The Latin cross-border project finance market has been taking a thumping. Many commercial banks, especially European ones, are unable to get access at reasonable rates to US dollar funding and have left the space entirely or are cherry picking only the safest or most lucrative deals.
Bankers are wondering if this signals a return to the markets of 2009 after the Lehman Brothers collapse or portends something even worse.
Bankers strike a sanguine note overall. The region is no stranger to crises, and project finance deals are relatively resistant, they argue. Basic infrastructure upgrades are a government priority through the region and often receive strong backing, they say, pointing out that local state development banks are operating ever more vigorously in the area.
But they acknowledge that the current environment is threatening, particularly for larger deals; that the speed of closing deals is being dramatically affected; that commercial bank tranches are being slashed; and that prices have risen substantially to reflect the higher costs of funding.
“There are pretty drastic changes underway,” says Isaac Deutsch, head of the Latin American department and managing director at Sumitomo Mitsui Banking Corporation in New York. After a burst of activity through 2010 and the first part of 2011, the new European crisis started to hit the Latin project finance markets in August, showing some lag after the crisis as is typical because of the protracted nature of closing complex project finance deals, he says.
Clarence Tong, senior vice-president, project finance Americas at Mizuho Corporate Bank in New York, agrees the market is suffering from the withdrawal of European banks. “Changes in the roster of banks are already happening in the last couple of months and will keep on for much of the year,” he says.
NOTABLE EXITS
“Projects might require more support from multilaterals this year since the commercial bank market will be significantly less liquid,” says John Graham, lead investment officer in the IDB’s structured and corporate finance division. “Many deals will have to wait until the market gets through this rough patch, which means that sponsors may seek construction period financing and deal with the long-term pieces later in spite of the re-fi risk that this creates.”
The loss of European banks is particularly aggravating as they formed the backbone of the Latin project finance market after US banks largely pulled out in the early 2000s.
Today, many of the key names are absent. They include Banco Espirito Santo of Portugal; Unicredito, which is said to have closed its project finance area in New York; Intesa of Italy; and surprisingly the big French banks including Société Générale and Crédit Agricole, both of which had been consistently present in the market and very disciplined investors.
Tong says that some European banks are trying to sell their portfolios of project finance deals. In part, that’s to help them fund losses on Greek debt, he believes. “2012 is starting to look like 2009 although for different reasons: the appetite from the commercial market appears to be bleak,” says Graham.
Maria Rosa Garcia Otero, executive director of syndications at WestLB in New York, agrees that there has been an exodus of European banks, but says she was seeing a slight return of interest in February. When she talked to banks last November, many had point blank declined to listen to any pitches; now they are listening and even trying for credit approval, she says. The pricing on project finance deals is higher, and European banks have seen some stability return in the US dollar funding market, says Garcia Otero.
In this thin environment for deals, large deals are particularly watched as they typically require greater commercial bank participation and a larger number of lenders.
“There are not enough commercial banks lending to cover the large transactions. Those banks that are still in the market are opting to do smaller ticket sizes, of say $50 rather than $100 million,” says Tong.
The dearth of financing may tilt the balance of power in favour of the lenders so that smaller tickets than usual will get you a seat at the decision-making table, says Graham.
Pricing has been affected. In a normal market, bids for project finance deals by commercial banks cluster in a range of 25bp where risks are relatively simple at around 150–200bp. Today, prices have jumped to Libor plus 250–275bp for simpler deals and a much wider 350–375bp over Libor for more complex ones, says Deutsch, although other bankers called that discrepancy greater than they were seeing.
Bankers say the few large deals that have successfully piloted their way through the markets are exceptionally well supported.
Ecopetrol successfully closed a $3.5 billion debt financing for the $5 billion Refineria de Cartagena (Reficar) at the end of last year. On the surface, the Cartagena refinery deal seemed very successful. But negotiations were protracted and the deal closed with just four commercial banks, a greatly diminished roster. They were the Bank of Tokyo-Mitsubishi, Banco Bibao Vizcaya Argentaria, HSBC and Sumitomo Mitsui Banking Corporation. “Remember this was a landmark deal that everyone had wanted to be part of,” Deutsch says.
Another banker underlined the generous political support forthcoming from the US, which helped developers secure chunky funding from the US Exim Bank. It provided a $2.65 billion direct loan with an all-in interest rate of 4.37% and further guaranteed $100 million.
The other large deal in the market, Etileno XXI, which requires some $3.2 billion in debt financing, is being structured around multilaterals and export credit agencies (ECAs) with reliance on commercial banks pared right back, says Deutsch. Sumitomo Mitsui is the adviser on that deal. Braskem (65%) and Mexico’s Idesa are building the Etileno XXI petrochemical plant in Coatzacoalcos in Veracruz state Mexico.
