Rating criteria for toll road projects. February 2018

Transcription

1 Rating criteria for toll road projects February 2018

2 Criteria contacts Pawan Agrawal Chief Analytical Officer CRISIL Ratings Sameer Charania Director Rating Criteria and Product Development Somasekhar Vemuri Senior Director Rating Criteria and Product Development Ankit Dhawan Senior Rating Analyst Rating Criteria and Product Development In case of any feedback or queries, you may write to us at 2

3 Executive summary A growing demand for transport infrastructure is a key feature of all developing economies. In general, there is a strong correlation between the number of vehicles being used and the length of the road network. There has been a rise in private sector participation in the Indian roads sector over the past 15 years. CRISIL has been actively involved in rating bond issues and bank loan instruments of several private sector tollroad projects. In addition, CRISIL has maintained a close interface with industry associations, central and state ministries, lenders, and potential toll-road operators. This experience places it in a unique position to undertake rating exercises in the roads sector. CRISIL's rating framework 1 for analysing the credit quality of toll-based bonds encompasses the following business risk factors: Demand risk, especially traffic growth Project construction risk Project operating risk In addition, CRISIL s framework for assessing the financial risk of the firm centrally factors in the debt service coverage ratio (DSCR) and liquidity. Business risk analysis The analysis takes into consideration critical factors such as projected traffic volumes, cost savings for users, inbuilt flexibility in the concession agreement, and toll revisions, to determine the overall commercial viability of the project. Traffic volumes forecast for the toll-road project The mix and volume of expected traffic on a proposed toll-road facility is assessed by referring to the origindestination surveys conducted by reputed consultants and project advisors. The survey's timing is critical to comprehend the effect of seasonal variations. Principal considerations for this are an analysis of the traffic mix (based on the type of vehicle), origin, destination, purpose, and frequency of traffic. A balanced mix of vehicles improves the commercial viability of the facility. A toll road used exclusively by freight vehicles (such as single-axle trucks) may place pressure on operations and maintenance (O&M) costs. Furthermore, freight traffic is sensitive to seasonal variations (such as increased flows in post-harvest agricultural operations); traffic volumes may also diminish in times of industrial recession. These details are linked with the level of economic activity in the area. Factors such as the type of goods in transit, local and regional demand for these goods, and frequency of movement, are directly related to the stability and growth of industrial and economic activity in the vicinity of the toll-road. The strength of the economic base of the principal origins and destinations of the toll-road is reflected in the traffic volumes forecast for the proposed project. 1 For accessing previous published document on Rating criteria for toll road projects, kindly follow this link: 3

4 An important consideration is that the creation of toll roads does not mean existing road facilities cease to exist. Existing facilities can pose serious competition for limited-access toll roads. The scope of improvement of these due to the creation of a toll road can add to the uncertainty in forecasting traffic volumes for the proposed project. In addition, CRISIL analyses the forecasts with reference to the network of feeder roads and distributaries, which will channelise traffic into the proposed toll-road. Excessive dependence on a few feeder roads can adversely influence the movement of traffic to such roads. Experience indicates that in many instances the traffic volumes were highly over-estimated, which resulted in significant financial pressure on the operating entity subsequently. CRISIL conducts a sensitivity analysis on traffic volumes and places importance on the break-even traffic levels while evaluating toll-road projects. Estimating willingness of users to pay Willingness of users to pay for services is a critical assumption in assessing commercial viability. The demand forecast for the proposed toll-road will materialise into a revenue stream only if the benefits accruing to users are in excess of the costs (toll charges). These benefits take the form of savings in: Vehicle operating costs (VOCs), Transit time Distance covered Given the high-speed, superior quality surface and high safety features of toll-roads, users benefit in terms of significantly lower VOCs (lesser fuel consumption and wear-and-tear). Revenue risks associated with toll roads that can offer such benefits on a sustainable basis are considerably lower. Flexibility in concession agreement and toll revisions Concession periods are of fixed or variable durations. In the latter case, the build-operate-transfer operator has the option of extending the concession period if the anticipated revenue streams do not materialise. This reduces the pressure of setting higher toll charges in the initial phase of operations compared with a fixed concession period regime. Furthermore, if the quality of assets of a project is good at the end of the concession period, the private operator can extend the arrangement. This reduces the overall project risks compared with fixed-duration concession agreements. Well-defined flexibility in the concession agreement is a positive factor in the risk assessment, as in such agreements the concession period may get extended if the anticipated revenue streams don t materialise If the revisions in toll charges are pegged to price movements, they improve the overall project risk profile. Some concession agreements specify the precise amount and timing of toll revisions. The recommendations made by the National Highways Authority of India in the model concession agreement, which links toll-charge revisions to changes in the wholesale price index and rupee-dollar exchange rate, are a fair and clear measure in ensuring timely revisions in toll charges. Project construction risk Delays in project construction can seriously impair revenue-generating and debt-servicing prospects. The issues considered by CRISIL in assessing project construction risks relate to: The profile of stakeholders and the financial structure of the special purpose vehicle (SPV) undertaking the construction 4

