2003 Allahabad Bank 50 + GS 50 Tier II Bonds 7% 7.08 Mar 12 2003 Mar 28 2003 National Textile Corporation (NTC) 174NCD AAA(SO)CRISIL 7.75% 5 Mar 28 2003 Mar 28 2003 HUDCO 100 Taxable NCD AAA(SO)Fitch 7.10, 7.30 and 7.50% respectivel y 105 & 7yrs Mar 7 2003 Mar 25 2003
  24. 24. HUDCO 50 AAA (So)Fitch 6.10, 6.30 and 6.50%, for 5, 7 & 10 yr maturities respectivel y 105 & 7 yrs Mar 7 2003 Mar 25 2003 HUDCO 50 Tax-Free NCD AAA (So)Fitch 6.10, 6.30 and 6.50%, for 5, 7 and 10 yr maturity respectivel y 105 & 7 yrs Mar 7 2003 Mar 25 2003 Federal Bank 150 Tier II Bonds A+ Fitch 8% 6.25 Jan 15 2003 Mar 19 2003 Canara Bank 400 + GS 100 Tier II Bonds LAAA ICRA 6.70 & 6.90% respectivel y 7.08 & 10.08 Mar 5 2003 Mar 15 2003 NABARD 200 Tax-Free NCD AAA CRISIL 5.25% 5 Mar 5 2003 Mar 11 2003 NABARD 200 Tax-Free Priority Sector NCD AAA CRISIL 5.10% 5 Mar 5 2003 Mar 11 2003 With many bond issues, the issuer is required to retain some portion of the proceeds from sale of the bonds, sometimes as much as 10%, as a reserve fund. This increases significantly the imputed interest cost of the bonds. A 5% face value issue might actually cost the issuer 5.5% approximate due to the cost of the reserve.
  25. 25. Issuance cost (one time) will be nearly 2-3% of bond issue that includes all legal obligations and credit rating expenses. So by looking at the above details Gujarat Adani Port Ltd can issue bond with coupon rate 11%-14% and as per my view they should go for following types of bonds to raise money Assumed bond Bond which is issued by one corporation but whose liability is taken on by another corporation. This bond they can issue because GAPL is new company they don’t have any proven reputation in market so they can issue this bonds and liability can taken over by Adani Exports Ltd. Which is flagship and very reputed company. Callable bond A bond, which the issuer has the right to redeem prior to its maturity date, under certain conditions. When issued, the bond will explain when it can be redeemed and what the price will be. In most cases, the price will be slightly above the par value for the bond and will increase the earlier the bond is called. A company will often call a bond if it is paying a higher coupon than the current market interest rates. Basically, the company can reissue the same bonds at a lower interest rate, saving them some amount on all the coupon payments; this process is called "refunding." Unfortunately, these are also the same circumstances in which the bonds have the highest price; interest rates have decreased since the bonds were issued, increasing the price. In many cases, the company will have the right to call the bonds at a lower price than the market price. If a bond is called, the bondholder will be notified by mail and have no choice in the matter. The bond will stop paying interest shortly after the bond is called, so there is no reason to hold on to it. Companies also typically advertise in major financial publications to notify bondholders. Generally, callable bonds will carry something
  26. 26. called call protection. This means that there is some period of time during which the bond cannot be called. Also called redeemable bond. Opposite of irredeemable bond or non-callable bond. GAPL can go for this bond because as per the current market condition we can not predict any thing about interest rate scenario so better to have bond with callable option so in adverse condition we can not get into trouble by paying higher interests. Combination bond A bond which is backed both by revenue from the project for which the borrowing is being done as well as by the full faith and credit of the company issuing it. Convertible bond A corporate bond, usually a junior debenture, that can be exchanged, at the option of the holder, for a specific number of shares of the company's preferred stock or common stock. Convertibility affects the performance of the bond in certain ways. First and foremost, convertible bonds tend to have lower interest rates than non-convertibles because they also accrue value as the price of the underlying stock rises. In this way, convertible bonds offer some of the benefits of both stocks and bonds. Convertibles earn interest even when the stock is trading down or sideways, but when the stock price rises, the value of the convertible increases. Therefore, convertibles can offer protection against a decline in stock price. Because they are sold at a premium over the price of the stock, convertibles should be expected to earn that premium back in the first three or four years after purchase. In some cases, convertibles may be callable, at which point the yield will cease.
  27. 27. 7.SECURITISATION Securitisation is a Financial Instrument, which serves to the basic needs of the Economy i.e. Long Tenure, Low Cost of Capital and Market acceptable. The Objective of the "True Securitisation" is to create a multiple assets generation at a lower Cost of Capital while protecting the Beneficial Interest of the Investors. The Infrastructure Sector is the biggest Capital Deficit Sector of Indian Economy; it requires Financial Engineering and Innovations to Fund the Infrastructure Projects. One of best the solution to this problem is "Securitisation". The objective of this study is to understand the concept of Securitisation and how it can be helpful to GAPL in Debt Restructuring. The scope of work of includes to understand the basic concept of Securitisation, its applications and the technique that can be used on Infrastructure Development and Financing. The scope of Work is Limited to Infrastructure Projects Funding in GAPL. Introduction to Securitisation Securitisation is the buzzword in today's World of Finance. It's not a new subject to the developed economies. It is certainly a new concept for the emerging markets like India. The Technique of Securitisation definitely holds a great promise for a Developing Country like India. One of the Major Issue in the Development of Infrastructure Sector in India is the availability of the long-term resources for the sector. One such financial innovation to raise a long-term resource is "Securitisation". Securitisation is the Financial Instrument of the new Millennium.
  28. 28. Securitisation is "Structured Project Finance". The financial instrument is structured or tailored to the risk-return and maturity needs of the investors, rather than a simple claim against an entity or asset. The popular use of the term Structured Finance in today's financial world is to refer to such financing instruments where the financier does not look at the entity as a risk: but tries to align the financing to specific cash accruals of the borrower. Definition Traditionally there are many definitions of 'Securitisation'. Each definition aims at defining this Financial Jargon. Some of the definitions are: - "Securitisation is the process of pooling and re-packaging of homogenous illiquid financial assets into marketable securities that can be sold to investors." "Every such process which converts a financial relation into a transaction." "The Creation of a Security based on a stream of Cash flows, such that the security is liquidated by Cash Flows. In simple words: - "Selling the Cash flow generated from the assets (either existing or future) against the charge of the assets, by converting them into homogenous market negotiable instruments is known as Securitisation." The meaning of Securitisation can also be expressed as: - Securitisation is the process of commoditisation. Every application of securitisation ends into the marketability of the Financial Instrument into the Capital Market. Thus Securitisation aims at Commoditisation of the illiquid financial claims. Securitisation is the process of Integration and Differentiation.
