The next generation of Indonesian project finance explained

Author: | Published: 24 Oct 2012
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Indonesia’s renewables market expects more local bank involvement and more commercial bank led-deals that do not rely so heavily on export credit agencies’ (ECAs) political risk mitigation elements.

Indonesia has seen record levels of foreign investment in energy and infrastructure projects in recent years - so much so that the country's infrastructure market has almost developed into an asset class of its own, with hedge funds and private equity firms emerging solely focused on the sector.

But foreign banks and export credit agencies have traditionally dominated project financing in both sectors. Domestic financial institutions have chosen largely not to get involved.

Speaking at IFLR's 2012 Indonesia Forum, Asia Renewables' managing director Edward McCartin said local banks
had not got involved in project finance deals as distinct from commercial banking deals where the lending is to the parent on balance sheet.

“Where they have done project finance deals they have offered terms that most sponsors would not agree to,” he said. “As banks would not see equity returns until all debt was paid, despite internationally acceptable debt service coverage ratios.”

The foreign banks have driven Indonesian project finance development for two reasons, he said. Most deals involved ECA support for foreign equipment, as there were no Indonesian suppliers for the larger equipment, and a lack of expertise in power deals.

Instead local banks traditionally stayed in real estate lending and commercial banking where they loaned to corporates on a full balance sheet basis.

“It is the choice of local banks to get involved in project finance lending where the parent company is not responsible for the debt but rather recourse is limited to the project and its cash streams,” he said.

Project finance banks operating in this space, are more like partners than bankers in putting up 75% of the money into the deal, McCartin said.

“As a result, they are going to know that deal almost as well as you do," he said. "It's a very different mindset from the traditional banker."

Gibson Dunn's Saptak Santra said Indonesian banks still preferred to lend on a corporate level as opposed to providing upfront financing for energy and infrastructure projects on a recourse and non-recourse basis.

Local banks were also reticent to enter the secondary market through project and infrastructure M&A, he said.

McCartin said there were banks trying to get their heads round partnering on a transaction but it’s hard to compete against the ECAs and foreign banks,” he said. “There is a lot of liquidity offshore.”

McCartin predicted commercial banks would begin to take more risks upfront for construction in project finance transactions perhaps through bond issuances or use of other capital markets products.

The third generation
“The first generation of Indonesian project finance transactions were all ECA deals,” he said. “The second generation were a mix of local banks and one off deals that did not really go anywhere.”

“We are moving into the third generation now being led by ECA and domestic bank deals but hopefully moving into more commercial bank led-deals that do not rely so heavily on ECA's political risk mitigation elements,” he said.

Indeed, McCartin believed more change would come. Structural reforms were being undertaken, he said. But he warned they would take time to effect real change.

In the meantime, he advised anyone considering Indonesian investment to first invest time and energy into building relationships with prospective targets.

“Potential targets need to know you, they need to understand you, they need to know how you're potentially going to react and that takes time,” he said.

“Indonesia is enigma, but it's not going to change,” he said. “Foreign investors need to work to understand the place, and to understand the diversity of its culture and politics.”

See also

Wampu deal unleashes Indonesian renewable

Why Indonesia coal is best avoided

How to improve Indonesian corporate governance

Is MIST the next BRIC?