Heavyweight infrastructure development requires heavyweight capital. But securing long term funds is not getting any easier
Africa’s infrastructure needs are vast. Nigeria’s central bank governor Charles Soludo estimates his country alone needs to spend $34 billion every year on its infrastructure for the next 15 years. On a pan-African view, the Africa Finance Corporation, a Lagos-based investment bank set up last year with $2 billion of authorized capital reckons, there will be $130 billion in infrastructure investment opportunities over the next five years.
Encouraged by this projected flurry of new projects, local banks, development institutions and foreign investors have plunged into projects to develop Africa’s infrastructure and unleashed a tide of liquidity previously unseen in the continent.
New foreign players include PME African Infrastructure Opportunities, backed by the Swiss wealth manager Helvetica and the activist investor Principle Capital Group. Last July, the fund broke new ground when it listed on London’s alternative stock market AIM, raising $180 million. That month, the Pan-African Infrastructure Development Fund, initiated by the help of the African Union, was launched with an initial commitment of $625 million from domestic institutional investors, local banks and foreign investors. It hopes to eventually raise $1.2 billion. The arrival of dedicated African infrastructure funds run by western portfolio managers suggests the sector is gradually becoming an emerging asset class.
The welcome mat
“Africa now has a welcome mat out for foreign investors,” says Thomas Gibian, chief executive officer of Emerging Capital Partners (ECP). ECP runs five African private equity funds, including the AIG Africa Infrastructure Fund, which was established in 2000 and EMP Africa Fund II. This closed in December 2005 with more than $500 million in commitments.
Other mainstream investment vehicles include the South African-focused African Infrastructure Investment Fund, set up in 2004 and managed jointly by global project finance trailblazer Macquarie Bank and Old Mutual Asset Managers. Local banks too have been quick to rack up their lending to the sector while institutions such as South Africa’s Rand Merchant Bank are also keen to become principal equity investors. However, it’s not all plain sailing. Africa with its weaker credit quality is now facing the sub-prime crisis where assets are being repriced amid growing levels of risk aversion.
“Banks have seen an adjustment in risk but sponsors and sellers of projects have not yet readjusted to this new reality. The pain will soon be borne out,” says one head of project financing at a South African investment bank. Indeed, domestic banks are already feeling the pinch. In Africa, Libor – the London Inter-Bank Offer Rate – overwhelmingly references foreign currency borrowing. As a result, the crisis in short-term money markets has spilled over to raise the cost of funding for African projects.
To date, this has not derailed any deals – instead, it has hiked the cost of new transactions and refinancing operations for existing projects. Transactions are being more cautiously structured. “It is a question of making project economics work, deferring capital expenditure, and persuading investors that you can roll over funding,” says Jonathan Wood, head of project finance at Standard Bank.
In effect, transactions have been designed with modest debt to equity ratios so the revenues generated by a project should easily cover the cost of interest and repayments. Foreign investors are likely to remain committed for the longer term. “Africa’s lack of correlation with other markets – as well as the attractive risk return potential of many projects – means investors will keep their appetite,” says Gibian.
New liquidity sources
In addition to new liquidity pools from the Middle East and China creating new financing opportunities, structural changes in the region’s economies suggest infrastructure finance will become mainstream over the medium to long term. Four factors are driving this trend: better, more sophisticated fiscal management; improved sovereign creditworthiness; a general diversification away from government securities due to the lower interest rates on offer; and banking consolidation offering benefits of scale.
“With banks liberalizing and consolidating over the last couple of years, there is now a huge capacity for local banks to participate in financing and organize syndications with other institutions and investors,” says Gibian. And against this is the backdrop that countries such as Ghana, Kenya, and Gabon are providing. These have introduced long-duration sovereign bonds that provide pricing benchmarks for private financiers for long-term project work. The financial infrastructure to make deals happen is also consolidating.
The emergence of domestic investors means more projects can benefit from local currency financings. Here some investors have been further encouraged by the relative exchange rate stability of regional currencies in Nigeria, South Africa and Ghana in particular.
Challenges
But the overwhelming challenge still remains matching the tenor, cost and currency of bank capital to the financing requirements of long-term infrastructure projects. Most banks raise the their deposits in a local currency and for short tenors – five years tends to be the maximum – but infrastructure projects require funds for longer tenors and frequently in hard currencies.
“To get funds in a local currency for a power project or toll-road, you have to pay exorbitantly high interest rates. And that means tariffs will have to go up,” says Ravi Suri, head of Middle East and Africa project finance at Standard Chartered. “The other route is to get a dollar financing and lower interest rates but can you hedge the currency risks – which is the worst devil?”
Securing longer-term dollar finance still incurs expensive premiums as well. “If foreign banks lend into Africa then you have country risk that stops lending for more than three to five years unless the deal is underpinned by offshore escrow accounts or has World Bank support or other political mitigants,” says Wood. This means that most deals feature a small local currency element alongside the majority dollar tranche.
And one constant pre-occupation for bankers and investors alike is whether in the competition for international funding, credit standards have been relaxed to the borrower’s advantage. Borrowers may have successfully secured weaker covenants and fewer expensive hedges from compliant lenders since domestic banks have limited portfolio management experience, says Wood. Gibian said this has become a hot issue. “It’s not as if banks are not aware that large amounts of capital and declining credit standards could result in a worrying situation. We have been impressed with the recognition of financial institutions that this needs to be resisted.”
But investors complain that, while some projects make clear economic sense, in practice they are brought to the market with poor structures and insufficient technical rigor, making them unbankable. “I don’t know why it’s still taking so long to get bankable projects off the ground. It requires a huge amount of dedication and a skilful sponsor – this is a real challenge,” says Rod Evison, Africa portfolio director at UK government-owned fund Capital for Development (CDC).
But the political risks of dealing with some African governments combined with atrocious regulatory frameworks limit the scope for private financing for some deals. “Privatisation is a means to an end, not an end in itself. If private capital is deployed before an appropriate regulatory framework is in place then you are in trouble,” says Standard Chartered’s Suri.
Indeed, before infrastructure finance explodes in the region, bankers, investors and constructors will have to endure scrapped or bitterly renegotiated contracts as the continent develops its own risk management history.