Amid the banking sector’s persistently gloomy headlines, it is easy to forget that business is still being done. The project finance sector, for example, even managed to chalk up one or two records in 2008. According to data provider Dealogic’s Global Project Finance Review 2008, total volume for the year rose by 13% to $315bn. Western Europe was up by 20% on 2007, reaching $80.4bn, and Asia volumes grew by a staggering 77%, to $65.6bn, the highest annual Asian total on record. Helped by the $20bn Sakhalin II Second Phase project – the largest project ever recorded – eastern European volumes rocketed by 256% to $27.7bn.
Volume drops
The sector is in no way immune to what is happening in the global economy or financial markets, however. Volume tailed off towards the end of the year, with the fourth quarter reaching $54.8bn, representing just 17% of the annual total and a drop of 22% compared with Q4 2007. Volumes in individual regions also varied considerably, with three of them down significantly when compared to 2007.
US volumes, which dropped by 15%, dragged down the Americas – although the US remained the leading nation globally. In the Middle East and Africa, despite a 72% increase in Saudi Arabia and the $10bn Saudi Kayan Petrochemical Complex deal – the second largest deal of 2008 – volumes fell by 32%, reaching $54.7bn over 53 deals.
The widespread dislocations in the financial markets led to a similarly mixed picture in terms of financing. While equity financing increased by 45% to $74.4bn and loan borrowing reached record levels in 2008, rising by 11% to its highest-ever total of $234.9bn, bond financing plummeted by 62% to just $5.7bn, the lowest annual issuance since 1995.
The volume of refinancing also fell by 30% to $40.4bn, from $57.8bn in 2007. Of that, the energy sector accounted for 46% of total refinancings via 49 projects worth $18.6bn.
Pre-crisis rollover
Royal Bank of Scotland topped the mandated lead arranger rankings for 2008 with $8.1bn from 73 deals. But, according to Mike Nawas, global head of corporate and structured debt capital markets at RBS, last year’s figures, although they look hopeful, are a little misleading. The lion’s share of project financing comes from lending, and much of that was agreed pre-crisis, he says.
“Last year, the true syndicated loan market was effectively shut and replaced by large club transactions, and there is a high probability that this will continue into 2009,” says Mr Nawas. “Overall, the project finance market saw modest growth. However, that growth actually reflected deals that were mandated or in progress before the worst of the crunch. The syndicated loan market is likely to be much smaller in 2009.”
Despite the fact that the leveraged loan market has evaporated and that collateralised loan obligations have either pulled out or resized their demand, activity in the investment-grade bond market shows that there is some investor appetite out there. Mr Nawas agrees, although he says it is largely for projects that are under way. Greater performance benchmarking is needed before the bond market can hope to develop further, he adds.
“Within the bond market, there is appetite for those assets that are operational, but it remains a challenge for projects that are still in construction,” says Mr Nawas. “There is comfort among bond investors with respect to the risk profile of project finance and appetite for these assets has increased relative to riskier asset classes.
“In order for the bond market to develop further in project finance, there is a need for precedents, education and evidence of successes. It is also key that there is a move among project financiers to more standardisation, which would support external ratings and provide a benchmark for investors,” he says.
Polarised markets
According to Reiner Boehning, co-head of the project finance group at Credit Suisse, the market is polarising, with deals at the high and low ends getting done, but many projects in the middle struggling to find funding. “At the high end – where you find government guaranteed and investment-grade projects – it is possible to put together bank or other funding,” says Mr Boehning. “At the other end, distressed deals, restructurings and forced refinancings of between $150m and $250m are being priced to the hedge fund universe, with yields around the mid-teens or higher, and they may get done. Everything in the middle is a bit hit and miss. Where they do get done, it is in the form of club deals and not syndications. Needless to say, pricing across the credit spectrum has moved up substantially.”
With capital more constrained and more expensive, and competition for funding high, project financing has lost some of its allure. Where it used to win over less profitable corporate lending, the repricing of corporate risk – along with the greater potential for ancillary business which corporate business possesses – has led many banks to pull back, or even pull out, from project finance.
Government guarantee
Many remaining project finance bankers are pinning their hopes on the pledges by governments around the world to establish a ‘New Deal’ in a bid to stave off recession. During the Great Depression of the last century, US president Franklin D Roosevelt’s New Deal pumped $3bn into US infrastructure projects to prime the economy and stimulate productivity. It created 122,000 public buildings, 77,000 bridges, 664,000 miles of road, 285 airports and 8.5 million jobs. The project finance industry is hoping that the 21st-century version will have a similarly invigorating effect.
