BackRBI allows banks to offer credit enhancement to infrastructure bonds
The irrevocable credit enhancement will be 20% of the total bond issue and can be offered either by a single bank or a group
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Mumbai: To make bonds sold by infrastructure companies safer to invest in, the Reserve Bank of India (RBI) on Thursday allowed banks to offer partial credit enhancement (PCE) to bonds of companies and their subsidiaries engaged in putting up projects.
The irrevocable credit enhancement will be 20% of the total bond issue and can be offered either by a single bank or a group.
The enhancement will only be in the form of a non-funded irrevocable contingent line of credit, RBI’s guidelines on partial credit enhancement said.
Ideally, such companies should raise their funds from the corporate bond market, selling the papers to long-term investors such as insurance companies and pension funds as banks are not ideally suited to lend long with their resources maturing in the short to medium term. However, insurance and pension funds can only invest in highly rated papers that most infrastructure companies do not have because of the inherent risk in the initial stages of project implementation.
When a bank enhances the credit rating, long-term investors can buy into those papers comfortably.
The line of credit can be drawn “in case of shortfall in cash flows for servicing the bonds and thereby improve the credit rating of the bond issue", RBI said.
The facility, provided at the time of the bond issue, will be irrevocable and can be offered only to such companies whose pre-enhanced credit rating is BBB- or better, the central bank’s guidelines said.
Banks that provide credit guarantee cannot invest in the bonds but can provide other need-based credit facilities to the company.
The credit enhancement will be available only for servicing the bond and not for any other purpose “irrespective of the seniority of claims of other creditors in relation to the bond holders", the guidelines said.
“In the event of the project failure/bankruptcy, in terms of repayment priority, the PCE must rank below the claims of the enhanced bond holders," it added.
If any amount is drawn from the credit enhancement provided by banks, the unpaid accrued interest will be excluded from the calculation of the remaining amount available for drawing.
The drawn PCE facilities will be treated as an advance in the balance sheet of banks, while the undrawn facilities will be an off-balance-sheet item.
Banks will have to set aside capital for providing PCE, which will vary depending on the pre-enhanced rating of the bonds, but PCE exposure to a single counter-party or group of counter-parties should not exceed 5% of the bank’s single or group borrower limit, the notification said, adding that the aggregate PCE exposure of a bank shall not exceed 20% of the bank’s core capital.
“The credit enhancement will push up a bond’s ratings two-three notches up and will be very helpful for infrastructure companies as they will not only get good prices for their bonds, they will also be able to attract global insurance and pension funds who put money only in highly rated bonds," said N.S. Venkatesh, executive director of IDBI Bank and chairman of Fixed Income Money Markets and Derivatives Association (Fimmda).
“In a default situation, the loss giving share usually works out to about 40%. If 20% of the total bonds are insured, it is a huge comfort to investors," Venkatesh said.
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