for big business. Alison Warner reports.
Competition among banks in project finance is reaching boiling point. The upsets in emerging markets of recent years - notably the Dabhol power project in India and the currency crisis in Mexico -appear to have little long-term dampening effect on the enthusiasm of bankers and other lenders. In Europe, the drawn-out debt-crisis at Eurotunnel, the operator of the Channel tunnel, also seems to have done little to turn down the heat.
The needs for financing in both emerging markets and the so-called "developed" markets are stoking the business, together with an increasing appetite among banks to lend on transactions, enabling project sponsors to achieve increasingly aggressive terms.
The shift to privatisation of infrastructure around the world, along with deregulation, has brought remarkable changes to project finance in recent years. Country risk boundaries in emerging markets are being
broken. The latest innovation is in the UK, where the UK government's private finance initiative (PFI) is applying project finance techniques to new types of assets.
Ten years ago natural resources and big industrial projects dominated. Today, the bulk of the work is in privately owned infrastructure projects like power, transport, and utilities such as water and telecoms. The range of funding sources has widened from the syndicated loan market to include the US and UK bond markets, lending from the export credit agencies on project risk and local financial markets within some countries, notably Malaysia.
Gone are the days when bankers and advisers structured a project to fit the bank market only. Today it is a question of trying to fit a range of different funding sources to a project and adapting the structure to meet them, explains Kevin Files, director and head of project finance at HSBC Investment Bank. Banks compete usually through a competitive tender for private projects: "One of the most important things driving whether you win or not is how well you can structure the financing and get the project to fit the best of those markets - that's a much more complicated and a much more advisory-type business," he says.
The spectrum of countries where project financing deals are taking place has also broadened: "I suspect there are few countries in the world that are so horrible politically and economically that you can't seriously look at a project," comments Files.
For example, India, Indonesia, Brazil and China are all "doable"; some like Bangladesh are "a bit tricky but probably do-able with some kind of support."
Geoffrey Spence, director of structured finance at Deutsche Morgan Grenfell, observes that project finance has spread to be a global business: while activity in Asia dominated a couple of years ago, there is now a more equal spread in activity between regions, with as much happening in Europe now as in Asia, deals happening in Latin America, and even Africa showing signs of life.
There are also more opportunities to shift project risk than there used to be. Export credit agencies are now more willing to finance projects taking on project risk, says Files. Multilaterals are now offering guarantee programmes for projects in more difficult countries. Files judges that the World Bank's programme is probably the best, although it is difficult to use because the Bank requires a counter-guarantee from the host government.
The landmark Hub River power project in Pakistan, which cost $ 1.6 billion in debt and equity and took seven years to put together, used the World Bank's partial risk guarantee as a pilot in 1994. Last year's Uch power project in Pakistan, which concluded a debt financing package of $630 million (plus standbys of $60 million), was the first project to use the World Bank's partial risk guarantee since the Bank made it an integral part of its lending operations in 1994; it was also the debut guarantee operation between the World Bank and its private sector arm, the International Finance Corporation (IFC).
After the Hub River project had broken the ground in Pakistan, within the next two years, a further nine private power projects reached financial close. Similarly, in Indonesia, the Paiton Energy Project, for which $ 1.9 billion of debt financing was secured in 1995, paved the way for PT Jawa Power project, or Paiton II, for which $ 1.3 billion debt financing was closed last year.
In China, the first few limited recourse project financings are starting to trickle through. Two significant deals are the Shanghai Bovis Thames Da Chang Water Treatment project, closed in April 1996, which BZW, the investment banking division of Barclays Bank, believes is the first true limited recourse financing for a project in China to be completed without a foreign currency guarantee from a Chinese financial institution.
Richard Oliver and Robert Mabon, managing directors of structured finance at BZW, which acted as co-ordinating bank among the four lead arrangers for the $53.4 million syndicated loan facility, explain that lenders are taking the risk of non-availability of US dollars in the domestic foreign exchange market, which is considered acceptable in view of China's strong balance of payments performance and the increasing convertibility of the renminbi. They regard it as a forerunner for further deals in China.
Deutsche Morgan Grenfell closed $ 128 million financing in September 1996 for the Tanshan power project, which it believes is the first genuine limited recourse financing for a power project in China, for which it was lead arranger and adviser. Another significant power deal is Laibin B, which is the first build-operate-transfer project formally approved by the State Planning Commission of China, which it has called the pilot project to create a template for further BOT projects.
Spence comments that a number of such deals in the last couple of years have broken the country risk boundary. Bankers now all have their suite of options for mitigating country risk. "The next cutting edge is here in the UK, where we are applying project finance techniques to different types of assets."
The PFI was originally proposed by the UK government in late 1992. It is a government tendering methodology bringing private project financing techniques and management to sectors as diverse as shadow toll roads, where the government pays the operator of the roads an agreed rate according to the number of vehicles which pass over it, hospitals, prisons, computer systems, water and sewerage systems, air traffic control centres, and privatisation of government property and services.
Deals closed so far in the UK include two private prisons and the Pound 300 million ($500 million) link road around Leeds.
