The global financial crisis (GFC) changed the landscape for the project financing market. Seven years since the onset of the GFC, the more recent collapse of commodity prices, the instability of certain sovereigns' credit standing and political unrest in certain regions of the world have been contributing factors to the slow pace of the recovery of the project financing market. Despite this challenging and ever evolving environment, 2015 has seen the consolidation of the key trends in the project financing market which emerged post-GFC. Export credit agencies (ECAs) and multilateral and development finance institutions (DFIs) continue to play a pivotal role not only in plugging funding gaps but also providing structuring expertise to bring deals to market. Alongside traditional lending techniques, the project financing market continues to explore the increased use of project bonds (noting that predominantly North America and Europe have realised this on any sizeable scale). Developers and investors have become more diverse and many project financing practitioners see the role of private equity growing in the year ahead, notably in emerging markets.
Pivotal role of ECAs and DFIs
As a direct consequence of the GFC, ECAs and DFIs had to step-up their already increasing involvement to finance major projects and have, as a result, built a global portfolio of energy and infrastructure projects. The role of ECAs and DFIs remains central in the project financing space. In addition to plugging funding gaps, ECAs and DFIs are now largely involved in the structuring of transactions in particular where, without their support, projects would not be able to successfully reach financial close due to political or geographical risks or credit standing of host countries. This trend is likely to continue for the foreseeable future as ECAs and DFIs continue to evolve and develop intelligent strategies and funding techniques to strategically unlock, leverage and catalyse the flow of private and domestic money into projects.
"US government agencies have been critical to the successful financing of many large infrastructure and energy projects"
There are more opportunities globally for ECAs and DFIs to cooperate in the financing of large-scale energy and infrastructure projects such as the multi-billion pound Intercity Express Programme in the UK involving the Japanese Bank for International Cooperation's (JBIC) first lending to a UK project alongside the EIB, or the Noor solar projects in Ouarzazate (Morocco) where several DFIs and other international institutions are providing funding.
In Africa, DFIs have historically been very active in funding strategic projects and projects where international commercial banks' credit approvals would be difficult to obtain. ECAs (in particular Asian ECAs) have capitalised on dynamic sponsors investing in the power and resources sectors to get a growing share of the market. The involvement of ECAs and DFIs remains key to provide the comfort required by international commercial banks to lend in the continent.
In Asia, the Asian Infrastructure Investment Bank recently launched by China will undoubtedly become a strong player on the Asian financing market competing with the Asian Development Bank and the International Finance Corporation in the region.
The notable exception from this trend of increased ECA involvement in the market is US Ex-Im Bank, which was forced to cease financing new projects when its authorisation expired on June 30 2015 until such time as the US Congress approves its re-authorisation. Before its lapse in authorisation, however, US Ex-Im Bank was providing a record volume of financing to global projects.
Role of governments
Governments have also developed financing products to boost the viability of critical infrastructure and energy projects. These instruments generally take the form of support in direct lending or through debt guarantees allowing the selected projects to benefit from the sovereigns' credit standing. For example, HM Treasury is involved in the financing of the Hinkley Point C nuclear power project in the UK under its UK Guarantees Scheme where it is anticipated that HM Treasury will provide a £2 billion ($3.1 billion) guarantee to the bondholders to cover interest and principal under their bonds and therefore wrap certain risks associated with the project.
Political and financial support from governments on projects such as Hinkley Point C give rise to a number of specific considerations (for example state aid) which need to be addressed at the structuring stage. In the UK, a pipeline of nuclear projects – such as the Horizon's Wylfa and NuGen's Moorside nuclear power projects – are presently anticipated to be brought to the project financing market and will likely benefit from a certain level of governmental support in line with the national priority to develop sustainable low carbon energy generation.
Similarly, US government agencies have been critical to the successful financing of many large infrastructure and energy projects in the US. The US department of transportation's TIFIA programme loans have been instrumental in the limited recourse financing of large US transportation projects, such as the $950 million in subordinated loans provided to finance the landmark I-4 Ultimate Highway Project in Florida. Equally, the US department of energy's Loan Guarantee Programme has been active in the energy sector, including providing almost $8.5 billion in loan guarantees to support the financing of the Vogtle advanced nuclear power project in the state of Georgia, with the final guarantee commitments closing in June 2015.
