The Hindu Business Line : Takeout financing yet to take-off

Takeout financing involves securitising of infrastructure advances by primary financiers, especially banks, in favour of long-term financial institutions.

C. Shivkumar

Bangalore, July 6 In a bid to kick-start infrastructure lending, the Union Finance Minister, Mr Pranab Mukherjee, has revisited the idea of takeout financing in the Union Budget.

He said that the India Infrastructure Finance Company would soon evolve a ‘takeout financing scheme’ in consultation with banks to increase infrastructure lending. Takeout financing involves securitising of infrastructure advances by primary financiers, especially banks, in favour of long-term financial institutions. The mechanism, an example of off-balance sheet funding, allows banks to sell assets to financial institutions at a mutually agreed price.

Takeout financing, though, is not a new concept. It was originally proposed by the Infrastructure Development Finance Company in 1998. Other specialised financial institutions such as Power Finance Corporation Ltd, Rural Electrification Corporation Ltd and HUDCO have also expressed interest in such methods of funding. The latest entrant in this market is India Infrastructure Finance Company Ltd. Despite the interest in this funding arrangement, few deals have actually taken off due to the absence of long-term resources. Take out financiers require long-term capital for securitisation of the project loans from banks, which are normally the primary financiers for power, highways, ports, urban infrastructure and aviation infrastructure. Since banks essentially rely on short-term resources, they are faced with a mismatch of assets and liabilities when they fund long-term assets.

Supply, a problem

But supply of long-term resources is a problem for specialised financial institutions as well. Even the government faces immense difficulties when it wants to borrow resources for the long-term. This constraint in raising long-term resources is evident from the high-yield spreads between one and 10-year government paper. This spread is currently 300 basis points, despite a liquidity overhang in the financial markets.

Moreover, banks that raised long-term capital in the form of upper tier-II bonds, paid rates anywhere between 9 and 10 per cent. After factoring the cost of maintaining reserves, the effective cost of long-term capital for the banks are closer to 10.5 per cent. Raising long-term funds from the international markets is also difficult in view of the high spreads over the London Inter Bank Offered Rates. Even at spreads of over 700 basis points, cross border resources are not available.

This implies that any takeout financing would likely be done only at very high discounting rates, perhaps at over12 per cent, since the secondary financier would also have to earn a substantial spread. Few banks are prepared to part with assets, particularly standard assets, at such high spreads, since it would imply losses to the banks, or a spread deficit of up to 3 per cent. Besides, high costs of the takeout funding are likely to have large cost implications on projects.

For instance, in the case of power projects, bids for the Ultra Mega Power Projects were done on tariffs of anywhere between Rs 2 and Rs 2.10 a unit. High funding costs would prove such tariffs unsustainable, or the project promoters would have to pare their return on equity. The only financial institution with long-term resources currently is the Life Insurance Corporation of India. However, life insurers seldom invest in corporate debt that is rated below ‘AA’. A classic instance was the case of the recent Tata Motors funding, where LIC’s funding was tied to corporate guarantees from the State Bank of India.

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