  29. 29. The process of securitisation integrates all the illiquid financial claims or loans (pooling) and then differentiates them into marketable lot securities (homogenous). Need for Securitisation The market size per investor comes down as the number of investor goes on increasing. The small investor is not a professional investor. His basic requirement is to invest in an instrument, which is easy to understand, and is easily liquidable. This is need of the investor, innovated into a new financial instrument i.e. "Securitisation". The world of finance prefers Securitised Instruments due to the following reasons: Borrowers requires high amount of capital. This is clearly outside the range of the small investors. This difficultly was sorted out by the financial intermediation of the Bank/FIs where the bank would pool the resources of the investors' savings and in turn they lend the capital pooled to the borrowers. Small investor is not a professional investor. The small investor understands homogenous, liquid, easy to understand and market tradable instrument. The importance of liquidity is high for the small investor. FIs cannot liquidate the investment directly to the investor in a small run as this would definitely lead to asset-liability mismatch. Thus, an easy to understand homogenous financial instrument with easy liquidity features holds a great promise in the world of finance. Moreover a credit rating label on such a Financial Instruments increases the investors' confidence in such an investment.
  30. 30. Economic Significance of Securitisation The economic impact of securitisation is as follows: Securitisation Reduces Cost of Capital: Securitisation tends to eliminate fund-based intermediation. The intermediary in the process turns down to a specialized service oriented firm and thus charges some reasonable fees, which is lower than the fund based intermediation costs. Securitisation Encourages Savings: Securitisation encourages savings, the investors gets best benefits by investing in securitised paper. Securitisation creates efficient Financial Markets Securitisation changes the roles of the financial intermediary from a fund-based activity to a service based activity. A service-oriented market is more efficient than a fund based market. Securitisation Diversifies Risk Securitisation diversifies risk by creating different tranches in the t ransaction. Securitisation Focuses on the use of the resources and not their ownership The Investors does not look at the originator, but his interest lies in the performance of the asset. Features of Securitisation The following are the features of the Securitisation: 1. Homogenous Product The securitised instrument is a designed in a homogenous quantity and market acceptable lot. 2. Marketability and Merchantable Quality The Instrument is homogenous market acceptable lot and as it is generally
  31. 31. consist of the rating label, so it is of merchantable quality also. For Merchantable Quality the instrument should also posses the feature of the wide distribution also. 3. Special Purpose Vehicle The Instrument is issued by a SPV, the structure of the SPV is designed in such a manner that the SPV remains "Bankruptcy Remote" from the Originator. Thus the Investors Beneficial Interest is protected in this manner. 4. Recourse Securitisation is an asset bases structured financing concept, the investors holds the beneficial interest in the assets so it should be a non-resource featured. Limited Recourse is done by the Originator to enhance the credit rating of the transaction. 5. Assets Features The assets should have the following features: 1. It should represent cashflows 2. It should have high level of comfort i.e. quality of receivables should be good. 3. It should be isolated from the Originator. 4. It should be free from withholding taxes / pre paid taxes. 5. The pool of the assets should contain homogenous assets. 6. It should have periodic payments. 6. Issuer Features The following types of companies are the originators of the securitisation exercise: 1. Real Estate Finance Companies 2. Auto Finance Companies 3. Credit Card Companies
  32. 32. 4. Hoteliers 5. Power Generating and Telecom Companies 6. Banks 7. Infrastructure Project Companies like Toll Road Companies. 7. Investors Most of the Investors in the securitised instruments are professionalised investors which include FIs, Mutual Funds, High Net worth Investors, etc. Basic Process of Securitisation The basis process of Securitisation is explained in the following steps: - 1. Estimation of the Cash Flows The originator estimates the cash flows from the underlying assets. For this purpose, the originator uses his historical data. Appropriate and accurate calculations are done keeping in view of the pre payments rates, amortization, etc for estimation of the cash flows. 2. Creation of SPV The next step is to create a SPV. The basis logic behind the creation of SPV is: a. To isolate the underlying assets from the originator. This is an important step in the whole process as the ultimate result of this is "Bankruptcy Remoteness" from the Originator. b. Aggregation of the underlying assets into Pool. Thus the assignment of the cash flow to the SPV is done in this manner. 3. SPV issues securities/notes to Investors The SPV formed (Trust / MF / Corporate Form) now issues securities/notes to the investors to invest in the securitised exercise done by the originator.
  33. 33. 4. Investors - Proceeds of the issue of securities to SPV The collection from the investors for there investment in the securitised instrument is proceeds to the SPV. SPV in turn channelises this proceeds to the Originator. 5. Collection and Servicing from the Obligors The Originator generally performs this function. In some cases, specialised servicing agents are appointed to collect and service from the loan obligors. 6. Pass Over to the SPV In this step the Servicing agent passes the collected payments from the obligors to the SPV less his fees. 7. Reinvestment of Cash Flows The SPV if permitted does reinvestments of the proceeds from the Servicing agent (Generally in the Pay Through Structures) and in turn receives the reinvestment proceeds also. If the structure of the instrument is Pass through Structure then directly Step no. 8 is followed after Step no. 6. 8. Payment to the Investors The Investors earns on his investments by receiving the proceeds from the SPV. Depending upon the structure of the Instrument the payment of the investment is done to the Investors. 9. Originators Residuary Profit After the payments done to the Investors if any residuary is left that is passed on the Originator as his residuary profit, which is generally maintained, by the originator for the over-collaterisation and guarantee purpose.
  34. 34. Different Forms of Securitisation Structures 1) Pass Through Structure: 1.Investors get a proportional interest in pool of receivables. 2.Monthly Collections are divided proportionally among the Investors. 3.All the investors receive proportional payments - no slower or faster payments. 4.Refinement can be done in the form of 'Senior' or 'Junior' investors to enhance the credit rating of the transaction. 5. Pre-payments are passed on to the Investors. 6. No reinvestment of cash collected. 7. Thus, SPV is a passive conduit. Pass Through Structure:
  35. 35. 2) Pay through Structure: 1.Structure is almost similar to the Debt instrument, but with an off balance sheet treatment to the originator 2.Investors get a proportional interest in pool of receivables. 3.SPV reinvests the amount collected generally in a AAA rated paper (Guaranteed Investment) 4. Investors are serviced on the dates of the schedule payment; the payment for this is released from the Receiving and the Paying Bank Account. 5. Pre-payments are reinvested in the Guaranteed Investment Paper. 6. Thus, SPV is an active conduit. Pay Through Structure:
  36. 36. Benefits of Securitisation The following are benefits of Securitisation to the Issuer: - 1. Lower Cost 2. Asset - Liability Mismatch solution 3. Dictation of the rating for the transaction 4. Retail Distribution of the asset 5. Multiple asset creation ability 6. Off balance sheet financing 7. Relief in Capital Adequacy requirements 8. Improvement in the Capital Structure 9. Not regulated as loan 10. Avoids Interest rate risks 11. Escapes taxes based on interest The following are the benefits of Securitisation to the Investors: 1. Best Rating Investments. 2. Better Matching with investment objectives. 3. Perfect tool of Hedging. 4. Lesser Regulations. 5. Higher Yields on Investment. Applications of Securitisation Following are the mostly used applications of securitisation: 1. Residential Mortgage Backed Securitisation. 2. Commercial Mortgage Backed Securitisation. 3. Auto Loan Securitisation. 4. Equipment Lease Securitisation. 5. Credit Card Receivables Securitisation. 6. Bank Loan Securitisation. 7. Aircraft Lease Securitisation 8. Insurance Risk Securitisation
  37. 37. 9. Intellectual Property Rights Securitisation 10. Future Flow Securitisation For GAPL most important is Future Flow Securitisation because in this future cash flow is securitised at security. The Indian Experience Securitisation began in India in the early nineties. CRISIL rate the first securitisation programme in India in 1991 when Citibank securitised a pool from its auto loan pool and placed the paper with GIC Mutual Fund. The volume involved was about Rs. 16 crores. The Rating Agencies experience has so far in the asset-backed securities has been good. Reportedly, there have been a few unrated transactions in the market. Type of Assets In terms of the asset profile, car loan/hire-purchase receivables account for over 65% of the transaction with the rest being accounted for by truck receivables. Higher yields and relatively low delinquencies in auto loans in general are the main reasons for this asset category being preferred for securitisation. Because of the inherent higher yields in auto loans, the originator could offer attractive yields to the investor and still book profits. There has been only one transaction of securitisation of housing loan till date. While three are some legal hurdles like the absence of the foreclosure laws, the main reason has been the low yield inherent in this asset category. While the interest rates on auto loans are generally higher than the housing loans rates. Auto loans are presently in the range of 14% to 18% while housing loans are in the range of 11.75% to 15%. Since the interest rates were ruling high till recently, it was not possible for the originator to offer competitive yield to the investors without booking losses. The long tenure of housing loans was another problem, as housing loans are typically for nearly 15 years of tenure and not many investors have appetite for such long tenure securities.
