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Thanks to a need for yield, investors are chasing project bonds. After some initial stumbles, such bonds are becoming a global phenomenon.
They might not have got off to the best start, but project bonds are back on the agenda. In Europe the pilot phase of the EU’s 2020 Project Bond Initiative, implemented by the European Investment Bank, started in 2012 to great fanfare.
“The Project Bond Initiative provides an opportunity for reopening capital markets as a source of financing for crucial transport, energy and communications infrastructure essential for ensuring growth and competitiveness in Europe,” said Werner Hoyer, president of the EIB.
But it almost fell at the first hurdle, thanks to the Castor Project, a large offshore submarine gas storage facility in Spain. In July 2013, it was the first to issue project bonds; a €1.4bn (US$1.53bn) offering with EIB project bond credit enhancement. One of the country’s biggest investments in its gas system, the project was supposed to store 30% of Spain’s daily gas consumption.
As an idea it was clever. The plan was to re-adapt an oil field that was spent as a gas storage facility. The problem is that it did not work. Construction work had seismic effects that resulted in more than 200 earthquakes. Activity was halted immediately, and the only action in the last few years has been lawyers playing the blame game.
The problem has not affected the European issuance of project bonds as much as expected. As one banker says, “there has only been a knock-on effect for offshore gas storage financing”, still it took until May this year for another project bond to emerge in Spain – the €184.5m 27-year 3.169% senior secured issue for the Meridiam-led A66 Benavente–Zamora motorway.
A greater impact on the issue of project bonds in Europe was the debt crisis.
“In all European countries, we have seen a constant decline in [infrastructure] investment, both in the public and private sector. We must reverse that trend,” said Italian Finance Minister Pier Carlo Padoan last year.
Progress has been slow. The first Italian project bond since the debt crisis only put its head above the parapet in April last year – the €700m project bond refinancing of the Passante di Mestre toll road near Venice. It has been delayed several times, but is expected to close this autumn.
Although motorways financings are not the only type of project bond that are being looked at (the UK’s £305.4m Greater Gabbard offshore transmission link 4.137% 19-year bond deal through HSBC and Santander springs to mind), it is in road financing that the most consistently successful projects have been seen in Europe. That project bonds could cope with complex and longer tenor structures was proved by the €620m L2 Marseilles ring road scheme in 2013.
That deal was done without EIB assistance, but the two best-known deals since, have. The way was led in March 2014 by the €577.9m 31.5-year 4.49% project bond financing the A11 motorway, a fast road connection out of the port of Bruges-Zeebrugge in Flanders, Belgium.
“The A11 is the first motorway scheme to benefit from the EC-EIB Project Bond Initiative that helps institutional investors back long-term infrastructure investment,” said EIB vice-president Pim van Ballekom.
It was followed towards the end of last year with the €429m 2043 2.957% Bundesautobahn A7 project, a 65km stretch of the motorway north of Hamburg in Germany via Credit Agricole and Societe Generale. And there are several others in the pipeline.
What is encouraging issuance is that there is global investor demand for anything that even in the broadest sense can be called a project bond. Jason Russell, deputy global head of DCM syndicate SG, describes issues as “chased furiously by just about every source of liquidity”.
It is not just the longer tenor on these deals that attracts pension funds and insurance companies, but an explicit (or even implicit) government backing that makes them so attractive. Added to this, the hunt for yield is such that investors are prepared to look at them in a way that they did not before and consider the whole duration of the bond.
“The hunt for yield and scarcity of assets means that more investors are prepared to take the front-end risk – not just banks,” Russell said.
While Europe has settled into a comfortable issuance groove, in other parts of the world there are specialist areas that have been attracting financing in the aftermath of legal changes. Take Turkey for example.
Parliament introduced a new public-private partnership law specifically aimed at healthcare projects in 2013 that was designed to attract more foreign investment. It has been a huge success and, for the past few years, the most interesting project money has been flowing into the sector.
Hospitals so far have been built on the traditional bank-funded PPP model – the €540m Adana Integrated Healthcare Campus Project in southern Turkey signed in mid-December got the ball rolling – but the first project bond is now being planned. This will be for the Meridiam-led €350m hospital in Elazig, in eastern Turkey via HSBC.
The appetite for project bond paper is such that investors are flooding into areas where in previous times they might have been more cautious. Latin America has seen particular innovation.
As one banker says: “People are hungry for assets if the framework is in any way appropriate.”
What is noteworthy, for example, about the financing for the metro in Peruvian capital Lima is not just that a project that had been discussed since the 1970s got away. A construction and planning soap opera in itself, financing was concluded in February this year with a US$204m equivalent 24.8-year bond. What speaks to the demand of the AA+ rated paper is that it printed at 4.75% – the lowest project rate ever for the country.
Demand can also be seen in Peru in the US$274m project bond financing for a fibre-optic network concession in Peru for Mexican media group TV Azteca. At the beginning of April the 2031s, which have a 9.5-year average life, were priced to yield 5.875%.
By no stretch of the imagination was it an easy bond to sell. The project has complex features on top of never having been done before; there is no full government guarantee; and there were not insignificant country risks that caused concerns for foreign investors, especially ahead of next year’s elections. Still, the fact that the paper printed is significant in and of itself, notwithstanding the punchy coupon.
It remains a curiosity that the region of the world with the biggest need for funding and the biggest opportunity remains Africa, where there is a huge focus on development.
Although Chinese funding has ramped up significantly in recent years and now accounts for an estimated 20% of funding, the Brookings Institute estimates that there is still a US$93bn gap in the continent’s infrastructure needs and there are few signs of project bonds.
Aside from power generation, the key area is anything at all to do with natural resources, but bankers say that financing remains disjointed. Many deals remain directly sponsored by the government and banks remain cautious about other financing.
“There are just too many significant questions about jurisdictional issues,” said one regional banker sadly.
Elephant in the room
As big a regional elephant in the room is Asia. Again, despite the clear need for infrastructure funding, to-date project bonds have remained off the table. This is partly due to a lack of familiarity with the product as well as questions about legal frameworks for the complex structures. Still, one of the more interesting project bonds, in the broadest sense of the word, at the moment is not only Asian, but comes with an Islamic structure.
At the end of April, Khazanah Nasional, Malaysia’s sovereign wealth fund, set up a M$1bn (US$282m) sukuk ihsan programme, which has been rated AAA by a domestic agency, to finance longer term social projects. The first issue under the programme came only a month later – a M$100m–$150m privately placed tranche to fund school construction. It was priced at a comfortable 50bp over equivalent govvies to yield around 4.3%. Future tranches will fund projects such as hospital construction.
It is worth considering whether the much-trailed rise in US interest rates later this year might impact project bond pricing. The answer is less clear-cut and immediate than might be imagined.
SG’s Russell summed up the universal view. “It is hard to generalise. But it will take longer for pricing to react to rates movement. When interest rates do go up in the US, it is not necessarily the case that there will be an immediate follow-through to credit spreads and pricing for these asset classes.”
He explained that the long duration of infrastructure projects – 40 years is not uncommon – meant that both sides take a longer perspective on debt.
This is positive news for both issuers and investors. The former have a continued impetus to issue. Since they can be fairly sure that there will not be a spike in the spreads they will have to pay which could make bond issues too expensive, there is no reason for them not to issue and to consider both Africa and South-East Asia more seriously.
And with any rise in interest rates unlikely to be extreme, investors can continue to take advantage of the pick-up that project bonds offer over other paper and lock in long-term rates.