In such large deals, involving complex combinations of banks, multilaterals and ECAs, which all have different lending criteria, standards and procedures, speed has had to be sacrificed.
“Timing to put deals together has been shot. We used to have deadlines and calendars with commitment by a set date. That has gone, and now you just have to wait until the lenders are ready,” says Garcia Otero. There are delays to all but the best supported deals, she says.
TIME FOR SOLUTIONS
Facing these stiff headwinds, bankers are pushing clients to think about financing from the word go and be as open minded as possible as to sources of funding: “Clients need to tap as many sources of liquidity as they can,” says Garcia Otero.
“You need to change the way you think about your project. During procurement, you need to be thinking about financing and partnerships and how to tap ECA programmes. We are advising clients not necessarily to use the cheapest equipment, but a procurement strategy that taps ECAs which have programmes for direct lending,” says Deutsch.
Some Asian ECAs can provide lending that is not solely tied to provision of goods and services, but incorporate general interest criteria such as long-term export contracts, which is an avenue for mining companies, he says.
Multilaterals are increasingly interested in infrastructure and project finance and are staffing up to understand the assets better, says Chee Mee Hu, managing director for Moody’s Project Finance and Infrastructure Group. “They are seeing more and more value in the area and have a more active dialogue with us and the market,” she says.
“Almost every project finance deal will have some multilateral and ECA participation,” says Deutsch. Still, some European banks are even shying away from deals with ECA participation, as their cost of funding is higher than the Libor plus 200bp rate typically offered in these deals, says one banker.
By getting together, multilaterals can help anchor deals. This year may result in the return of multi-agency financings and other official sources of credit to complement the available resources from the commercial market, says Graham.
Still, he predicts that projects with market risk such as highways, ports and airports will be a more difficult sell as liquidity becomes tighter and banks get more selective.
Banks headquartered in other countries, such as Japan and Canada, have been relatively unscathed by the funding crisis and are seen as a possible replacement for their wounded European counterparts. Funding costs have risen slightly for these banks too, but not as much, says Tong. “We are getting calls from clients looking for more reasonable pricing,” he says.
However, Canadian and Japanese banks cannot fill the void left by the Europeans and would prefer to work in conjunction with them. “I prefer to see a healthy industry rather than one that’s unbalanced at this point. No bank can work in isolation,” Tong says.
Local banks are playing a bigger role in lending on project finance. In some cases, they have cheaper costs of US dollar funding than European banks. However, few are able to offer the long tenors that European banks can assemble, typically being capped at seven or 10 years.
That has bankers thinking creatively on how to include local banks in shorter-term financings. One structure that is increasingly being tested out is the mini perm. Mini perms are shorter-term financings, typically to cover just the construction phase of a project, and are then taken out through local or international capital market financing.
They are popular with local financial institutions, which are just entering the project finance space, which often get to arrange the fee-heavy project finance bond afterwards.
The difficulty is that local project finance bond markets have not gained great trust with local institutional investors: “The project finance bond market seems like a potential saviour, but its use has been relatively limited to areas such as oil rigs with fixed-term contracts,” says Deutsch.
International capital markets are also being used in some deals, for example in the case of Petrobras’ procurement of drilling assets from ships to rigs, says Hu. In recent deals banks have provided short-term financing of some $750 million, which is taken out through the US 144a market, she says. Again, these need strong developer participation to be feasible.
For all these solutions, the hard truth is that some larger deals, of which there are increasingly many, will probably need to be delayed until markets recover. If that is not possible, sponsors are sometimes being advised to break up deals into smaller parts with funding on an as-and-when-needed basis.
But in some cases, such phasing can prove expensive or impractical as the fixed costs get front-loaded into the initial stages, making the deal economics very complicated, says Graham. This year, practicality will be the name of the game for those wanting to get projects up-and-running, he says.
The motto may be “get something workable stitched together for now and worry about optimizing the long-term financing piece later.”
If few expect much activity over much of the year and report disappointing pipelines, and bankers too busy putting together complex deals to worry about chasing new business, some point to the end of the year as a potential turning point.
The light at the end of the tunnel should come from ports and airports, which typically have strong international sponsors and have US dollar revenues, making them some of the safest assets. Interest in such deals is likely to signal a wider recuperation.
But bankers caution that the current crisis does not stem from a flight from risk but a lack of liquidity and a spike in pricing for US dollar funding, which needs to be resolved before the market gets back on an even footing.
With funding at least stabilizing for European banks, this year is likely to be one of slow recuperation. Most bankers admit that the outlook is at best murky with few deals being touted in the market now, and believe that it will be only towards the end of the year that some deal volume returns, in the very safest sectors. “We are concerned by low deal flow,” says Garcia Otero. “But most bankers are just too focused on closing the deals that they have than worry about new business.”