  38. 38. Originators The originators in the transactions rated in the past include Citibank, Ashok Leyland Finance Ltd, 20th Century Finance Corporation Ltd, Tata Finance Ltd, etc have securitised there loans. Alternate funding, asset/liability mismatch correction and profit booking have been the main motivating factors for these originators. Investors Investors in ABS in the past have been Institutional Investors, Multinational Banks and Mutual Funds. Cost of Securitisation Different cost involved in a securitisation are the interest rate (discount rate) given to the investors, cost of maintaining cash collateral, stamp duty, SPV expenses, legal fee and the rating fee. The interest rate is the rate used to discount the future cash flows of the pool to arrive at the consideration to be paid. The cost of maintaining cash collateral is the interest income foregone due to blocking of funds in the collateral. Stamp duty differs along the different states. In 5 states viz Maharashtra, Gujarat, Karnataka, Tamilnadu and West Bengal have reduced reduced stamp duty on securitisation transaction to 0.1%. SPV expenses would be the fee payable to the SPV. Often it may not be necessary to from a company to act as the SPV, if one of the existing investment companies could be used as SPV. The legal fees is normally a lump sum, not directly related to the volume of the transaction. Rating fee has two components viz the rating fee and the surveillance fees. Most of the Rating Agencies like CRISIL, CARE, ICRA, Fitch India, etc charges initial fees as 0.1% of future receivables for the first year and the surveillance fee is 0.05% of remaining receivables for every year of surveillance. For a Rs. 50 Crore transaction with a 10% cash collateral, cost other than the coupon rate on the ABS could be about 0.75% p.a. if the rate of the discount or the coupon rate on the ABS is 12% p.a., total cost could be around 14.75% p.a. inclusive of the stamp duty, legal fee, rating fee and interest fee and interest loss
  39. 39. on the cash collateral. If other forms of credit enhancement like over- collateralization is used, interest loss on the cash collateral could be reduced thereby reducing the overall cost. Extent of Credit Enhancement The level of the credit enhancement has varied between 7% to 25% of the receivables securitised for an AAA rating depending upon the quality of the portfolio and the pool. The extent of credit enhancement has shown a decline over the years. In the United States, the minimum credit enhancement goes lower to 3% to 4% of the principal amount. Liquidity Many of the securitisation issue are listed at the Wholesale Debt Market of the NSE and a mechanism of market making is also incorporated in some of the issues. Liquidity in general for all debt instruments could be considered to be better in India. Lack of awareness could further reduce the liquidity in case of ABS or RMBS. Major Constraint of Securitisation in India Legal Issues Transfer of a loan amount to conveyance and hence is subject to the stamp duty. As stamp duty on conveyance comes under the purview of the State, the stamp duty is different in different states. High level of stamp duties would make the securitisation transaction uneconomical. Maharashtra, Gujarat, Tamilnadu, Karnataka and West Bengal have reduced the stamp duty payable on securitisation transactions involving some asset classes substantially in order to encourage the development of this instrument. In some of the other states, the incidence of stamp duty is as high as 13 - 14%.
  40. 40. Absence of foreclosure laws and slow legal process in India are areas of concern. Ideally, a separate legislation recognizing the rights of the investors in ABS or their trustees to effectively recover the dues from the underlying obligors without the involvement of the originator and without having to approach the Court would help develop the market for securitisation. This, however, would be a time consuming process. There are some uncertainties with regard to some legal issues like stamp duty on transfer of PTCs. It would help if the concerned authorities issue clarification in this regard. As securitisation is a relatively new concept, there have not been any legal cases in this area. In the absence of the same, it is not know how Courts would view these transactions and how the investors stand vis-à-vis the originator in the event of bankruptcy of the originator. In the absence of the same, one would have to go by professional advice. Taxation Issues These are uncertainties regarding taxability of SPVs, applicability of Tax Deducted at Source (TDS) to PTCs, treatment of interest tax post securitisation, etc. As regards to securitisation of housing loans, there was uncertainty as to who would issue the certificate confirming the payment of principal and interest to enable the borrowers to claim tax concessions. Some clarification from the Tax Authorities in this regard would be beneficial. à Accounting Issues There is no accounting guidelines on the treatment of securitisation transaction in the book s of the originator and the investors. The Institute of Chartered Accountants of India would issue the guidelines in this regard in the coming months.
  41. 41. Lack of Third Party Servicers In securitisation Transaction, normally, the originator acts as the servicer for the securitised pool of assets. To that extent dependence of the originator continues even after the sale of receivables. Though the agreement provides for the investors to change the servicer in case they are not satisfied with the performance of the servicer, in India, the efficacy of alternate servicer needs to be fully tested. Lack of data across economic cycles Lack of long track record of performance of assets over economic cycles is not available in India. This is because housing and consumer loans in the organized sector is not as old in India as it is in the developed countries. In the US for example, the historical performance of mortgages for decades including the great depression of 1930 are available. The kind of database helps one to predict the behavior of assets in adverse conditions better. Lack of sophisticated Information Systems A sophisticated information system is very important for securitisation. The information requirement of rating agencies is fairly detailed both at the time of initial rating and subsequent surveillance. Currently, not all originators systems are fully geared to meet the information requirements. Co-mingling of Cashflows The risk that the cash flows from the securitised pool would get mixed with those of the originator is referred to as co-mingling risk. If the originators rating is not high this presents a problem. Internationally, a time limit is specified within which the pool of cashflows should be transferred to the designated account. This could pose a problem, if the contracts in the securitised pool are geographically dispersed across many states and regions. There is a lack of quick fund transfer systems in India. Hence, more time may have to be allowed for the transfer of funds.
