The European Investment Bank has put the infrastructure gap for the central and eastern European countries (CEE) region at almost €500bn, a figure that obviously cannot be met purely through public spending, particularly with many nations still attempting fiscal consolidation. “There definitely continues to be a need for infrastructure spending, and if we look down the line five years from now, that need is just going to be increasing,” says Claire Coustar, co-head of CEEMEA structured credit trading and head of structuring for CEEMEA financing at Deutsche Bank.
Any hope of a vibrant institutional market for project financing in the region is distant, though, with a few exceptions. “It’s overwhelmingly still a bank market, particularly in the Balkans and Turkey,” says Coustar. “In some eastern European countries, like Slovakia, the Czech Republic and Poland, you are seeing more institutional money coming in as people become more comfortable with sovereign risk in those countries.”
Whenever bank liquidity is high, it tends to impede the development of capital market involvement. “There is a large amount of liquidity around from banks who are very interested in financing long term infrastructure,” says Markus Kriegler, head of corporate finance at Erste Group Bank in Vienna. “At the moment banks are both active and aggressive although the picture can change quite considerably.”
R1 the right one
There are, though, positive examples of using the capital markets. The R1 Expressway refinancing in Slovakia is an example: a €1.242bn bond issue of 25.8 year bonds with an average bond life of 15.5 years. This deal, completed at the end of 2013 and the biggest project bond placement in the region that year, was the first PPP refinancing in
Slovakia and followed lengthy negotiations between the public and private sectors over allocation of risk and remuneration. The bond took out €1bn of loans that had been signed in August 2009 among a club of 13 banks, including the EBRD and KfW, and in doing so sharply reduced the project’s debt costs.
“Slovakian Expressway showed that, for the right structure that ticks all the right boxes — strong investment grade, funded, bond format, fixed rate and long dated — these transactions attract institutional money,” says Coustar.
Institutional capital tends not to want floating rate debt or long availability loans in transactions like these, preferring liquid bond instruments with a fixed rate that they can trade in and out of.
Investors also tend to want to avoid risk they feel they can’t control.
“Project bonds as public infrastructure financing instruments are rather rare because there are certain risks, like construction and market risk, that limit capital market investors’ appetite,” says Alina Woloszyn, partner at KPMG in Warsaw.
But if that risk is mitigated or concluded — by a highway that’s operational, for example, as was the case in Slovakia — it becomes much easier to attract professionally managed finance. “Institutional money tends to be more interested once you’ve finished the construction phase of a project,” Coustar adds. “Naturally institutional money tends to want to be funded on day one: it doesn’t like long availability periods as it’s not very capital efficient. So once you get past the construction phase on some projects, you will probably start seeing refinancings with institutional money.”
Hard to follow
So there is a model. The problem is that the Slovakia deal is still very much an outlier. “Other than [that] example, there has been no major project bond used for financing infrastructure in the region,” says Kriegler, whose Erste Group was an investor in the bond.
Still, it’s a useful template at least. “I would expect that for other projects, bonds will now be seriously considered as one element of the financing.” Indeed, the next one might be another Slovakian deal, the D4-R7 ring road around Bratislava, another PPP with PricewaterhouseCoopers as an adviser. “That will be a major project with a volume way above €1bn,” Kriegler says.
Two things in particular can help bring about deals like this: government policy making it attractive for international institutional investment to come in and the availability of deep local currency pools of capital.
“Historically, the biggest hold up in terms of going ahead with infrastructure is getting governments to put the programmes in place,” says Coustar. She does see positive examples — notably Turkey, introducing things such as assumption agreements and quasi-government support for privately funded infrastructure projects — but says there need to be more. “I would like to see more proactivity on the part of some emerging market governments in terms of their willingness to do more infrastructure through the private sector,” she says. “A lot of the time there is still a preference to use quasi-sovereign entities to lead the fundraising. If you want the development of private sector funds, you need the first step, which is the government being willing to award concessions to the private sector and to support transactions,” through availability payment, debt assumption or similar instruments.
EIB’s role
If things aren’t being put in place in individual nations, then clearly multilaterals have to play a role. The European Investment Bank in particular has sought to develop enhancements to help deals get along, as part of the broader Juncker Plan, the €315bn initiative unveiled by European Commission president Jean-Claude Juncker last year, which aims to use €21bn of EU funds (€5bn of it through the EIB) to raise private cash in the capital markets in order to get unfunded infrastructure projects moving.
“Everyone is now looking closely at the instruments we might get under the Juncker initiative, which would be very helpful,” says Kriegler. “I think the sort of leverage they want to achieve can only be done if there is an instrument that is subordinated and takes the first loss in a project structure,” he adds. “That will enable bonds to achieve a better rating, which would make it effective for long term investing. If IFIs want to have a bigger role here, it needs to be in terms of creating these subordinated instruments to put a layer between equity and senior debt.”
If not the EIB, then the role of other multilaterals, export credit agencies and so forth is essential, particularly on true greenfield projects where there’s no government or quasi-government support such as availability payments or debt assumption agreements.
On the second point — local institutional capital — the picture is mixed. “In a country like Poland, local funding could play a role,” says Kriegler. “There is a deep market there, with institutional investors like insurance companies who have become quite active in the credit market. There have been examples — not in infrastructure, but in buyouts — where you can finance amounts equivalent to billions of euros in zlotys.” He says the same could be true of the Czech Republic, were the country to push more for the development of PPPs.
Beyond that, if Israel is considered part of the region, then that’s certainly an example. “We even structured one deal there [the Ashalim project in the Negev desert] partly in local currency even though the revenues were in dollars, specifically to tap into local currency demand from local Israeli funds,” says Coustar. But that’s about it. “Those deals work in local currency markets where interest rates are not too high. So in Turkey it would be very difficult unless you had a matching profile of local currency revenues and debt, which is rarely the case with these transactions.”
Muni bonds and PPPs
There is another method of using the capital markets to fund infrastructure, but it is indirect, using city or municipal bonds to fund a budget which can then be used for infrastructure. “City bonds usually fund various infrastructure purposes and they are not usually dedicated to specific capex,” says Woloszyn at KPMG.
This tends to be the norm in her home market. “Poland has the most mature and liquid capital markets in the region, but despite that, infrastructure financing here is mainly done through EU funds and public budgets.”
PPPs, she says, remain rare in Poland. What can be done to change that? “The key to success would be promotion of these structures among public sector decision-makers, a public procurement process and simplifying the PPP regulatory framework,” she says.
“I see strong interest from various investors in infrastructure projects and the PPP model. But there is a limited number of infrastructure projects that are bankable or ready to be placed in the market.”
As for the type of deal that works, roads are the natural fit: stable, predictable long term cashflows and a clear point when construction risk disappears and it becomes easier for investors to assess risk and reward.
Others say airports and health — Croatia, for example, has tendered hospital development on a PPP basis — although energy is an increasingly complex area for investors, particularly given uncertainties around oil and other commodity prices and their impact on the economic viability of projects. Kriegler also points to renewable energy projects, which he thinks are well suited to private investment and indeed have so far been almost entirely financed on that basis.
Kriegler believes it is a question of momentum and demonstration. “There is a need to build track records in these kinds of projects so investors can see that there have been successful projects in the past,” he says. “The more that have been successful, the easier it will be to raise funds.”
And if deals do come along successfully, there is a hope that the demonstration effect can build a practical, vibrant market. “With those steps in place, you can get enough investors looking at transactions to move to stage two, which is more traditional non-recourse infrastructure financing, like in western Europe and the US,” says Coustar. “That’s the long term goal.