Opening doors to funding

IFR LatAm Special Report 2012
14 min read

Banks are increasing the interplay between their project financing and debt capital markets business to bring solutions to the region’s looming funding challenges.

Latin America is grappling with a US$1trn problem. That is the estimated sum the region’s governments are planning to invest in infrastructure over the next decade as they try to convert massive economic potential into reality.

The problem comes from how the region will finance its ambitious goals at a time when one of its most reliable sources of funding is drying up.

Historically, European banks have acted as the go-to providers of syndicated loans for project finance, providing more than half the supply in 2011. However, the European sovereign debt crisis and the changing regulatory landscape are causing a shake-up in the competitive landscape – and the way large-scale projects will be financed in the future.

Nasser Malik, head of global project and infrastructure finance at Citigroup said: “The US dollar funding pressures on some European banks are having an impact on project financings in LatAm, where the bulk of financings are denominated in US dollars.”

For example, recently it emerged that BNP Paribas had put a portfolio of US$11bn of loans to oil and gas companies up for sale as it seeks to offload dollar assets and shrink its balance sheet. Some of the loans related to project finance, and the sector is falling in the cross-hairs of deleveraging because its loans are long term, illiquid and subject to considerable execution risk which makes statistics misleading. In 2011 the volume of syndicated loans provided for project finance in LatAm hit US$13bn, more than a threefold increase on the previous year and the best year for issuance since 2008.

John Greenwood, a director in the project & infrastructure finance group at Citigroup in New York said: “While on paper 2011 seemed like a good year for project finance loans, volumes were related to commitments that pre-dated last year.” In other words, the funding challenge for project finance in Latin America, has not yet hit home. Malik said: “The next five years will be all about finding innovative solutions to solve for project sponsor objectives within a new market reality. Local investors will also be key to unlocking more infrastructure funding going forward.”

Identifying investors

Banks that are not pulling back from the market hope that the next generation of financing solutions will provide the projects with the financing they need. That means identifying international investors willing to invest in the region’s projects through the capital markets.

“With some banks being more frugal with their balance sheets in project and export financing, sponsors will need to find a more plentiful supply of capital. In the long-term investment-grade bonds would be the best solution,” said Duncan Caird, head of project and export finance for the Americas at HSBC.

“The next five years will be all about finding innovative solutions to solve for project sponsor objectives within a new market reality. Local investors will also be key to unlocking more infrastructure funding”

“We are seeing more refinancings with a bond, and also bridge-to-bond financing structures, or term loans to investors that include a consideration of a project bond. Importantly, increasingly sponsors like the idea of bonds because they provide a means of recycling capital, thereby allowing banks with their lending limits, to lend into new projects. The bonds thus provide new sources of capital, oft post-construction, with the benefits of duration and competitive fixed rates matching project cashflows.”

Brazil: worth its salt?

The Rio Carnival is a staple in the tourist guides to show Brazil’s party-loving face to the world, but even the “host with the most” might be wishing it could take a break. According to analysis by HSBC, the main infrastructure sectors in Brazil are expected to invest around US$200bn between now and 2014, when the country hosts the Football World Cup. Two years later, it will host the Olympics and bankers say there will be a massive investment in “social infrastructure”.

In addition, the government also has two highly ambitious growth acceleration programmes, covering not just roads but ports and airports, sanitation and energy.

Brazil is the region’s most active market for project finance and probably the most ambitious. The biggest source financing for project sponsors is Brazil’s development bank BNDES, which currently accounts for 68% of the country’s long-term lending market. The rest has come historically from syndicated loans provided by European banks.

Local bankers say BNDES does not have sufficient firepower to meet the country’s infrastructure investment needs, while the government is keen to reduce its role – between 2009 and 2010 the Brazilian Treasury pumped US$100bn into BNDES, inflating the country’s national debt along the way. BNDES has reduced its share of the project loans market from 80%, but many believe that however much the government may wish to water down its involvement, BNDES will remain a dominant funding source for years to come.

The US$200bn investment programme does not include a further US$225bn of investment planned by Petrobras, the country’s government-backed energy giant which is aiming to triple oil output to 6.4m barrels of oil a day by 2020. Petrobras aims to meet this ambitious target through its ownership of Brazil’s potentially lucrative pre-salt oil fields, so-called because they lie under a layer of subsalt in an area the size of New York state off the coast of Rio de Janeiro.

Against this backdrop, the government is turning to private investors to fill any potential funding gap. In October the Brazilian government announced a regulation that will allow tax breaks on investments in project finance bonds, making a key move to shift more of the infrastructure project financing in the country to the capital markets.

The federal government has issued a decree that sets guidelines for the issuance of local bonds to fund infrastructure projects considered a priority for Brazil. The regulation complements a law enacted last year that indicates that project bonds in key sectors will be tax-free for foreign investors and local retail investors. Brazilian institutional investors will pay only a 15% tax on such bonds, as opposed to the 34% applied to gains from fixed income investments.

According to The Brazilian Association of Pension Funds, Brazilian pension funds had R$572bn under management as of September 2011, 17% of which was invested in government debt. Project finance bonds would provide inflation-linked long-term returns for pension funds.