  42. 42. Future Prospects of Securitisation in India Since late eighties, when securitisation made its beginning in India, the number as well as the size of transactions has grown over the years. This trend is likely to continue and the market would witness considerable growth in the coming years. Currently the annual disbursement of truck loans is estimated to be around Rs. 11,000 Crores and the same for the car loans has been estimated to be around Rs. 8,000 Crores. The outstanding housing loans to individuals as of now are estimated to be around Rs. 10,500 Crores. These figures are indicative of the volume of securitisation that is possible. It would help in the development of ABS market particularly the mortgage backed securities (MBS) market, it some incentives are given to these instrument in the form of fiscal incentives like tax concessions. For example, MBS could be declared as eligible investments by provident funds and pension funds and could be declared as Infrastructure Bonds. So far, companies securitised assets to raise funds without adding to borrowings. This helped companies which had high debt equity ratio. The motivating factor in some securitisation transaction in the past was the ability to book profits upfront. While these could continue to be demanded drivers for securitisation. Securitisation is likely to be increasingly used for better asset liability management. As securitisation replaces long to medium term assets by cash, the weightage average maturity of assets of the company comes down. This is a big comfort, as typically, NBFCs were funding three-year assets with one year fixed deposits. Further, the NBFCs which are required to bring down the excess deposit level could use the proceeds of securitisation to retire the fixed deposits. Traditionally in the fund based business segment of the financial services sector in India, a single entity was engaged in the entire gamut of activities viz raising funds, locating borrowers, credit appraisal of the borrowers, servicing of the loans and recovery. Owing to the rapidly changing environment, some kind of realignment is likely to happen in this sector. One could see some specializations emerging in the market. In developed economies, particularly in the mortgage
  43. 43. market, there is a lot of specialization. Typically in these markets a single entity could not perform more than one or two of the activities mentioned earlier. This is also in line with the increasing emphasis on "core competence". Instead of an entity engaging in all the activities, it makes sense to focus on a few areas where it has competitive advantage. The trend is already visible in the auto loan sector. Owing to many regulatory changes, many NBFCs are finding it difficult to raise funds at competitive rates. These NBFCs, however, have a relatively low cost distribution network in place to originate and service loans. On the other hand, large companies and Foreign Banks find that it is not economical to create a large distribution network in terms of extensive branch network across the country due to their high cost structure. However, these companies, given their size, parent support, managerial talent and a high credit rating have a much stronger funding capability. Securitisation could be effectively used to combine these two complementary pool of resources. NBFCs could originate loans and securities them and sell to large companies. And they could use the proceeds of the sale to originate more loans and the process could go on. The small NBFCs could continue to service the loans which would ensure a steady flow of fee income. While many transactions are under way in the auto loan sector, this trend has also extended to housing sector also. In housing finance the funding required is of a much longer tenure and thus far more difficult to raise. Securitisation will benefit infrastructure financing because it: - * Permits funding agencies whose sector exposures are choked, to continue funding to those sectors. * Permits the participation of a much large number of investors by issue of marketable securities. * Lowers the cost of funding infrastructure projects; long term funding ( a sine quo non for most infrastructure projects) is more feasible in securitised structures
  44. 44. than conventional lending. * facilities risk participation amongst intermediaries that specialise in handling each of the components of risks associated with infrastructure funding (while these may initially be borne by regular financial intermediaries and insurance companies, it is expected that specialized institutions would develop over time) * Shifts focus of funding agencies of to evaluation of credit risk of the transaction structure rather than overall project risk. This is because the other components of project risk would be borne by specialized intermediaries at a fee cost. Thus, in a nut shell securitisation will change the project evaluation parameters to an exposure driven by Credit Rating of a transaction structure rather than overall project risk and also securitisation will facilitate participation of a large number of investors by ensuring tradability of issued Negotiable Instrument (Participation Certificates). Thus these considerations would facilitate the process of financial intermediation for resource raising of fund Infrastructure Projects. The outcome of which will reduce the cost of funding for Infrastructure Projects in the long run. Securitisation works on the principle of unbundling cash flows - Customizing risk and Evolving Superior credit structure * In the Conventional financing pattern is: - Driven by credit extended in the form of non-tradable loans - Project risk compensated by high cost of debt - Sponsor comfort and "right" to project cash flows - Key driver * Securitisation in Infrastructure Financing will: - - Disseminate risk by identifying risk parameters . Allocate cash flows to lenders/investors . Leverage on structure of infrastructure projects - Quasi Government risk - Lending driven by Credit Rating of Structure rather than overall project risk
  45. 45. - Participation of a large number of investors . Tradability of loans - Participation /Pass thru Certificates •Thus the whole mechanism results in the reduction in cost of capital for the Infrastructure Projects. Policy Measures Requirements for Port sector Port a. Sectoral Framework - Background and Issues: India has a long coastal line dotted with over 11 major ports and 140 minor ports. Major Port Trust of India manages the major ports and the minor ports are managed by State Maritime Boards. The major ports handle over 87% of all India sea-borne throughput of cargo aggregating million tons annually. The port infrastructure can effectively handle millions tons of cargo annually and is operating at optimal levels. It is estimated that India requires port handling capacity of 540.51 millions tons (2005-06). The port sector in India is governed under the Indian Port Act, 1908 and the Major Port Trust Act, 1963. These acts have permitted private sector investment in the following manner: 1. Setting up of major ports at several locations across the coastline. The states of Maharashtra, Gujarat and Andhra Pradesh have embarked on development initiatives in this segment. 2. Privatisation of support services at major ports. Government of Gujarat has identified 10 Greenfield Port Projects and has seen substantive Investment from the Private sector for the development of the Port Sector in the sate of Gujarat b. Financial Outlay required in Port Sector : The investment outlay required by the Port sector is estimated at Rs. 8000 crores in the Ninth Plan and an annual outlay of Rs. 953 crores was provided for the
  46. 46. financial year 198-1999. It is proposed that 50% of capital requirement i.e. Rs. 4000 crore would be raised from the private sector. Relevance of Securitisation of Port Sector of Infrastructure Port Sector: The revenues of typical port projects would be in the nature of stowage and loading revenues levied on ships which stop at the port of call. In addition, ports tend to provide storage facilities for chemicals, cargo, petroleum products, etc. to several large companies. The port authority/operator contract such storage facilities for a long tenure. The port revenues of this nature are amenable to securitisation. Criteria for structuring securitisation transaction *Assets or Cash flows should be of an operative nature and it should likely to be translated into a cash flow at a future date with minimal risk of performance * Isolating Credit risk of the Originator (Owner of such assets or receipt of cash flow) from that of the Obligor (Payor for the obligations/asset sought to be securitised) *Evolving a "bankruptcy" remote structure for the transaction i.e. a transaction structure which will not be impacted by the bankruptcy/default of the Originator of the cash flows. This is conventionally achieved through: a. "True Sale" of cash flow or the "right" to receive cash flow. b. Setting up of an independent "Special Purpose Vehicle" which would provide an appropriate framework for capital market participation. *Credit enhancement based on the following principles: a. Credit rating/standing of the Obligor b. Providing adequate collateral for investors participating in the "securitised" paper c. Evolving a suitable risk framework compromising of "Senior" investors who have the first "right" on cash flows and "Sub-ordinate" investors who would bear significant portion of the credit risk on the Obligor.
  47. 47. The advantage for Originators would be realising an upfront cash flows in exchange of future receipts which would be "securitised" in favor of the SPV and its investors. The following diagram explains structuring of the securitisation transaction for the Infrastructure Project: - Diagram: Structuring Securitisation Transaction Based on the structuring of the Transaction, securitisation can be applied in the Pre-Implementation Stage and also in the Post Commissioning Stage. Features of the transaction: 1.Under the BOT law, Concession agreement is signed between the Infrastructure Project Company (SPV), the Project Sponsoring Company executes the EPC contract on behalf of the SPV.