These new financing models in the UK are spreading elsewhere. "The logic of privatisation and the logic of deregulation is to adopt private finance initiative-type schemes in other countries and we have seen a lot of interest from other governments - mainly European - in what the UK is doing in PFI," says Gordon McKechnie, managing director for project finance at NatWest Markets.
In Finland, design-build-finance-operate (DBFO) shadow toll road schemes are heading to financial close, while in Portugal a bid process for shadow toll roads is about to start. Spain is also keen to follow the UK model. In the European Union, the need for countries to reduce borrowing requirements to bring their budget deficits within Maastricht criteria is a driver. Outside Europe, South Africa is proposing private prisons, toll roads and private water schemes.
In another innovation in the UK, a number of power plants are being developed on a "merchant plant" basis, where no electricity offtake contracts are signed and bank finance takes the risk on the future level of pool prices in the UK.
Of sources of funds for projects, some bankers see an increasing role for public bond markets, principally the US bond market and the UK long dated sterling market.
The Ras Laffan Liquefied Natural Gas project in Qatar is seen as a landmark deal in the trend for projects to tap the capital markets. Debt financing of $2.55 billion was signed in December; Goldman Sachs acted as financial adviser to Ras Laffan and also lead managed the $ 1.2 billion bond issue, which was co-led by CS First Boston. Bank and export credit agencies provided facilities amounting to $ 1.35 billion. Total project cost was $3.4 billion. Industrial Bank of Japan (IBJ) and Credit Suisse were joint financial advisers to the sponsors JGC and MW Kellogg.
Michael Crosland and Paul Fairbairn, project managers of IBJ, claim that this is the first time that the bond issue has been concluded at the same time as the bank/export credit agency financing for a big project. Typically the bank issue is concluded first and the bond issue is used to refinance the project, usually at the end of construction, which is more expensive than doing both at the same time.
They explain that on Ras Laffan the sponsors provided completion guarantees which enabled the bond issue to occur before construction had been completed.
Guy Spaull, head of project finance of Chase Investment Bank, comments that before this deal the main focus for the US bond market in financing projects had been power projects, mainly in the US with a few in Latin America and Asia.
"Ras Laffan breaks the mould," he says, in that bond market investors took a new country risk and were willing to invest in an industry other than power. "Clearly there will be an increased focus on the potential use of the capital markets in future projects."
Nevertheless, international capital markets are unlikely to prove a bottomless source of project financing for hungry emerging markets. Douglas Gustafson, Europe representative of the IFC, comments: "The development of local markets is in some ways a determinant of how fast some of these things can progress, because there's a limit to the amount of external debt that should be raised and can be raised."
Despite the greater availability of options to mitigate country risk, the possibility that a government will not perform as it has promised remain a hazard that can jeopardise a project.
A high profile example has been the power station project sponsored by Enron, the US gas developer, at Dabhol in Maharashtra in India. The state government in Maharashtra in 1995 had halted the project, which had been agreed, financed and under construction, citing grounds such as corruption and lack of transparency in the original negotiations. It appears to have been revived by a Bombay High Court decision in December 1996 to reject a labour union challenge.
The Dabhol case has not helped the prospects of the other seven so called "fast track" power projects in India, which have been going on for five years or more.
Richard Grant, managing director of the power and environmental infrastructure finance group at Chase, explains the idea was that the Indian federal government would guarantee the guarantees of the state governments, which in turn would guarantee the obligations of the state power companies.
However, the state power companies are not credit-worthy and the state governments are virtually bankrupt. "This is something short of a perfect situation, even if it had worked... if anything happens you are looking at the rest of your life in an Indian court litigating these obligations," says Grant.
Countries which get them done have a sense of urgency: "The government decides it will happen."
While India and China, which dominate the need for power, have been laggards, Grant points to Turkey as the best example in the emerging world of a country which has taken decisions to make deals happen. Chase is busy in Turkey advising or arranging debt for projects.
But it is not only governments of emerging markets that fail to keep their promises or move the goal posts in a deal. Sources which were close to the financing of Eurotunnel, which has lumbered 225 banks with Pound 8 billion debt, claim that many of the cost overruns resulted from the fact that the UK and French governments changed the safety specifications.
Under a normal concession agreement, the governments should have had to pay up. Eurotunnel had a flawed concession agreement from the private sector's point of view; the contractors wrote their own contracts, which meant they effectively negotiated with themselves. Eurotunnel was an exception to every rule, say bankers, a hybrid rather than a true project finance deal. Others argue that the project was so big that it had to absorb some of the costs itself.
The Eurotunnel fiasco appears to have done little to dampen banks' enthusiasm for project finance. Kit Beer, managing director and head of project finance for Europe, Middle East and Africa at Bank of America, observes that in the UK particularly, competition among banks has driven final loan maturities to beyond 20 years for certain infrastructure deals. These levels would have been unheard of three years ago and pricing, even at these maturities, is breaking the 1 per cent margin.
Some bankers are muttering that such aggression is a recipe for another Latin America. In the banking cycle of boom and bust, Spence believes that the project finance market is standing at the more extreme edges of the bottom: "The point in time where people have to make a decision to stop is not far away."
Reprinted with permission from The Banker, FT Publications.
