LIC-led NBFC may offer up to Rs1 trillion credit guarantee

State-run insurer Life Insurance Corp. of India or LIC will structure its credit guarantee company in a manner that will allow it to guarantee infrastructure projects worth Rs.50,000 crore to Rs.1 trillion, said two people familiar with the development.

The credit guarantee firm, which will be set up as a non-banking financial company (NBFC), is part of the government’s plan to aid infrastructure projects by speeding up the flow of funds to the sector. In his Union budget speech in February, finance minister Arun Jaitley said that LIC will set up a dedicated fund to provide credit enhancement to infrastructure projects. The proposal is now starting to get fleshed out.

LIC will hold a 15-20% promoter stake in the proposed NBFC while the rest of the equity in the company would be offered to large foreign funds, domestic insurers and institutional investors, said the two people cited above.

“LIC will hold 15-20% stake or more if allowed by the insurance regulator and the government. Rest of the stake may be held by other public sector insurance companies, domestic financial institutions and global investors,” said one of the people cited above. “Discussions are on and the company should start by September this year,” this person added while requesting anonymity as talks are confidential.

An email sent to LIC on Monday seeking details remained unanswered.

The NBFC will provide credit guarantees to large infrastructure projects, especially those launched by the central and state governments in the road and power sectors.

A well-capitalized credit guarantor would be a good initiative, said Ananda Bhoumik, managing director and chief analytical officer, India Ratings and Research Pvt. Ltd.

“LIC itself is a large investor in the infrastructure space so it will be well-acquainted with the business. Once the product offerings from LIC’s credit guarantee fund start coming in, all credit rating agencies will have to evaluate the risks and help the market understand them in the context of credit guarantee and the structure of the model,” Bhoumik said.

A credit guarantee from an LIC sponsored firm will help bump up the rating of a infrastructure project in return for a fee. This could be particularly helpful for infrastructure projects in the post-completion phase when they can use an enhanced credit rating to raise cheaper funds from the market. These funds can then replace more expensive bank loans taken during construction.

“Throughout the construction period the entire funding is typically from banks, but post the construction if there is a credit enhancement their bonds will be upgraded to AA and it will be easier for them to get funding from the market so that they can free up the bank capital channel again and bring in more lending to develop their other projects,” Bhoumik said.

While bond investors typically want to invest in instruments rated AA and above, most infrastructure projects have ratings no better than BBB.

The LIC-led NBFC, which is likely to be headed by a finance ministry official, will begin with a seed capital of Rs.500-1,000 crore. If the amount of seed capital is high, the company will be in a position to provide a larger quantum of guarantees. Typically, the amount of guarantee offered by a credit guarantee fund or company is linked to the capital base of the entity and pre-determined number of times that the equity capital can be leveraged.

LIC will be the first contributor to the NBFC’s initial seed capital for its new unit, said the first person.

According to Pawan Agrawal, chief analytical officer, Crisil Ratings, the launch of credit enhancement fund will be an important step.

“Usually, the infrastructure projects even after completion are rated in the A or BBB category, primarily due to their highly leveraged nature, and low liquidity cushion. The credit enhancement fund can act as a bridge to enhance the ratings of these infrastructure projects, and enable their access to the bond markets,” Agrawal said.

“This also addresses an important identified need in the Indian market to increase the variety of credit enhancement providers, which can take the first loss risk, thereby providing credit enhancement. This credit enhancement fund, once operationalized, will address this need,” Agrawal added.

The talks between the government and LIC to set up the NBFC are in advanced stages. The government is likely to approach the Reserve Bank of India (RBI) for an NBFC licence in the next few weeks so that the company starts operations latest by September.

The proposed entity will not only provide credit guarantees but also may raise funds for infrastructure projects by issuing bonds at a later stage, the second person said.

To be sure, this is not the first time the government is attempting to use a credit guarantee model to help ease funding constraints faced by infrastructure firms.

At present, the government, through its wholly owned company India Infrastructure Finance Co. Ltd (IIFCL), provides partial credit guarantee facilities to infrastructure companies.

A partial credit guarantee is one which supports only a part of the project cost.

LIC will now join IIFCL in the credit guarantee business.

“It is a good business for LIC. We will prefer to fund only large, viable government-backed infrastructure projects. On a seed capital of Rs.500-1000 crore, the NBFC will be able to provide guarantees to projects costing up to Rs.50,000 crore-Rs.1 trillion,” said the first person cited above.

“LIC will charge fees for providing credit guarantee and unless the project fails in some rare event due to any unforeseen circumstances, the fees earned through credit guarantee will remain as a profit for the NBFC,” this person added.

With assets of around Rs.20 trillion, LIC is the largest and the only state-run life insurer in India. LIC Housing Finance Ltd and LIC Mutual Fund currently its two main subsidiaries.