  48. 48. 2. The Project Sponsoring Company provides credit enhancement in terms of cash collateral or guarantees or stand by finance facility to enhance the credit rating of the transaction. 3. The Project Lenders are paid back by the project cash flow. 4. Project Risk is mitigated partly by the concession agreement here. 5.The whole exercise will be an off balance sheet financing treatment for the project sponsoring company. Securitisation in the Post Commissioning Stage * In the Post Commissioning Stage, there is Multiple Project Risk Participation can be attracted to optimize the cost of fund. * The Project Risk is almost diminished in the Post Commissioning Stage. *Thus in this manner a large number of Investor base can be attracted in the Financing of the Infrastructure Projects. The diagram of "relevance of the securitisation on Road Sector" explains the process of securitisation in the post commissioning stage. Benefits of Securitisation in infrastructure financing The Major Benefits of Securitisation in Infrastructure Financing: - *Reduction in the Cost of Capital à Alternative Source of Fund. * Technique of Risk Mitigation. Regulatory and Legal Issues to be addressed The following are the regulatory and the legal issues which are acting as hindrances to the development of the market for securitisation: - a. Legal Issues: - * Partial Assignment of Debt under the Indian Law. * Sale of future receivables which operates as an executory contract and therefore is not covered under the definition of debt under law. * Rights of "Securitised" asset owners or lenders vis a vis rights of conventional
  49. 49. lenders who take a charge on all book debts "present" and "future". These covenants make it difficult to consummate "Securitisation" transactions. * Incidence of Stamp duty on assignment of cash flow and receivables is prohibitive and therefore renders securitisation transactions fiscally unviable. b. Taxation Issues: - *Section 60 transfer of income i.e. is transfer of Income without transfer of assets *SPV structure is incidence to the Double Taxation. * Transferability of Fiscal benefits to the SPV of the Infrastructure Projects and Investors via: - 1. Section 80IA 2. Section 10(23)(g) 3. Section 88 c. Accounting Issues: - * For Infrastructure Company Securitising the Assets the Income received in Advance, there are no specific guidelines on Advance Income received. à For SPV the income generated will be treated as Profit or interest income is also to be issued. d. Company Act and RBI: - * The classification of an SPV - NBFC than it will require 1. Registration requirements 2. SLR requirements 3. Loan/Investment restrictions * Fixed v/s Floating charge on the SPV is also to be addressed. It is anticipated that a change in various regulations and an overall framework for securitisation may provide impetus to infrastructure financing in the Indian Context.
  50. 50. Major Securitisation Deals in India Sr. No. Deal Issue Structured By Rating Agency Amount (Rs. Crs.) Time Remarks 1. Citibank Auto loan NA CRISIL 16 1991 First Securitisation Exercise in India. 2. RSEB-RIICO SBI CAPS ICRA 250 1995 In the Fashion of Securitisation 3. PFSL ICICI CRISIL 60 1997 First Listed Deal 4. India Infrastructure Developers Limited ICICI CRISIL 409 1999 Innovative Deal from the house of L&T. 5. NHB-HDFC SBI CAPS CRISIL 88.8 2000 India's First RMBS Funds Requirements for Ports Year Total Cost of Additional Capacity Creation Internal Resources Available (MOST) Internal Resources Available (Experts) Additional Resources Available (MOST) Additional Resources Available (Experts) 1996-01 1,00,729 68,166 59,991 32,562 40,738 2001-06 1,53,836 1,18,819 75,147 35,019 78,689
  51. 51. Conclusion 1.In case of GAPL right now they don’t have any fixed contracted revenue in considerable amount but in future they have a great advantage in doing this types of deals. 2.Securitisation is a very fast and a complex subject in the financial engineering. It is certainly a very new concept in the emerging market like India. 3. Securitisation will definitely solve some problems of the Infrastructure Financing in India. 4.Already 5 states in India have taken crucial steps in reducing the stamp duty for the transaction structured on the basis of Securitisation. 5.While certain legal, taxation, accounting and other regulatory issues are in the limelight and are needed to be addressed soon. 6. With the new instrument becoming familiar to the market and further as the retail investor takes interests in securitised products, the cost of the capital will come down over a period of time. 7.In any country, more complex the Capital market is and greater the depth it has in its Debt Market, the economy of that country is considered to be Highly Matured.
  52. 52. 8.PRIVATE INSURANCE SECTOR FUNDING 1)Life Business: In terms of explanation in Section 27 A of the Act, the Authority has determined that assets relating to Pension business, Annuity business and Linked Life Insurance business shall not form part of the Controlled Fund for the purpose of that section. Without prejudice to Section 27 or Section 27A of the Act, - Every insurer carrying on the business of life-insurance shall invest and at all times keep invested his controlled fund (other than funds relating to pension and general annuity business and unit linked life insurance business) in the following manner: Infrastructure and Social Sector For the purpose of this requirement, Infrastructure and Social Sector shall have the meaning as given in regulation 2(h) of Insurance Regulatory and Development Authority (Registration of Indian Insurance Companies) Regulations, 2000 and as defined in the Insurance Regulatory and Development Authority (Obligations of Insurers to Rural and Social Sector) Regulations, 2000 respectively. They can invest 15% or more in companies which fall under the definition. 2) General Business: Without prejudice to Section 27 or Section 27B of the Act, - Every insurer carrying on the business of general insurance shall invest and at all times keep invested his total assets in the manner not less than 10% in infrastructure and social sector companies as per section 2(h):
  53. 53. As per regulation 2(h) of Insurance Regulatory and Development Authority (Registration of Indian Insurance Companies) Regulations, 2000 "infrastructure facility" means --- i.A road, highway, bridge, airport, port, Railways including BOLT, road transport system, a water supply project, irrigation project, industrial parks, water treatment system, solid waste management system, sanitation and sewerage system; ii.Generation or distribution or transmission of power; iii.Telecommunication; iv.Project for housing; v.Any other public facility of a similar nature as may be notified by the Authority in this behalf in the Official Gazette; Other Conditions That Insurance Company Has To Follow. 1.Every insurer shall endeavor to maintain a proper balance between the investments made in infrastructure sector and those in the social sector. Bonds issued for development of these sectors, duly guaranteed by Government or otherwise rated not less than ‘‘AA’’ by independent, reputed and recognized rating agencies, issued by others would qualify for compliance of this regulation. 2.All investment in assets/ instruments, which are capable of being rated as per market practice, is based on rating of such assets/ instruments. 3.The rating should be by an independent, reputed and recognized Indian or foreign rating agency. 4.The assets/ instruments under consideration for investment shall be of a grade not less than “AA” of investment grade as per their current rating. In
  54. 54. case Investments of this grade are not available to meet the investment requirements of the investing insurance company and investment committee of the investing insurance company is fully satisfied about the same, then, for the reasons to be recorded in the investment committee’s minutes, the investment committee may approve investment in instruments carrying current rating of not less than +A. Investments in the +A to be kept to the minimum. 5.The rating of Debt Instruments issued by all India financial institutions recognized as such by RBI may be of ‘AAA’ or equivalent rating. In case investment of this grade are not available to meet the requirements of the investing insurance company and investment committee of the investing insurance company is fully satisfied about the same, then, for the reasons to be recorded in the investment committee’s minutes, the investment committee may approve investments in instruments carrying current rating of not less than ‘AA’ or equivalent as rated by an independent, reputed and recognized Indian or foreign rating agency. 6.No investment shall be made in an asset/ instrument, which is capable of being rated as per market practice but has not been rated. 7.Investments in equity shares listed on a recognized stock exchange should be made in actively traded and liquid instruments viz., its trading volume does not fall below ten thousand units in any trading session during the last 12 months or trading value of which exceeds Rs. 10 lacs in any trading session during last 12 months.” As per the section 2(h) GAPL is falling under the required category but as indicated in other condition that company will require credit rating of ‘AA’ or guarantee from the government and GAPL has not acquire credit rating yet so after they get rating they can exercises this option.