The return of commercial banks
The project financing market has also seen the return of a wider group of international commercial banks. As demonstrated by this year's various project finance league tables, Japanese commercial banks continue to lead the pack, but an increasing number of banks are now more active in the project financing market. Chinese commercial banks, already managing large project portfolios, are extending their reach to Europe on the back of transactions such as the Hinkley Point C nuclear power project, following their Chinese clients like Japanese banks have successfully been doing for years. International commercial banks have become more familiar with post-crisis new capital adequacy requirements and are now more comfortable with the new landscape. Where long-term tenors remain an issue, short-term financing techniques – such as soft and hard mini-perms – continue to feature on deals leaving the refinancing risk a matter for the post-construction phase.
In some jurisdictions such as Turkey or China, strong local commercial banks have access to the liquidity required to finance large-scale energy and infrastructure projects presenting additional options to sponsors looking to invest in those countries. This has been seen on recent projects such as the financing of the Gebze-Orhangazi-Izmir motorway project in Turkey which was arranged by a group of leading Turkish banks alongside one international commercial bank.
Continued development of project bond solutions
The project bond market continues to develop, most notably in North America and Europe. Unwrapped project bond deals are notably on the rise in Europe, attracting pension funds, asset managers and insurers. The M8 motorway project was the first UK roads project involving a project bond since the onset of the GFC. The unwrapped bond solution, however, has only had limited use to date. Investors have historically had little appetite for construction risk and will therefore usually continue to demand credit substitution or enhancement. The EIB's Project Bond Credit Enhancement (PBCE) product first launched in 2012 has now successfully been used on several transactions, including the financing of the A7 motorway PPP in Germany, and more transactions are in the pipeline.
In the US, the unique market for (US federal) tax exempt bond debt has allowed many transportation projects to be financed with long-term 'private activity bonds'. Subject to rating agency diligence relating to construction and other project risks, underwriters and bond purchasers are comfortable providing long-term bond financing on an unwrapped basis, such as in the case of the $600 million bond financing of the Pennsylvania Rapid Bridge Replacement Project, though partial credit wraps have been used when commercially beneficial, such as in the Goethals Bridge Project and the Portsmouth Bypass Project. Private placement issuances are also now actively considered as a means of financing projects in the US and an alternative to tax exempt bonds, and made up a portion of the financing of the $5.75 billion purchase of the Indiana Toll Road concession.
Project bonds may, however, be difficult to implement in a certain number of emerging markets not sufficiently mature or sophisticated to accommodate this alternative way of funding, and remain therefore a credible alternative funding solution in economically developed countries.
Africa and other emerging markets have seen a higher level of equity investments from funds and other financial investors. Private equity is on the rise. Funds and other investors are now getting more familiar with the risks associated with greenfield projects, including in emerging markets. Japanese and Chinese investors are particularly active but are not alone. Dedicated funds are created in Europe and elsewhere to channel investments in Africa and other emerging countries and provide additional sources available to fund energy and infrastructure projects.
Sponsors (and sometimes authorities procuring the projects) continue to seek opportunities for the refinancing of projects which closed in the aftermath of the GFC and with today's favourable pricing, we expect to continue to see an abundance of projects seeking refinancing. In the UK, recent multi-billion pound refinancings have concluded on the Intercity Express Programme and Thameslink PPP projects and at the time of writing it is noted that several large refinancings are being structured in the oil and gas and utilities sector, particularly in the Middle East. In the US, the senior bank debt on the $1.83 billion Interstate 595 corridor project in Florida, which originally achieved financial close during the GFC, was successfully refinanced with long-term bond debt.
Commodity price effect
Plunging commodity prices have rendered many energy projects uneconomic, particularly in the oil sector. The world's largest energy companies have (according to the Financial Times) shelved $200 billion of spending on new projects in an urgent round of cost-cutting. There has been a knock-on effect for projects earmarked for project finance solutions most notably in the mining and LNG sectors. While most of these projects appear to be delayed rather than cancelled, it remains to be seen whether these projects will be considered economical as we move into 2016.
In the US, the boom in inexpensive natural gas has resulted in a focus on LNG export facilities. A good example is the successful financing of the Freeport LNG $12.5 billion three-train natural gas liquefaction and LNG loading facility project in Texas.
A world of opportunities
The project financing market is still largely in transition but market players have found ways to adjust to the new dynamic resulting from the global financial crisis. There are opportunities on the market for sponsors seeking to raise funds and financiers willing to build or grow their project portfolios. This is welcome news, if not the sign of a post-transition era.
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