Building the future
Latin America is in urgent need of more infrastructure funding but regulation is constraining commercial banks’ ability to provide it. Step forward the development banks, which have been financing the sector for decades and must fill the vacuum left by the retreat.
In Asia, around 5% of GDP is invested in infrastructure, said Cesar Canedo-Arguelles, CEO at Corporacion Interamericana para el Financiamiento de Infraestructura (CIFI), a Panama-based development bank that provides financing and advisory services to small and medium-sized infrastructure projects in Latin America. “In Latin America the figure is much lower, but that is where we need to be,” he said.
Yet despite the need for such significant investment, in Latin America – as elsewhere – infrastructure projects face a particular challenge securing funding from banks in the short term, said Canedo-Arguelles. This is because under the latest iteration of the Basel Committee on Banking Supervision’s regulations, banks will be required to hold more capital against such long-term financing and the construction risk it entails – especially in the mid-market, where CIFI operates.
Setting aside capital requirements, infrastructure remains an attractive space to be, said Canedo-Arguelles. He acknowledged there are challenges: the sector has high barriers to entry and requires very thorough due diligence, such as understanding sponsors and the local environmental and social issues, which requires expertise.
“It is capital intensive and the assets are very long term, which does not suit all institutions,” he said. “But for other institutions, like pension funds, that can be a positive thing. The sector is actually less volatile and more predictable than other sectors, the default rate is lower too, and if the fundamentals are strong and the due diligence is well done, the project can generate very stable cashflows that are typically inflation-linked.”
It is against this backdrop that a number of development banks in Latin America with a particular focus on infrastructure financing are flourishing. Perhaps the best known is Caracas-based Development Bank of Latin America (Corporacion Andina de Fomento, or CAF), which was founded in 1970 and which has a particular focus on transport projects and energy – especially electricity and distribution.
CAF was one of the first development banks to focus on infrastructure, said Gabriel Felpeto, its director of financial policies and international bond issues. “We still allocate around 70% of our capital to the sector. When we were founded, the other development banks in the region tended to focus on social projects, and while others now look at infrastructure too, we think we still allocate more to the sector than our peers.”
CAF is a significant player in LatAm infrastucture: it had nearly US$30.5bn in assets on its balance sheet in 2014, and that year made US$11.7bn in loans, while at the end of 2015, it had US$20.4bn of loans outstanding. Typically, around 80% of those loans are made to public sector institutions, with durations of typically 10–20 years. Yet it is relatively small in terms of headcount, employing only 600 people across 13 offices, which it cites as an advantage and a source of efficiency when making investment decisions.
Elsewhere, the Central American Bank for Economic Integration (Cabei) is smaller than CAF but, with around US$8bn in assets, it is a large institution in Latin American terms. Its mandate is to facilitate the integration of Central American economies, while furthering social and economic development in the region. Infrastructure is at the heart of that.
Since 2005, Cabei has made loans totalling US$14bn to projects in line with its mandate, of which nearly 80% has gone to the Central American public sector. The remaining 20% has gone to the private sector, especially to infrastructure projects that include energy and toll roads, in which it has traditionally had some expertise, as well as to financial institutions, which in turn make loans to SMEs and micro businesses.
CIFI is the smallest of the three, but the only one that is privately owned. Since launch, it has made loans of around US$1.2bn and its current portfolio is worth around US$300m, comprising loans that are on average US$10m–$15m in size.
A large continent
The regions covered overlap to some extent but the three development banks have different areas of focus. CIFI is particularly active in Central America, as well as the Caribbean and Andean Countries – economies well suited to its own size.
It is active elsewhere on an opportunistic basis, although the larger economies of Brazil, Chile, Argentina and Mexico see greater competition, being better served by big banks and other development institutions.
The two regions within Latin America also have different macroeconomic drivers. “Central American economies are more closely tied to the US, whereas South American countries are more dominated by commodities and are therefore more closely tied to Asia,” said Canedo-Arguelles.
Cabei is similarly focused on Central America. It claims to have provided around 50% of the money that has been invested in the region by development institutions in the last 10 years. But it has the advantage of being focused exclusively on this area and of being small, which means it can act faster in dispersing funds than our larger peers, it said.
“We are interested in new members to join to help us diversify our sources of funding and our loan book,” said a spokesperson at Cabei. “We have embarked on a diversification strategy at the level of capitalisation and lending that should result in added exposure to countries like Panama and the Dominican Republic.”