  55. 55. 9. MEZZANINE FINANCE What is Mezzanine Finance? Mezzanine Finance has two fundamental perspectives. First is in terms of capital structure wherein mezzanine financing is used to fill the gap between equity and senior debt. It is generally structured as subordinated debt with warrants or some other equity feature or as preferred stock. The second definition is in the venture capital parlance, mezzanine financing is a an instrument that bridges gap between the initial rounds of venture financing and a liquidity event like an IPO, acquisition or refinancing. This financing is generally structured as subordinate debt with warrants having a term of not more than 3 years. Simply put, mezzanine finance is a cross between a loan and equity in the form of a call option or convertible that allows the investor to convert the loan into an equity investment at a previously agreed price. It is usually subordinated to senior debt but ranks higher than common equity. Some mezzanine finance investors may not incorporate an equity component. Instead, they may accept a higher stepped-up interest rate towards the end of the loan or incorporate some type of formula tied to the performance of the company (e.g. a percentage of the sales or profit). The borrower will have to pay a higher interest rate or coupon rate than senior debt, usually at 10-12% p.a., but suffers less dilutive effect in shareholding compared to pure equity investments. Moreover, as mezzanine finance is usually a subordinated loan, its loan covenants are usually less stringent than senior debt. Mezzanine finance has traditionally been perceived as a bridging loan, but it is increasingly used as a stand-alone investment in buyouts or as a substantial investment to further expands a business.
  56. 56. The Indian Perspective Traditionally, the Indian banking practice has focused on asset covers. The emphasis on cash flows has been less as bankers over the years have followed Chore and Tandon Committee norms. As per the current norms, more borrowing means more asset cover from the borrowers, when the borrower is unable to support further borrowing through assets they are left gasping for funds. This is especially true in case of buyouts and turnarounds where conventional financers refuse to participate due to restrictive policy framework. Also, lackluster IPO market and lack of private finance in Indian markets has resulted in a funding void, it is here that mezzanine finance options can be exercised to bridge this gap. Realizing the need for corporate funding prior to IPO and non-asset based borrowings many overseas funds have setup dedicated mezzanine funds in India based on attractive returns. It is expected that this paradigm will soon catch up in a big way. Private equity players and multilateral agencies are gradually occupying the areas avoided by Banks & FIs. The focus of evaluation would now be more on cash flows and earnings. Corporate aspiring for ambitious buy-outs, turnarounds, expansion and non-asset based borrowings will have a an alternative available. Although the concept of Mezzanine finance is in the introduction stage, industry dynamics indicate that the road ahead for mezzanine finance is promising.
  57. 57. Characteristics of Mezzanine Finance Salient Features Key benefits Drawbacks · Adds additional tier of financing between equity and debt. · Cost is higher than traditional debt, but lesser than equity · Claim over the financial assets is senior to equity and trade creditors while junior to secured lender · Generally in the form of preference shares, convertible loans, participating loan or combination of it. · Can avail credit enhancement with exclusive use of debt service reserve account. · Useful for startups, infrastructure projects, buyouts, acquisitions and turnaround cases · Does not require additional asset cover · Exit route for lenders is pre-defined · Lender can avail option of capital appreciation thorough equity conversion · Seniors lenders can use mezzanine as buffer against risk · Lenders/VCs can avail higher returns based on their evaluation skills and relationship · Leads to over leveraging, which may not be suitable for some projects · Senior lenders can block payments to mezzanine lenders, if the senior debt is not serviced · Invites provisions on payment stream that can’t be changed even by senior lenders · In case of default, mezzanine lenders can stop senior lenders from accelerating their installments. while, Senior lender can compel mezzanine lenders to grant waivers. · Document intensive
  58. 58. Key comparisons among different classes of investment Senior Debt High Yield Bond Mezzanine Finance Private Equity Venture Capital Nature Loan, ranks highest in times of liquidation Loan, subordinated to senior debt but ranks higher than common equity Loan, subordinated to senior loan and usually bonds but ranks higher than common equity Usually common equity, however may be in the form of convertible bond with a low coupon rate Convents/ undertakings Stringent Less stringent than senior debt Less stringent than senior debt Least stringent Equity component Absent Absent Call option/convertible bond to convert into common equity Common equity. Option to convert to common equity if it is a convertible bond Shareholding dilutive effect Absent Absent Less dilutive than private equity/venture capital More dilutive than mezzanine finance Return expected from investors Market lending rate 12-14% p.a. 18-20% p.a., inclusive of 10- 12% p.a. coupon rate, with the remaining return from the equity portion or higher stepped up interest rate/other formula tied to the performance of the company 30%-35% p.a.
  59. 59. CONCLUSION Mezzanine finance is at a introduction stage in India with very few publicized deals. I want to suggest mezzanine finance deal which is based on GAPL’s future performance we take loan at lower rate but if we earn good profit we’ll give share of that profit to lender but as it is less popular and all legal aspect are still not clear GAPL can consider it after looking at all the legal aspects only. The benefits offered by this novel method of financing promises alternative options to the CFOs . M&As, huge expansion (big ticket projects) and turnarounds are domains where funds are some time required more than what an enterprise can borrow. Let’s see how mezzanine finance has been useful in such cases where firms have failed to obtain conventional finances. In case of large-scale projects, fund requirement often exceed the estimated cost and procuring fresh loans may not be easy. On the other hand, equity route may not be preferred since it dilutes promoters’ holding. In such cases, mezzanine finance rescues the project. Recently, a power utility in Kerala is reportedly arranging for mezzanine finance, which would result in an additional tier of finance in the company. The structure of the instrument would provide advantages to all the participants viz. sponsors (equity providers), senior lenders and subordinate debt providers. It is reportedly considered by a domestic infrastructure financing company .Mezzanine financing is crucial in financing acquisition as it its flexible nature allows tailor made funding solution that contributes significantly in improving equity returns. When companies lack free reserves to make a buyout that has tremendous value creation potential in the form of synergy. In such case, mezzanine financing could be seen as suitable alternative. Classic example for mezzanine financing in India is Tata tea’s acquisition of Tetley group. Here, Tata tea could acquire a global giant Tetley with limited “risk and cash flow pressure” on its balance sheet. This leverage buyout deal was funded through senior debt as well as mezzanine finance. Here, an acquirer could target large size acquisition with a limited risk and cash flow requirement.
