Hospitality sector- The Credit Angle

No matter who we are whether an entrepreneur or a lender we always learn from our experiences. In good times we have funded aggressively based on projections of operators/ hotel brands etc or relied on feasibility studies done by third parties. But if economy is in bad shape, most of the projects we funded are gradually turning into stress asset then it is but obvious that we don’t want the said industry exposure or we increase the risk weightage to that particular sector due to which most of the healthy projects gone into stress. As a result banking industry along with other industry is also suffering due to increase in stressed assets as well as moderate to negative credit growth.

First or for most thing is that policy makers or think tank at central banks are still not able to ascertain the COVID issue and not able to figure out which sector is going to impact at what level. However undoubtedly travel industry will hit the most. Reason being stay home tendency of people even after lock down is lifted.

For a developing country like ours it is really important to keep the growth in positive direction at least. We are having focus on MSME sector which is fine but somehow it seems that tourism sector doesn’t get the focus which it deserves in India, seeing its versatility. 

Even if we don’t focus on international tourism we have so much variety in language, nature, demography, climate across the states, therefore a huge domestic tourism can be explored and a capacity is definitely required in value for money segment of hospitality industry.

Best way to increase the credit flow in current time is not just by providing liquidity through working capital but also right time to pump in Infra projects which will be coming after one year or more. This will help by two ways. Employment issue will be addressed and product demand is planned post one year which gives comfort. So better to encourage corporates by offering them term loans for expansion of projects or acquisition of stressed assets. Furthermore It is advisable that categorizes 3 star and above category hotels in Infra segment.

While evaluating the proposal of hospitality few key criteria needs to be addressed:

First is moratorium period

As we always consider that hotels will be completed at best in 2 years and 2.5 years moratorium will suffice however debt repayment of hotel should start from 3^rd year. So best way if moratorium cannot be increased beyond 2.5 years then the timing of disbursement should be given in such a manner that majority funding shall be released once structure of property is ready. For any hotel interior and furniture fixture cost is 60%. 

Second is DE ratio. 

Majority of stressed hotel proposals of today has been stuck on last mile funding or due to change in proposal expansion before even the phase I is complete and revenue is started. The temptation of grand opening of promoters always stop them by not opening in phases but the most important thing is timing first bucket of product. 

So it is best that even if its partial COD then also its fine with the lender. At least interest payment in Moratorium shall not go from promoter’s pocket.

In any case the overall DE ratio should not increase beyond 2:1 (Metros locations) & 1.5: 1 (Tier 2 and other places). Further there should be a head wise debt funding limits for the project. Land (zero bank funding), Construction (40%), Interior & plant & Machinery (70%). This will help lenders to force the promoter to bring in equity portion upfront.

Third is demand forecast or projections.

Most of the hoteliers’ even international brands give aggressive projections to get the operator contract or assignment to run the hotel. Best way to evaluate the projection by considering minimum profitability levels below which operators or brands are taking only basic cost. Generally it is 60% of the projected margins. Minimum guarantee or assurance of projections from operator or brand should always be taken along with a one pager demand forecast from the branch head is enough to support the numbers. This easily can be done by visiting travel web portals & aggregators. Thanks to the travel platforms forecasting of hotel ARR has become very convenient. Self-evaluation the project rather than relying on third party TEV will give autonomy to the branch heads who recommends the proposal. This will lot of comfort during tough times. 

Relevance of external credit rating

For a new project it will always a below investment grade rating i.e. BB or below that. Once revenue is generated then only these rating methods become more relevant. Rating exercise as well as feasibility study always delays the process of appraisal. Around 10% of projects suffered just because the credit solution doesn’t reach on time.

Converting Debt into Equity or mezzanine equity

Like SDR (Strategic Debt conversion) earlier approved by RBI, there has to be solution of assets which needs last mile funding and mortgaged to banks. Entire industry loans which are having exposure above Rs. 20 crs should be allowed for this kind of restructuring where around 25% to 50% of debt can be paid back ended by converting into mezzanine structure (Debenture with a 2 to 4% coupon) with a tenure of 3 to 5 years based on mutual comfort of promoters & lenders. During this time lenders should also allow promoter to sale this much of stake and repay the said amount as and when the economy comes in positive mode.

Once property is ready it becomes business and the value is different so selling the hotel asset in future years always get higher value as it is also having a flavor of real estate unlike any machinery which get depreciates year by year.

Once such solution to existing assets will come from lenders then entrepreneurs will also get encouragement to come up and set up new projects rather than holding cash in hand.

Bottom line is that as a lender we should go aggressively on the expansion or acquisition of hotel project funding in this time as good as MSME sector and differentiate it from Realty or commercial real estate as it is not rather it should be treated as part of Infra industry while evaluating.