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AfricaMay 2 2016

Who will fund east Africa's infrastructure shortfall?

Although infrastructure across the continent is crying out for investment, the pro-business environment in east Africa makes the region particularly attractive for lenders. However, the challenge for both local and international banks is finding well-structured and bankable deals, as James King discovers.
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Who will fund east Africa's infrastructure shortfall?

East Africa’s project finance and infrastructure market is booming. As governments across the region invest in their power generation capacity, transport networks and vital industries, sizeable opportunities are opening up for local, regional and international lenders looking to capitalise on these developments. Though similar dynamics are unfolding across the continent at large, particularly in west Africa and the Southern African Development Community countries, the states of the East African Community (EAC) – Kenya, Tanzania, Rwanda, Burundi, Uganda and South Sudan – offer unique potential in the current economic climate.

Not only have they been, in relative terms, less affected by the economic volatility that has hit other areas of the continent, but key jurisdictions have been highly effective at developing pro-business investment frameworks for infrastructure development, particularly around power generation. Taken together, this makes the EAC one of the more attractive investment opportunities on the continent today.  

Infrastructure need

“The east Africa region has enjoyed pretty robust growth over the past four to five years and if the current commodity price cycle continues it will benefit further. Over the short term we definitely take a bullish perspective on the region,” says Ngugi Kiuna, head of investment banking at Rand Merchant Bank, a division of South Africa’s FirstRand Limited.

Across sub-Saharan Africa as a whole, it is estimated that just over $90bn of funding is needed each year for the next decade to address the infrastructure shortfall. Of this number, $60bn is needed for new infrastructure and about $30bn for the upkeep of existing infrastructure, according to research from Deloitte. These requirements span a broad range of needs, including transportation, power generation, industrial, information communication and technology (ICT) and logistical infrastructure.

In the EAC, which has a population of 264 million, the challenges associated with rapid urbanisation and industrial development, coupled with a historical lack of infrastructure spending, mean that the need for investment is particularly pressing. Encouragingly, the regional bloc is taking issues around infrastructure growth seriously. For one, the EAC has endorsed a 10-year investment strategy to promote priority regional infrastructure projects.

It is also holding regular briefing roundtables for investors and financiers to help mobilise the estimated $100bn that the EAC believes is required to support its priority infrastructure requirements over the next 10 years. In terms of development priorities, none are more urgent than the region’s deficiencies in energy production. According to research from PwC, east Africa has the lowest access to power of any sub-region on the continent, a problem that is adversely impacting households and businesses alike.

Power generation

To address this deficiency, governments across the region are now investing in their power generation capacity. Business Monitor International estimates that about $17bn-worth of power generation projects are under way or in the pipeline across the EAC. In addition, steps are being taken to incentivise private sector investment in this area with supportive regulatory and investment frameworks now in place to encourage the growth of independent power producers (IPPs).

“Though there is a strong mix of infrastructure development projects taking place across east Africa today, it is fundamentally a power generation story. And what is clear is that renewable projects are now leading the way in the region. There are some excellent investments in wind, solar and thermal energy,” says David White, chairman of the Emerging Africa Infrastructure Fund.

Kenya alone is expected to add an additional 5000 megawatts (MW) of generation capacity over the next 10 years. Meanwhile, Uganda is expected to double its power generation potential over the next three years, from a total of about 850MW at present to 1500MW. Broadly, these requirements and investments are mirrored in the region’s other markets, though the extent to which these jurisdictions have developed supportive investment frameworks varies.

“Kenya, Uganda and Rwanda offer great models for investment in power generation. These governments have worked hard to find ways to support this sector and encourage the input of independent producers,” says Mr White.

Bankable deals 

For local, regional and international financial institutions alike, the scale of this investment is offering attractive opportunities. But the challenge for many banks is finding well-structured and bankable deals.

“Across Africa today, at first glance it looks as though there is a significant opportunity for project finance given the scale of the continent’s infrastructure requirements. But the list of opportunities reduces when you consider how many of these potential deals are actually bankable,” says Daniel Zinman, of Rand Merchant Bank’s infrastructure finance team.

The difficulty in securing bankable deals arises for a number of reasons. First, there is a question of project scale. With IPPs in the renewable space, it is not uncommon to see producers pitch smaller sized power production facilities that are too small for commercial lenders to secure an appropriate return from. “A 10MW IPP project, for example, is too small for a commercial lender because the returns are so low,” says Mr White.

Other challenges involve working with first-time management groups and navigating a complex government bureaucracy. “The project finance market in east Africa offers a diverse set of challenges and opportunities. As a bank, it pays to invest more time looking into a deal and ensuring that the management team has the experience and there is the right kind of financial and technical support in position,” says Helmut Engelbrecht, head of investment banking for South Africa’s Standard Bank.

These problems point to a further difficulty facing commercial banks. Though gauging a project’s viability during its early stages can be advantageous, significant effort can be expended on a deal that may ultimately be unbankable. But unless lenders get a foot in the door early, the scale of their role and the opportunity will diminish.

“Typically when an African infrastructure deal is at the point of being bankable it is too late for a commercial bank to get involved, as arrangers and lead bankers have already been selected. You have to identify the opportunity and potential very early on if you want to play a lead role,” says Mr Zinman.