  60. 60. List of Abbreviations AEL Adani Export Limited AFF A.F.Ferguson & Company AMPR Adaipur Mundra Port Railway APL Adani Port Limited BOOT Build, Own, Operare and Transfer BOT Build, Own and Transfer CCOE Chief Control of Explosive CD Chart Datum CFS Container Freight Station CMIE Center for Monitoring Indian Economy COT Crude Oil Terminal CT Container Terminal DBT Dry Bulk Terminal DOC De-Oiled Cake DPR Detailed Project Report DWT Dead Weight Tonnage FRM Fertiliser Raw Material GEB Gujarat Electricity Board GGSRL Guru Gobind Singh Refineries Limited GIIC Gujarat Industrial Ivestment corporation Limited GMB Gujarat Meritime Board GoG Government of Gujarat GPCB Gujarat Pollution Control Board GPIDCL Gujarat Port Infrastructure Development Company Limited GPPL Gujarat Pipvav Port Limited GSPL Gujarat State Petronet Limited HPCL Hindustan Petroleum Corporation Limited ICD Inland Container Depo JNPT Jawaharlal Nehru Port Trust KL Killo Liters LSHS Low Sulphar Heavy Stock MbPT Mumbai Port Trust Mn.Cum Million Cubic Meters McR Ministry of Railways MPT Multi Purpose Terminal MTP Monthly Traffic Plans NH National High Way NIO National Institute of Oceangraphy, Goa POL Petrolium, Oik & Lubricants R&D Receipt & Dispatch SBM Single Buoy Mooring SH State High Way TAMP Traffic Authority for Major Ports TEU Twenty Feet Equivalent Unit TPH Tons Per Hour TRIMS Tata AIG Risk Management Services VLCC Verry Large crude Carriers
  61. 61. 10.CREDIT RATING PROCESS INTRODUCTION What is a credit rating? A credit rating is an independent assessment of the creditworthiness of a bond (note or any security of indebtedness) by a credit rating agency. It measures the probability of the timely repayment of principal and interest of a bond. Generally, a higher credit rating would lead to a more favorable effect on the marketability of a bond. The credit rating symbols (long-term) are generally assigned with "triple A" as the highest and "triple B" (or Baa) as the lowest in investment grade (See below for definition of rating grades). Anything below triple B is commonly known as a "junk bond." Credit rating is essentially, the symbolic indicator of the current opinion of the rating agency on the relative ability and the willingness of the issuer of a financial (debt) instrument to met the (debt) service obligations as and when they arise. It other words, credit rating provides a simple system of gradation by which the relative capacities of companies (borrowers) to make timely repayment of interest and principal on a particular type of debt/financial instrument can be noted. Credit rating however is neither a general-purpose evaluation of a corporate entity nor an overall assessment of the credit risk likely to be involved in al the debt/financial instrument and do such issues contract intended to grade. A rating is specific to a debt clash financial instrument and is intended to grade different and specific instruments in terms of credit risks associated with particular instruments. Although it is an opinion expressed by an independent professional organization, on the basis of a detailed study of all the relevant factors, the rating does not amount to any recommendation to by, hold or sale an instruments as it does not take into considerations, which may influence an investment decision. As a fee-based financial advisory service, credit rating is obviously, extremely useful to investors, corporate (borrowers), banks, and financial institutions. For the investors, it is an indicator expressing the underlying credit quality of a (debt) issue program. The investor is fully informed about the company as any effect of change in business/economic condition of the company is evaluated and published regularly by the rating agencies. The corporate borrowers can raise fund at a cheaper rate with a good rating. It minimizes the role of ‘name recognition’ and lesser-known companies can also
  62. 62. approach the market on the basis of their rating. The fund ratings are useful to the bank and other financial institutions when they decide on lending and investment strategies. Although credit rating has been a long established part of the financial mechanism abroad, it is of relatively recent origin in the country. The first rating agency, Credit Rating Information Services of India Ltd. (CRISIL), was started in 1988. Initially it played a rather subdued role presumably because the institutional investors did not require the wisdom of the rating agency. In a change scenario where corporate are increasingly dependent on the public, the removal of restriction on interest rate and stipulation of a mandatory credit rating of a number of instruments since 1991 by the government/ SEBI, credit rating has emerged as a critical element in the functioning of the India debt/financial markets. In response to the ever increasing role of credit rating, two more agencies were set up in 1990 [Information and Credit Rating Services (ICRA) Ltd. And 1993 Credit Analysis and Research (CARE) Ltd. Respectively. The first private sector credit rating institution was set up as a joint venture between the JM Financial, Alliance Group and the International rating agency Duffs and Phelps in 1995, known as Phelps Credit Rating India Ltd. (DCR). In addition to the mandated ratings, these agencies are also diversifying into other instruments/sectors. Unlike abroad, unsolicited rating is still not done in India. Nevertheless, the increasing recognition to credit rating in the emerging financial services industry in the country marks a major transition from a corporate culture where names mattered to one where abstract grading count. This chapter examines the present status of the credit ratings industry/system in India. Section 1 of the chapter briefly profiles the credit ratings agencies, followed by the rating process in Section 2. The rated instruments and the rating symbols are discovered in the following section. The main points are summarized in the last section of the chapter. RATING PROCESS AND METHODOLOGY The process/procedure followed and the methodologies used generally by CRAs in respect of mandated and other instruments are briefly outlined in this section. Rating Process/Procedure All the four rating agencies in the country adopt a similar rating process. The steps followed by them in the rating process are illustrated with reference to 1) new issues/instruments 2) review of rating and 30flow chart of rating.
  63. 63. Rating Process of New Issues The following steps are involved in rating the issuers’ instruments for the first time before going public. Rating Agreement and Assignment of Analytical Team The process of rating starts with the issue of the rating request by the issuer of the instrument and the signing of the rating agreement. On receipt of the request, the credit rating (CRA) assigns an analytical team, comprising two/more analysts, one of whom would be the relevant business area are responsible for carrying out the rating assignments. Meeting with Management Prior to meeting with issuer, the analytical team obtains and analyses information relating to its financial statements, cash flow projections and other relevant information detailed below: 1) Annual reports for the past five years and interim reports for the past three years. - if annual reports do not include cash flow statements, then cash flow statements should be provided for the above periods. - if the interim reports do not contain balance sheets, these should also be provided. 2) Two copies of the latest prospectus offering statements and applications for listing on any major stock exchanges. 3) Consolidated financial statements for the past three fiscal ears by principal, subsidiary or division. 4) Two copies of the statements of projected sources and application of funds, balance-sheets and operating statements for at least next three years along with assumptions on which projections have been based. 5) Copies of existing loan agreements , along with recent compliance letters, if any. In the case of outstanding public debt issues, copies of compliance letters required by indenture of such debt should be furnished. 6) A certified copy of the resolution adopted by the board of the company authorizing the issuance of commercial paper and or other short-term debt instruments, including the name of authorized signatories. 7) List of the banks, showing lines of credit and contact officers for each, along with duly completed short-term borrowings from them in the prescribed format. 8) If applicable, the name of commercial paper dealer of the company, the planned use of proceeds from the sale of commercial paper, the amount of commercial paper to be used, and a specimen copy of the commercial paper note. 9) Biographical information on the company’s principal officers and the names of the board members There is no prescribed format for supplying above information but any format could be flexibly used to cover all the required information adequately.