Mexico elections

Bankers say the upcoming elections in Mexico have put certain infrastructure projects on hold, but they are positive about new financing routes as Mexico invests in more social infrastructure. In September Mexican construction company ICA closed a Ps9.7bn (US$709m) financing for the Sarre and Papagos public-to-private prison. The first entirely commercially financed greenfield social infrastructure concession in Mexico, the deal comprised a Ps7.1bn non-recourse certificados bursatiles bond issue and Ps2.6bn in equity.

Greenwood said: “New structures are emerging like public private partnerships in Mexico, but there is a process of investor education that is ongoing.”

Citigroup last year acted as joint bookrunner on a Ps3.5bn local project bond for three toll roads operated by Concesionaria de Autopistas del Sureste in the state of Chiapas in southern Mexico.

Panama – power and roads

In January HSBC worked on the refinancing by the government of Panama, through Empresa Nacional de Autopistas of its acquisition of toll road Corredor Sur from ICA but the country’s big infrastructure focus is on the energy sector. Generadora Pedregalito, one of the biggest hydroelectric projects developed by Panamanian investors, closed a US$60m bond. Like Panama, Colombia and Peru are also developing more hydroelectric schemes.

Educating the market

Bankers say there is a lack of urgency in bringing through new financing structures. Mario Espinosa, co-head of LatAm debt markets at Citigroup, said: “We’re not seeing a liquidity gap, yet we are at an inflexion point. We are seeing club financings rather than syndicates and banks are coming under relationship pressure.”

Some recent projects have been financed with an exit to the capital markets but they are so far not the norm, but banks like Citigroup and HSBC are preaching the new capital market orthodoxy – and have strategies to back it – albeit only since the financial crisis. Malik said: “In the aftermath of the crisis, Citigroup adopted a new strategy in project finance to reflect what we expect will be a shift from a model where banks hold inefficient assets, to one where distribution is the norm.”

The first benchmark project bond in the region was in November 2010, when HSBC acted as joint bookrunner on the US$1.5bn issue by Odebrecht, which took out a 2009 loan. According to the terms of the issue, the bonds were backed by two nearly completed drill ships, a 10-year charter agreement with Petrobras, the security package from the existing bank deal and the expertise of Odebrecht oil and gas as the operator. The deal achieved a Baa3 rating by Moody’s and a BBB by Fitch.

The biggest deal last year was a US$700m seven-year project bond for Queiroz Galvao, a Brazilian offshore oil rig maker, with the proceeds being used to refinance and releverage two semi-submersible rigs. The 5.25% bond was sold to yield 5.45% with Santander, HSBC and Citibank as lead bookrunners on the deal.

Many of the big financings come from a patchwork of sources – local and international banks, as well as development agencies. In November HSBC, WestLB, Caixa Geral and Santander joined the Inter-American Development Bank in closing a US$430m syndicated loan to finance the construction, operation and maintenance of a new private mixed-use container and liquids terminal in Brazil’s Santos Port, the largest port complex in the region.

The transaction involved a 15-year US$100m IDB A loan and a 12-year IDB B loan of US$330m to Empresa Brasileira de Terminais Portuários S.A. (Embraport) from WestLB, Caixa Geral de Depositos, HSBC and Banco Santander. In parallel, Caixa Economica Federal of Brazil also approved separate financing for the project totalling R$633m, funded by BNDES, which alongside the IDB financing, will make up the US$786m global senior debt package.

Caird added: “The Embraport deal involved Reais and dollar facilities with commercial banks and multilaterals to assist the financing, as well as financial advisory on the part of HSBC. This deal demonstrates the importance of a full-service offering in the region.”

The presence of BNDES – although welcome – could prove a hindrance to the development of innovative financing solutions in project finance. BNDES typically provides lending at 7% or 8%, while commercial rates are more in the order of 12% or 13%, according to local bankers. Espinosa added: “As long as BNDES provides long-dated loans at attractive rates it will be difficult to replace it as the main source of infrastructure finance.”

European exits

It is not just investors that fear being locked into long illiquid investments. BNP Paribas is among a host of other European banks looking to reduce their exposure to project finance loans. Malik said: “Some European banks are looking to sell pieces of their long-dated loan portfolios but the problem they face is that the original loan spreads were highly mispriced, so it is difficult for buyers and sellers to agree on a price.”

While banks may struggle to end their affair with project finance, the future for LatAm infrastructure may not be as gloomy as some predict. As bankers report evidence of increased appetite for Japanese banks to lend – although supply is so far muted – some Chinese state-backed investment vehicles are also looking to buy into the region’s resources boom.

Caird added: “Some may argue that the current European pressures may create a funding gap, but we believe multilaterals such as IDB, CABEI, BNDES, and governments will step in with various forms of support. It is also likely that BNDES may become even more flexible in select situations to mobilise capital given the huge needs in Brazil. Ultimately, good projects will find funding, provided sponsors can identify the best structure with either banks, MLAs or bond investors.”

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Opening doors to funding
A Mexican fan poses
Drum Queen Sheron Menezes of Portela samba school participates in the annual Carnival parade in Rio