Larsen & Toubro had a small financing issue that needed to be addressed. They required about $1.2bn – there were over 20 banks involved in the consortium which was proving quite onerous. So, the corporate finance team went to work on a plan to replace high-cost bank debt with bonds and commercial paper. This has had dramatic results reducing interest rates by 3.5% on a debt of £1.2bn. You can do the maths here but suffice to say the savings were considerable.
Photo of Alekh Gupta, Larsen & Toubro.
Larsen & Toubro Limited is a technology, engineering, construction and manufacturing company. It is one of the largest and most respected companies in India’s private sector.
Bank loans replaced with mix of bonds and commercial paper to the tune of $1.2bn
Larsen & Toubro (L&T) had tied up bank loans five years previously to finance the construction of a power plant in a special purchase vehicle (SPV) on a full project finance, non-recourse basis. “Financing a power generation company in India was a difficult proposition when the company was being formed around five years ago,” says Vipul Chandra, Head – Treasury. “The debt required was about $1.2bn. There was thus a large banking consortium, comprising 23 banks, the management of which was onerous and also the debt was at relatively high cost.”
In 2014, the company initiated an internal discussion on how significant cost savings might be achieved by replacing high-cost bank debt with bonds and commercial paper (CP). While moving from non-recourse bank debt to with-recourse capital market instruments, it was necessary to ensure the flexibility of divestment. L&T achieved that by structuring the bonds and CPs with short tenors and call options. The challenge in the bonds was the pricing of the call option. Since the whole structure was new in the market, investors asked for substantial yield pickup in return for the additional flexibility.
As per the bank loan terms, prepayment by refinancing would have attracted a charge, except in certain specific cases where the banks could waive the charge. The prepayment was handled in such a way that the conditions were achieved (specific dates were critical) and waivers were secured from each of the 23 banks in the consortium.
Loans from banks towards project cost and working capital, in the subsidiary company (Nabha Power) were refinanced with bonds and commercial paper, credit enhanced by the parent company, L&T. There were a series of bond issuances across one year, two year, three year and five year tenors and CP issuances of a few months tenor. The bonds with tenors of more than one year included call options that can be exercised upon change of control, and the valuation at call would be determined based on a transparent benchmark.
The Adam Smith Asia Award is a very prestigious award and there is intense competition for the same among the Asian corporates. Hence winning the award is a big achievement for the team and the Company. The award recognises the cutting edge initiatives taken by Corporate in the field of Finance.
The solution focused on replacing a bank consortium of 20 plus banks with credit-enhanced capital market instruments. The key benefit was a substantial reduction in interest cost (3.5% p.a.) on a debt of about $1.2bn. The savings thus were $40m per annum, for the next ten years. To retain flexibility of divestment, the bond was innovatively structured such that when the call option is exercised, the bonds are redeemed at a valuation determined by way of a formula based on movement in specific Reuters-published interest rates for the remaining tenor.
Best practice and innovation:
“Under the solution, the entire banking consortium was replaced with a few deals in the capital markets space, thus improving process efficiency and resulting into productivity gains for the finance team,” says Chandra.
The debt issue achieved pricing efficiency by breaking up the size into multiple tranches, and closing each on a bilateral basis with multiple market participants, including Indian banks, FIIs and mutual funds. The valuation methodology used for the call option exercise was an innovation in the Indian capital markets. By structuring the bank loan prepayment on specific dates, L&T were able to completely avoid the prepayment charge.
Mr. R. Govindan, VP – Corporate Finance at L&T, concludes: “While large bond sizes are common in international bond markets, issuing bonds of $1+bn, with credit enhancement and call options (with formula based valuation) within a short span of three months, is a significant achievement in Indian markets.”
Using bonds and CPs to finance a long-term asset to secure lower costs. Additionally the bonds were structured to provide for an anytime call option with a ‘make good’ feature so as to preserve divestment flexibility.
The whole structure was devised and executed within three months. Additionally, the execution required placing a significantly large amount of bonds in the market without moving the market. This was achieved by tranching out the issuances.
The solution resulted in annual savings of $40m.
Key learning points:
One should always keep reviewing the portfolio for potential improvements. What was a best fit solution in a particular business and economic situation may have scope for improvement under a changed environment.
Innovative solutions can and should be tried out for meeting business requirements and not discarded just because they haven’t been tried out in the market earlier.
It is important to take investor feedback on board in terms of what they are looking for while structuring a solution which fits the issuer requirements.