  64. 64. A complete brief followed by a discussion on management philosophy and plans should also be obtained. There are certain important aspects which should be known since these impact the credit quality of the instrument being rated. Discussions with the management might reveal more information as such discussion should cover the following matters: a) Discussion on the management philosophy and plan should camouflage the financial and operating data for the past five years and three to five years for future projections. b) Discussion on projections should reveal management objectives and future plans, that is future growth plan of the company should be crystallized. These projections are supposed to reflect a “management’s” best estimates of future financial posture of the company and incorporate underlying economic assumptions for the future as well as growth objectives, marketing strategies, spending plans and financing needs and alternatives. The financial projections play a significant role in the rating process as they indicated a management plan for the future. They illustrate the financial strategies of the company in terms of anticipated reliance on internal cash flow or outside funds. c) Discussion must help reveal the risks and opportunities which affect credit quality over the period covered under projections. Other key factors that the issuer believes will have an impact on the rating, including business segments analysis, portfolio analysis and so forth, should also be discussed. The analytical team then proceeds to have detailed meetings with the company’s’ management. To best serve the interests of the investors, a direct dialogue is maintained with the issuer as this enables the CRAs to incorporate non-public information in a rating decision and also enables the rating to be forward looking. The topics discussed during the management meeting are wide ranging, including competitive position, strategies, financial policies, historical performance and near and long-term financial and business outlook. Equal importance is placed on discussing the issues, business risk profile and strategies, in addition to reviewing financial data. The rating process ensures complete confidentiality of the information provided by the company. All information is kept strictly confidential by the rating group and is not used for any other purpose or by any third party other than the CRAs. Rating Committee After meeting with the management, the analysts present their report to a rating committee which then decides on the rating. The rating committee meeting is only aspect of the process in which the issuer does not participate directly. The rating is arrived at after a composite assessment of all the factors concerning the issuer, with the key issues getting greater attention from the rating committee.
  65. 65. Communication to the Issuer After the committee has assigned the rating, the rating decision is communicated to the issuer, along with the reasons or rationale supporting the rating. For a rating to have to an issuer or to an investor, the CRA must have credibility. The thoroughness and transparency of its rating methodology and the integrity and fairness of its approach are important factors in establishing and maintaining credibility. The CRAs are, therefore always willing to discuss with the management, the critical analytical factors that the committee focused on while determining the rating and also any factors that the company feels may not have been considered while assigning the rating. In the event that the issuer disagrees with the rating outcome, he may appeal the decision for which new/ additional information, which is material to the appeal and specifically addresses the concerns expressed in the rating rationale, need to be submitted to the analysts. Subsequently, a note is put up once again before the rating committee where the rating may or may not undergo a change. The client has the right to reject the rating and the whole exercise is kept confidential. The rating process, from the initial management meeting to the assignment of the rating normally takes three to four weeks. However, when required, the CRAs deliver the rating decision in shorter time frames. Dissemination to the Public Once the issuer accepts the rating, the CRAs disseminate it, alone with the rationale, through print media. Rating Review for Possible Change In case of rated instruments, the rated company is on the surveillance system of the credit rating agency and from time to time, the earlier rating is received. The CRA constantly monitors all ratings with reference to new political, economic and financial developments and industry trends. The CRA prepares annual review proposals for rating review committee. The following steps are necessary in the rating process for review cases. New Data of Company The analysts review the new information or data available on the company which might be sent to it by the company or it might have been procured through routine channels as strategic information under its surveillance approach. If the new information is crucial for rating decisions then analysts take action to collect more information as may be available from different sources and study the same from the angle of relevance and authentically. Rating Change On preliminary analysis of the new data, oif the analysts feel that there is a possibility for changing the rating, then the analysts request the issuer for a meeting with its management and proceed with a comprehensive rating analysis.
  66. 66. The rest of the procedure of presenting the rating opinion to a rating committee and so on is the same as is followed in the cases of new issues discussed above. Credit Rating Watch During the review monitoring or surveillance exercise, rating analysts might become aware of imminent events like merger and so on, which affect the rating and warrants rating change. In such a possibility, the issuer’s rating is put on ‘credit watch’ indicating the direction of a possible change and supporting reasons for a review. Once a decision to either change or present the rating has been made, the issue will be removed from ‘credit watch’. The duration of credit watch is for 90 days. In case the rating is modified, the same procedure of presentation to the rating committee, and so on are followed. ‘Credit watch’ indicates four situations for changing the rating, namely (1) “Negative” change indicating the possibility of downgrade, (2) “Positive” change indicating an upgrade (3) “Stable” implying no change in rating and (4) “Developing” implies and unusual situation in which the future events are so unclear that the rating may be changed either in negative or positive directions. Flow Chart of the Rating Process The steps for the rating process discussed in the foregone paragraphs can be summed up in the flow chart in Figure 16.1 Rating Methodology The rating methodology involves an analysis of the industry risk, the issuers business and financial risks. A rating is assigned after assessing all the factors that could affect the credit worthiness of the entity. Typically, the industry risk sets the stage for analyzing more specific company risk factors and establishing the priority of these factors in the overall evaluation. For instance, if the industry is highly competitive, careful assessment of the issuers’ market position is stressed. If the company has large capital requirements, the examination of cash flow adequacy assumes importance. The ratings are based on current information provided by the issuer or facts obtained from reliable both qualitative and quantitative criteria are employed in evaluating and monitoring the ratings. For Manufacturing Companies: The main elements of the rating methodology for manufacturing companies are outlined below. Business Risk Analysis: The rating analysis begins with an assessment of the company’s environment focussing on the strength of the industry prospects, pattern of business cycle as well as competitive factors affecting the industry. The vulnerability of the industry to government controls/regulations is assessed. The nature of competition is different for different industries based on price, product quality, distribution capabilities, product differentiation, service and so on.
  67. 67. The industries characterized by a steady growth in demand, ability to maintain without impairing future prospects, flexibility in the timing of capital outlays and moderate capital intensity are in a stronger position. When a company participates in more than one business, each segment is analyzed separately. A truly diversified company does not have a single business segment that is dominant and the company’s ability to manage diverse operation is significant factor. As part of the industry analysis, key rating factors are identified into keys to success and areas of vulnerability. The main industry and business factors assessed include: Industry Risk : Nature and basis of competition, key success factors, demand and supply position, structure of industry, cyclical/seasonal factors, government policies and so on. Market Position of the Issuing Entity Within the Industry : Market share, competitive advantage, selling and distribution arrangements, product and customer diversity and so on. Operating Efficiency of the Borrowing Entity : Locational advantages, labor relationship, cost structure, technological advantages and manufacturing efficiency as compared to competitors and so on. Legal Position : Terms of the issue document/prospectus, trustees and their responsibilities, system for timely payment and for protection against fraud/forgery and so on. While the CRAs do not have a minimum size criterion for any given rating level, the size of the company is a critical factor in the rating decision as smaller companies are more vulnerable to business cycle swings as compared to larger companies. In general, small companies are more concentrated in terms of product, number of customers and geography and, consequently, lack the benefits of diversification that can benefit larger firms. If the company being rated is a subsidiary or an affiliate, that is controlled by/has strong links with a dominant parent, then the rating also includes an analysis of the parent company’s credit quality. The parent company’s credit quality could have an impact on the issuer’s own credit quality. Financial Risk Analysis : After evaluation the issuer’s competitive position and operating environment, the analysis proceed to analyze the financial strength of the issuer. Financial risk is analyzed largely through quantitative means, particularly by using financial ratios. While the past financial performance of the