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Corporate Bonds

Project bonds can be big, but they can’t be clever

Congratulations are due to the banks and companies involved in last week’s Granvia and Greater Gabbard project bonds. They are helping to bring new capital into infrastructure finance. But the art of structuring these deals is to shield investors from nearly all risk. The real spadework in project finance is still being done by banks.

Last week was an encouraging one for those who see project bonds as a solution to Europe’s infrastructure finance needs.

Slovakia’s first public-private partnership, a €1.3bn expressway that opened in 2012, was fully refinanced with a €1.24bn 26 year amortising bond.

Meanwhile in the UK, a £305m 19 year bond financed the sale of a transmission link to the Greater Gabbard offshore windfarm to new owners, to comply with regulatory requirements that all such offshore cables be unbundled from the windfarm owners.

Both deals offered better financing terms than the project sponsors and their ultimate customers could have obtained with bank loans.

Also last week, a report from Preqin, the alternative assets research group, found that Europe-focused unlisted infrastructure funds holding final closes this year have raised €9bn, the same amount as in all the years from 2000 to 2006.

The institutional capital being allocated to this asset class, notably by pension funds and insurance companies, is running ahead of deal supply.

But before politicians, journalists and others rush to proclaim: ‘institutions take over from banks with competitive project finance, enabling new infrastructure investment’, it is essential to underline: the developing European project bond market is one for safe and simple risks.


Safe and sound

Consider the two projects financed last week. One was an expressway that had been operating for a year – the other a system of undersea cables and substations that had also been running for a year.

The private sector consortia operating each asset have to maintain it and keep it running, and get paid an availability payment provided the asset is functioning.

But there is no designing or building involved, and no market risk. The Slovak government will pay if the road is available, even if no one wants to drive on it. With Greater Gabbard, the availability payment will be made at no less than 90% of the full rate, even if the wires are available less than 90% of the time.

Each deal also has some of the many structural enhancement tools used in project finance, such as reserve funds, insurance and so on.

The Greater Gabbard deal has made use — for only the second time — of the Project Bond Credit Enhancement offered by the European Investment Bank, using capital supplied by the European Commission. This means that if for some reason the project struggles to pay its debt, it can call on a subordinated letter of credit worth 15% of the principal.

The Slovak bond was rated BBB+ by Standard & Poor’s, the same level as Moody’s rated the Greater Gabbard bond, before giving it a notch of uplift to A3 for the EIB credit enhancement.


Controlled risk, higher debt

These deals are therefore rated at the same level as typical European regulated utilities’ senior debt. Yet the risks involved are much simpler: just one asset in each case, with a guaranteed customer and little chance of anything going wrong.

The trade-off for this simplicity is twofold. On one hand, these projects are much more highly indebted than utilities — 89% of capital at Granvia, 90% for Greater Gabbard.

On the other, the single asset creates a concentration risk — if something did go wrong, the business would have no other activities to fall back on.

Analysts will differ on which kind of credit – the €20bn utility or the €1bn project – is riskier. But certainly, taking the rating agencies’ view as a baseline, investors are getting paid better for project bonds than utility bonds of like ratings.

Greater Gabbard’s bond, with a 12 year average life, was priced at 125bp over Gilts (very roughly, 130bp over mid-swaps). Granvia’s, with a 15.5 year average life, came at 235bp over mid-swaps, reflecting its lower rating, larger size and Slovakian location.

Even Greater Gabbard priced over 30bp wider than National Grid, whose regulated entities are also rated A3/A-.


Out at sea

Now consider another UK company: EnQuest. The oil and gas development and production company is unrated, though a FTSE 250 member with a £1.1bn market cap. It has just sanctioned development of the Kraken field in the North Sea, which holds 137m barrels of oil and will cost a net $1.4bn to bring on stream over the next three or four years.

EnQuest has just tapped its nine year retail bond for £10m, at a 5.25% coupon, paying just 110bp more yield than Greater Gabbard Ofto, which is rated A3 and has the EIB behind it. The bond is trading, very approximately, at 260bp over mid-swaps.

Most of EnQuest’s finance, however, comes from banks. Last month, it obtained a new $1.2bn six year loan facility underwritten by BNP Paribas and Scotia Bank. The margin on that loan is not disclosed, but since it has a senior status to the retail bond, it would be odd for it to be paying much more than the retail bond.

This money is going to be used to build a vast platform that will drill holes deep in the freezing, windy, North Sea and extract oil – ideally without spilling any of it. Then, EnQuest has to get its oil to market and hope the price is still attractive.

Compare that with keeping a road or cable maintained, and it is clear that the risks involved are of a completely different order.


Brain and brawn

The comparison of these deals suggests that project bonds do have a role in infrastructure finance — but it should not be dressed up as a sexy or daring one.

The Slovak road was built with bank finance, the Greater Gabbard cable by SSE and RWE — two utilities. Banks are going to finance the Kraken oil field.

Banks and big companies are there when things need to be built. They have the sophisticated skills needed to analyse and price these risks, then monitor them during their lives and cope with any adjustments that need to be made.

What capital markets are good at is size and duration. Now that the Slovak expressway and Greater Gabbard cable are finished, working well and just need looking after, bond investors can price them better than banks.

This is mainly because they are willing to lend for a very long time, meaning the payments that remunerate the project can be spread out for longer. The infrastructure customers will pay less each year – though more in the long run.

Banks for the hard bit, where they can get paid. Bonds for the easy bit, where it is all about getting the maximum debt and slowest amortisation on a predictable cashflow. That is likely to be the infrastructure finance template that works.

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