Cabei is also owned predominantly by the governments of the region in which it operates. It was founded in 1960 by the governments of Guatamala, El Salvador, Honduras, Nicaragua and Costa Rica. Since then, it has grown to 13 members, with Panama and the Dominican Republic joining from the region, as well as Belize, Mexico, Argentina and Colombia. Taiwan and Spain are also members from further afield, having joined in 1992 and 2004, respectively.
This broad partnership has helped it achieve a Single A rating and enables countries outside the area to support their own businesses that are active in the region, which is strategically important, given its proximity to the US.
Investors have been very supportive. Cabei has issued bonds in 20 markets across 17 currencies and raises around US$1bn per year, much of it through its MTN programme. “Our most important markets for funding are Mexico, Switzerland and Taiwan, where we are regular issuers,” said the spokesperson. But it has the flexibility to be opportunistic and issue wherever market conditions are favourable, always swapping the proceeds back into US dollars to avoid currency and interest rate risk.
CAF’s focus is a little broader and it diversifies its loans throughout the region. Its largest exposures are to Venezuela, Ecuador, Argentina and Peru, but no single country accounts for more than 15% of the portfolio. This is reflected by the ownership of the institution, with 96% of its shares held by LatAm or Caribbean countries. Spain and Portugal also have small stakes.
Felpeto said: “Our shareholder structure is a big difference between us and other development institutions. Typically, around 50% of shares of development banks are held by highly rated, non-borrowing countries, which helps them to obtain Triple A ratings. Because our shareholders are lower rated developing countries, we have had to earn our rating ourselves.”
When CAF was first rated in 1993 it was Triple B, the only investment-grade borrower in the region at the time. Since then, it has had a series of upgrades and is now AA–.
“Our rating has improved as we have changed the composition of our investor base, which currently is similar to other SSA issuers,” said Felpeto. ”US dollars and euros are important strategic markets for us and we do benchmarks in both every year. The Swiss franc market is also strategic for us and we have a loyal investor base in Switzerland, while Australian dollars has also become an important market for us since 2013, following our upgrade to our current rating.”
CAF has also issued in the Japanese Samurai and Uridashi markets, in South African rand and Turkish lire, as well as issuing a number of private placements in various currencies, always swapping back into its home currency of US dollars and hedging interest rate risk.
Created in 2001, CIFI has a quite different composition of shareholders. Among them is Cabei, as well as the International Finance Corporation and the Caribbean Development Bank, which between them own just over 26% of the company. The remainder is held by a number of local and international banks, as well as sovereign wealth funds.
But being a private institution puts it in a different position when it comes to funding. CIFI looked at raising capital in the capital markets about five years ago, but although it was well received by investors, this proved too expensive and it decided not to go ahead.
“For now, CIFI has not had much relation with the international investors,” said Canedo-Arguelles. “They liked our story but they wanted to invest in a bigger version of CIFI. Once we have grown large enough to make it work, we may go back to the capital markets. For now, we are looking at other options.”
He acknowledged that raising capital from banks with Basel IV coming soon, while maintaining the ability to offer competitive pricing on loans to its own own clients, might be a challenge.
“The next step for us is getting a local rating and then working with regional institutional investors like pension funds, insurance companies and family offices, because infrastructure is an interesting sector for them,” he said. “We are looking at whether we could do some private placements with them. Or another possibility is we could act like an asset manager on their behalf, managing investments they make in the sector on their behalf.”
This will also help a sector that will come under increasing pressure as highly indebted economies in the region scale back the assistance they provide directly to infrastructure. It makes sense for private capital, particularly institutions with longer dated liabilities like pension funds, to finance future infrastructure projects, especially if governments are no longer willing or able to do it themselves.
The possibility of partnerships with local institutional investors is also encouraging CIFI to look at making loans in local currencies – it has traditionally lent only in US dollars.
Canedo-Arguelles said: “We have always made loans in US dollars but we are looking at diversifying into local currencies, which makes sense for certain types of project that create revenue streams in local currency, such as toll roads. That removes the exchange rate risk. And it should also appeal more to local institutional investors, as they have local currency liabilities.”
That may also open up more opportunities in the larger South American markets, where there is greater demand for local currency-denominated loans for infrastructure projects.