5 Managerial capabilities of the promoters in undertaking large multi-phased projects Financial strength of the sponsor and its ability to raise resources for the project The reputation and track record of the engineering, procurement, and construction (EPC) contractor and its current financial position Legal considerations in project construction documents Scheduling of construction operations Covenants for timely construction Certain toll-road projects may involve large-scale land acquisition and associated rehabilitation and resettlement issues. The complexity of these factors will increase in cases where the road passes through several states. The extent to which the government is involved in acquiring land and related activities will have a strong bearing on the risks associated with the project. In addition, a lack of clarity in the legal arrangements between the financiers, equipment suppliers, and contractors can constrain timely completion. Penalties and bonuses associated with late and early completion, respectively, and their relation in quantum to the debt to be serviced over the period, form a part of CRISIL s analysis. Any situation wherein the penalty payable by project contractors is less than the liability towards the proposed debtholders is viewed adversely by CRISIL. Project operating risk The following prominent factors constitute operating risks for a toll-road facility: Development of competing facilities Improvement in status of existing free-access facilities Traffic diversions Status of feeder and distributary network Cost escalations in regular O&M and major maintenance (MMR) which need to be carried out Toll road projects not only compete with similar facilities but also with alternative modes of transport, such as railways. The likelihood of expansion and upgrading of such facilities is a concern in the risk assessment framework adopted by CRISIL. The threat from the development of competing facilities reduces in cases where the origin and destination of traffic for the proposed toll road is distributed over a large number of urban and industrial settlements. This would have a positive impact on the risk assessment of a toll-road project. CRISIL regards any prominent likelihood of traffic diversion and the presence of, and improvement in, existing freeaccess roads as negative factors in its rating decision. The involvement of the concessionaire in maintaining and upgrading feeder/link roads is a positive factor. Toll roads typically need to incur yearly O&M expenses. They may also need major maintenance, which involves overlay of the road surface; this is a large cost element. These costs may escalate due to inflation in the prices of inputs. CRISIL evaluates the adequacy of the O&M and MMR expenses in its projections, with respect to likely cost increases. 5

6 Financial risk Projected financial performance and DSCR CRISIL assesses the projected financial performance from the perspective of the project meeting its O&M charges and debt-servicing obligations. Specific attention is given to assumptions (such as growth in traffic volumes and flexibility of toll revisions) underlying the cash flow projections. The details for all categories of vehicles are considered separately. In addition, alternative scenarios are created to assess the sensitivity of the project to adverse developments in the operating environment. Based on the sensitivity of cash flows to the above factors, CRISIL assesses the ability of the project to service its debt obligation (principal+ interest). DSCR is a key indicator of the ability to service debt obligation and a critical aspect for assessing the overall credit quality. Financial flexibility Financial flexibility is assessed with reference to the dependence on a specific source of funds and the ability of the promoters to generate additional resources. The possibility of seeking support from government agencies involved in the project is also considered. In the initial stages, the projects may warrant some support from their promoters in order to service debt obligation. In addition, the manner in which the construction is scheduled and the likely implications on financial flexibility are examined. Provisions for credit enhancement Credit enhancement provisions, such as securitisation of toll revenue and guarantees extended by members of the SPV, are examined in assessing the financial risk. The extent of credit enhancements extended by the promoters, both through specific covenants in the underlying agreement and financial support for servicing debt are critical aspects of CRISIL's risk assessment exercise for toll-road ventures. Management risk analysis CRISIL follows the standard criteria used for all manufacturing companies. This is presented in detail in the CRISIL publication, Rating criteria for manufacturing and services sector companies. 6

7 Box 1: Rating methodology for toll road projects Demand risk Estimated traffic volume on the toll-road Users willingness to pay in relation to savings in costs, time and distance of transit Flexibility in concession agreements and toll revisions, and structure of project Concession period length, conditions on extension and termination/force majeure clauses Toll revision formula Project construction risk Project operating risk Development of competing facilities Improvement in existing facilities Status of feeder and distributary network O&M and MMR expenses and escalations in them Projected financial performance and DSCR Projected toll revenue (net of leakages) O&M and MMR expenses and escalations in them Debt-servicing requirements Taxes and dividends DSCR Financial flexibility Provision for credit enhancement 7

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