Competitive tension 

On top of these issues, the presence of development finance institutions (DFIs) can be a complicating factor. While the relationship between commercial banks and DFIs is essentially symbiotic, when it comes to project and infrastructure finance it is not without friction.

“In certain markets in Africa, there is certainly a degree of competitive tension between commercial banks and DFIs,” says Mark Schmaman of Rand Merchant Bank’s infrastructure finance team.

While development funds can kick off a project or a particular technology by assuming initial risk, a DFI’s ability to offer longer term tenors and lower rates than a commercial counterpart means that its funding packages can potentially be more attractive on paper.

“When you consider that DFIs can offer longer tenors and don’t need political risk insurance, commercial banks need to find other ways of adding value. We like to think we are flexible, innovative and responsive,” says Mr Schmaman.

Moreover, as development institutions are typically embedded in a country for long durations and benefit from strong ties to the sovereign, they do not face the same types of risks associated with commercial banks.

“Commercial banks typically approach a multilateral organisation such as the Multilateral Investment Guarantee Agency (MIGA), or a similar highly rated entity, and structure an insurance product to help transfer the country risk. But that comes at a cost. So whatever margin a bank is lending to a transaction, on top of that it has to overlay the cost of this protection,” says Mr Schmaman.

Given this set of challenges, and others, when a well-structured and bankable project finance deal does emerge it can often be inundated by commercial banks. In one of the continent’s most significant power generation deals closed in 2015, the Azuro Edo IPP project in Nigeria, a total of 15 banks participated, indicating the demand for a well-structured deal of this nature.

Current projects   

As Africa’s power generation sector matures and investment frameworks become more effective, this problem is likely to diminish. Similarly, by stimulating the input of IPPs and de-risking power generation as an investment opportunity, there is a greater chance that larger independent projects will emerge. For east Africa in particular, a number of sizeable projects are currently under development.

The Lake Turkana Wind Power Project (LTWP) is a good example. Consisting of a 310MW independent power plant and a 428-kilometre transmission line to connect the plant to the national grid, it will be the single largest wind farm on the continent when completed. At €623m in value, it also represents the single largest private investment in Kenya to date, according to the African Development Bank. Ancillary infrastructure requirements, including an electric grid collection system and upgrades to more than 200 kilometres of surrounding roads also form part of the project.

The African Development bank acted as mandated lead arranger for the project’s €436m of senior loan facilities and the €37.5m of subordinated loan facilities. Two South African lenders, Standard Bank and Nedbank, acted as co-arrangers for this debt-raising component. Meanwhile, the equity part of the deal included the participation of the project developers KP&P Africa, Aldwych International and a number of Nordic development finance institutions.

“The Lake Turkana project took a long time to reach financial close but it is a well-structured and ground-breaking transaction,” says Mr Engelbrecht.

Opportunities in oil 

While power generation dominates east Africa’s project and infrastructure finance landscape, the region is not without other opportunities. In particular, Kenya’s nascent oil and gas sector is experiencing rapid development even as oil prices remain depressed. This is likely to boost core infrastructure requirements around the extraction process but also support infrastructure including mid-stream facilities and associated structures around transportation and logistics.

“The break-even oil price in Kenya is about $25 a barrel and the government is now pushing ahead with plans to develop the country’s oil potential. There are a lot of opportunities emerging from this,” says Mr Kiuna at Rand Merchant Bank.

The construction of Kenya Pipeline Company’s (KPC) Mombasa-Nairobi oil pipeline, which commenced in August 2015, will provide a new 20-inch multi-product pipeline to replace an existing 37-year-old facility between the two cities.

With a project cost of about $500m, the pipeline is expected to increase the flow of petroleum products to above 1 million litres per hour from 730,000 litres per hour. This deal involved a mix of local, regional and international banks providing 70% – or about $350m – of the total lending requirements.

“Rand Merchant Bank was one of the leads in the consortium that financed KPC’s new multi-product pipeline between Mombasa and Nairobi,” says Mr Kiuna.

Home advantage 

There is little doubt that this infrastructure boom will present banks with an abundance of longer term opportunities, even if the number of well-structured deals remains limited. But for lenders with a regional presence, these developments offer even greater potential. For one, regional African banks are rooted in the continent and boast strategies that are exclusively focused on Africa’s longer term development.

As such, they have an excellent grasp of the market with a sizeable balance sheet to match. Though specific challenges do remain for regional banks, particularly around currency risks, a number of lenders from South Africa and Mauritius are already capitalising on these advantages. Mauritius Commercial Bank opened a representative office in Kenya in 2014, while the State Bank of Mauritius is currently completing a deal to acquire a local Kenyan lender, according to reports from Bloomberg.

Similarly, South Africa’s largest lenders have all been active in the region in recent years. “Over the past five to 10 years, FirstRand Bank has been executing an expansion drive into the rest of Africa. Rand Merchant Bank, and specifically the infrastructure finance team within Rand Merchant Bank, has been at the forefront of this process,” says Mr Zinman.

These trends bode well for Africa’s continued economic and social development. The roll out of new infrastructure will ultimately improve the continent’s business landscape, leading to fresh opportunities for private sector development and employment generation. Though challenges around financing exist, the role that local, regional and international banks are playing will be crucial to unlocking this longer term economic potential.  

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