Tata Steel is in talks with State Bank of India and Axis Bank to underwrite an INR220 billion (US$4.7 billion) loan to fund a steel plant in the eastern state of Orissa. The company is aiming to price at 11.25%, according to bankers with knowledge of the deal.
Although talks are still preliminary, the bankers say the loan may be given to Tata Steel’s SPV [special purpose vehicle]. This essentially takes the subsidiary off any recourse obligations, lifting Tata Steel from being responsible if the loan went into default. But with the amount of Indian restructured bank loans steadily climbing to 5% in December 2011 from 3.9% a year earlier due to defaults in construction and infrastructure sectors, Tata’s deal may be an overstretch for underwriters. Yet the prestige of the deal means bankers may be more than willing to provide loans to Tata Steel, which is the subsidiary of one of the India’s largest conglomerates.
“No banker in their right mind would let this deal slip away,” according to a Singapore-based credit strategist. “You’d be making an additional 100 to 125 basis points over more than an eight-year period, which is at least 10% extra in interest costs. But if the underwriters are not able to syndicate it off their books within the three to six months after, they will take a hit on their income statement. It will be a risk to their liquidity and capital. That could be a huge mark-to-market risk.”
Taking on such a risk at the company’s preferred pricing, especially if the project is not on Tata Steel’s balance sheet, is also a condition that lenders need to consider, according to a rival banker.
Although Tata Steel has been able to garner funding on a project level in the past, the fact that the loan will not be guaranteed by the company raises the stakes for banks, which are becoming increasingly stretched due to the amount of rising defaults.
“A number of banks hold a large amount of infrastructure loans that are on shaky ground,” said a Mumbai-based senior DCM banker. “To take a deal where Tata Steel has no recourse would be a challenge at 11.25%. Taking additional debt at aggressive pricing is not a prudent thing to do.”
And it is highly unlikely that foreign bankers will take part of this deal because it is denominated in rupees and they have don’t have enough liquidity in the currency. The fact that it is not backed by Tata Steel may be also unsettling, according to Hong Kong-based bankers at international lenders.
Indian banks have turned more cautious in their lending practices as a rising number of infrastructure projects have been delayed or gone bankrupt. The inability for the central and state governments to raise tariffs and expedite reforms on environmental and land acquisition issues have delayed power and metal projects, while the lag of coal distribution has also stymied power plants. Mounting losses are forcing more banks to restructure infrastructure loans.
Bank exposure to infrastructure is set to increase to INR9 trillion by 2015 from INR5.3 trillion at the end of financial year ending 2012, according to a report by Kotak Mahindra, with a significant portion going to state electricity boards that are in the process of restructuring their debt with banks and state governments.
Indian companies borrowed US$31 billion through syndicate loans so far this year, compared to US$71 billion during the same period in 2011, according to Dealogic. Tata Steel last tapped the syndicate loan market in November 2010 with a €73 million loan from BNP Paribas and Credit Agricole CIB.
Credit analysts warn that bankers and creditors should check the viability of the project in light of the existing problems that has entangled the infrastructure sector to make sure these issues will not affect the project’s financial health.
“Bankers and creditors would check a lot of the fine print to see what exactly the raw material linkages are and how well those are established before they finally commit,” said Ananda Bhoumik, a banking analyst at Fitch Ratings in Mumbai. “There has been concern that the raw material linkages may be difficult due to environmental reasons in the area where the plant is being set up. Tata, however, has the advantage of already having captive mines for its steel plant in Eastern India.”
Still Indian banks may have to further reduce project financing as gross domestic product fell to a nine-year low of 5.3% in the second quarter. That has made it difficult for more viable projects to come online, as a lack of investment and progress in structural reforms continue to delay implementing and executing projects.
It may also be challenging for banks to provide large amounts of long-term funding with external short-term loans. Tata Steel is rated ‘BB’ by Standard & Poor’s, ‘Ba3’ by Moody’s and ‘BB+’ by Fitch.
“Banks for prudential reasons are cautious on infrastructure lending, and have actually reduced exposure in some cases,” said Fitch’s Bhoumik. “From a concentration perspective banks have a limited ability to take on additional project lending given the problems with implementation. Banks also need to be clear on whether they have the appropriate funding structure. The current practice of using shorter-term deposits for long-term lending increases the refinancing risk that banks face. Ultimately, banks need to look at a more matched funding structure to reduce this risk.”
However, considering that there are a lack of infrastructure projects that are backed by financially healthy banks, lenders are expected to continue to provide funding for its major clients, even if that means overstretching their loan books.
“It’s bad for the banks because it’s not good to have this much exposure but they’re not going to turn them down if it’s a high quality owner,” according to a Hong Kong-based credit strategist. “They don’t want to lend to crappy infrastructure companies, so for a name like this which is one of the weaker entities within the Tata Group, they will make room because of the strong relationship it has with banks.”