Last year, infrastructure was already project finance’s second most active sector in both volume and deal count, with $80.7bn over 239 transactions. Going forward, the Organisation for Economic Co-operation and Development estimates that as much as $71,000bn – 3.5% of global gross domestic product – could be required for investment in roads, telecommunications, electricity and water infrastructure by 2030.
Like Mr Roosevelt, new US president Barack Obama has put forward a gargantuan stimulus plan. While much of it is in the form of tax cuts and short-term spending, a good chunk of the package is targeted at longer-term investments in infrastructure, such as $50bn to promote energy efficiency and alternative energy, and $30bn for roads and bridges.
Similarly, Brazil’s public investments in infrastructure grew by more than half in 2008, to R$11.3bn ($4.92bn). Most of it was spent in the second half of the year, and it is seen as representative of an explicit government policy to counter the effects of the global economic slowdown through public investment in infrastructure. In January, the Brazilian development bank, BNDES, the country’s largest state source of project finance, indicated that it might have R$110bn available to invest in infrastructure and industrial projects this year.
Some bankers say that this trend is already obvious in their deal pipeline. “A significant proportion of the projects we have in the pipeline are government-guaranteed,” says one European project finance banker based in the US. Other bankers warn that government backing for infrastructure investment notwithstanding, project finance is facing some very difficult challenges.
Steven Greenwald, a senior member of Credit Suisse’s project finance group, fears a growth in financial protectionism. With banks lending much more cautiously, which governments would want to see their big domestic banks lending hundreds of millions of dollars – often of taxpayers’ money – in the international project finance market?
Mr Greenwald says that governments might exert greater pressure to lend domestically. “This may mean that in the commercial banking sector there will be less appetite for doing big deals in the international market,” he adds.
Hope for a Green Deal?
There have been particularly high hopes for a ‘green’ New Deal, with policymakers from London to Beijing promising billions of dollars in clean technology investment to kick-start economies by creating millions of new low-carbon jobs. According to Dealogic, energy was the leading sector last year, and accounted for 35% of global project finance volumes, with $111.8bn. Of that, renewable fuel accounted for 63% and wind farms for 26%.
However, falling oil prices and shrinking credit markets have slowed the development of green infrastructure and impacted directly upon areas such as wind power, a capital-intensive sector where project financing plays a crucial role. With financing costs rising dramatically as banks cut back on lending, many (often highly leveraged) energy producers have been forced out of the market. A recent Credit Suisse report suggested that smaller developers below the publicly traded radar screen will be worse affected since they are wholly reliant on the project finance market.
There are already signs of trouble. Many of the forced refinancings and distressed restructurings have been in the wind sector. And, towards the end of last year, for example, US entrepreneur T Boone Pickens admitted that he would be scaling back a planned 4000 megawatt wind farm in Texas due to the high cost of capital.
Reasons to be cheerful
There is still some optimism. While only $20bn of energy’s total volumes came in the fourth quarter (a drop of 24% on Q4 2007), RBS’s Mr Nawas is convinced that the power sector will benefit from the current slowdown at the expense of commodity-based sectors such as oil and gas, and mining and metals, which will see reduced project finance volumes as commodity prices fall. “We expect to see growth in the power sector, especially in alternative energy sources/renewables, as governments continue to demonstrate their commitment to reducing emissions,” he says.
Moreover, some interesting deals are being done, albeit at the smaller end of the scale. At the end of last year, for example, Raser Technologies closed the last tranche of its combined $51m debt and tax equity financing for the Thermo geothermal project, its first project financing, led by Merrill Lynch. And the overall project finance pipeline, if lighter than banks would like, is not entirely empty.
Credit Suisse’s Mr Greenwald says the bank has several deals on the go, including a bank-financed infrastructure deal in the transport sector, an emerging market oil financing, two investment-grade bond deals, again in the oil sector, and a couple of deals for the US Department of Energy.
“The bond deals are both rated and ready to go, we’re just waiting for the market to be there,” he says. “My gut tells me that the [emerging market] oil deal will get done this quarter, and the infrastructure transaction has a decent chance of closing in this half.”
Clearly, it does not look as if the coming year will be easy for project sponsors or project financiers. Credit is tight, political pressure is increasing and the economic outlook is uncertain. Projects which would have been a certainty just a year ago now look too big and too expensive. But for some banks, the shrinking balance sheets of most financial institutions present a welcome opportunity.
Dealogic’s figures also reveal that in the Middle East, at least, Japanese banks – keen to find more profitable ways to invest deposits and client assets outside the stagnant home economy – increased their market share in both project finance and syndicated debt last year.Project finance volume by region, 2002-08Global sector share, 2008
