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AmericasJune 1 2017

How will Latin America's infrastructure needs be financed?

As recession and scandals continue to blight the region's economy, can Latin America’s infrastructure needs dovetail with those of international banks and investors? Silvia Pavoni reports.
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Mexico City airport

Infrastructure finance has changed over the past decade. Traditionally, banks’ balance sheets bore the risks of those long-term loans; now, feeling the squeeze of heavier capital constraints, lenders prefer to keep their project financing at shorter tenors and structure bonds instead. Attracting new sources of funds in the shape of specialists or institutional investors is vital both for banks wanting to remain active in the infrastructure space and for governments needing to get public works off the ground.

This is important for Latin America, where infrastructure needs are pressing and largely unmet. The region’s infrastructure gap would require $180bn a year to fill, according to industry estimates, while government budgets have been drained by the economic troubles of the past two years, from Brazil’s deep recession to Colombia’s slowing growth.

The region’s special relationship with China has yet to bear any fruit when it comes to infrastructure: the ambitious Beijing-backed $10bn rail link between Brazil and Peru has not progressed, and the $20bn Brazil-China Co-operation Fund for Increasing Productive Capacity, aimed at building infrastructure in Brazil, has so far produced only headlines.

All of this has meant that working with the private sector – both local and international – is more important than ever. In a recent report entitled ‘Rethinking infrastructure in Latin America and the Caribbean – spending better to achieve more’, the World Bank states that “public and concessional resources should only be deployed where commercial financing is not viable or cost-effective”.

Beyond financing

So is Latin American infrastructure viable for banks and investors? While banks consider long-dated infrastructure finance to no longer be a prospect, they see opportunity in leveraging their debt structuring and distribution skills in this field. When providing balance sheet financing, they now tend to keep tenors between five and 10 years, to see the project through its construction phase and, post-construction – when project risk becomes more palatable for the bond market – to direct infrastructure financing to long-term investors.

“It’s important that we regard infrastructure not just as something to finance,” says Daniel Zelikow, JPMorgan vice-chair of public sector and co-head of infrastructure finance and advisory. “We do a lot of structuring. We find the right home among our large investor base for the type of risk that’s relevant to them.” Mr Zelikow says that the team was set up to bring structuring and financing under one roof, as a direct response to banks pulling back from long-term lending and institutional investors’ growing interest in infrastructure-related assets.

Baruc Saez, managing director of international fixed income and project finance at Brazilian bank Itaú BBA, is equally confident about the regional bank’s position in the market. “We know the concessions, the sponsors, the local market. It’s not about just supplying capital, but also to bring in those investors from North America, Europe, Asia and partner up with them,” he says. “We can bring some of our capital too, but we won’t go 15 or 20 years on many projects. That would have to be a very strategic decision.”

For many institutions, infrastructure is still an interesting space. Looking at the overall pool of Latin American deals, the shift from loans to bonds becomes apparent, but so too does a reduction in volumes and a reshuffle of names.

Numbers up, value down

According to data provider Dealogic, infrastructure bonds as a proportion of total Latam infrastructure financing has grown from being less than one-quarter in 2015, to more than one-third in 2016. Total values, however, have been steadily decreasing, from $13.4bn in 2013 to $10.7bn in 2016.

As for banks more active in this space, international names such as Citi, JPMorgan and HSBC have moved their focus from loans to bonds, leaving traditional project financing to Latin American players, a handful of European lenders and a more dominant group of Asian banks. Santander’s lead in Dealogic’s 2016 ranking of infrastructure finance mandated lead arrangers is challenged by Japan’s Sumitomo Mitsui Financial Group, in second place, which secured $554m to the Latin American specialist’s $681m. Korea Development Bank and another Japanese name, Mizuho Financial Group, also rank among the top 10. Although absent from that list, Citi, JPMorgan and HSBC reappear in the bond bookrunners table, headed by Citi with $975m.

“The project finance market has pretty much flatlined,” says Jay Collins, vice-chairman for corporate and investment banking at Citi. “We need to do more to get more in the bond market [and] off banks’ balance sheets. We need to do more to mitigate risk.”

An example of where those risk mitigation efforts have paid off is Mexico City’s $2bn airport bond, a dual-tranche deal consisting of 10-year and 30-year notes sold by Citi’s local operation Banamex, as well as HSBC and JPMorgan, among others. The deal structure was so convincing that investors bought into the project at a very early stage of development and took on construction risk: repayments relied on the securitisation of existing and future passenger charges collected at the existing airport and the new airport, once operational.

Other bonds, in both local and international markets, are beginning to appear. While Latin America’s economic slowdown, combined with banks retreating from long-term project finance, explains much of the decline in financing volumes, there is an alternative explanation. Carlos Muñiz, global head of structured finance at Santander, says that, beyond the publicly available figures, there is an undetected infrastructure loan and bond market that shows investors’ interest in the field. Privately arranged deals, he says, are large and not visible in data providers’ charts.

“We’ve been doing transactions in Chile, in Mexico, in which we grant access to institutional investors through either public placements or through private placements, so what you see in the league tables is only the tip of the iceberg. It is only the public bonds that have been placed in the market,” says Mr Muñiz. “But there is a much bigger number of deals in which institutional investors such as Prudential, Allianz [and others, privately] have entered into projects either in loan or bond format. That’s a trend that is here to stay.” These investors can offer the long-term tranche of a loan, with the bank providing the shorter tenor.

Colombia’s method

This is encouraging, but much remains to be done to attract larger pools of international investors to Latin America’s concessions. Essential to the development of infrastructure bond markets is managing foreign exchange risk. While seasoned institutional investors such as Chile’s, for example, are good buyers of local currency debt, large infrastructure programmes inevitably need to appeal to a wider international set of buyers. But the regulatory environment of some countries can be seen as a deterrent rather than a magnet for those investors. With revenues such as toll road receipts that are only denominated in local currency, international investors as well as lenders are exposed to currency risk. And with the wild fluctuations of recent years, this risk can be very expensive to hedge.

To solve the issue, governments such as Colombia’s have been granting partial dollar repayments on public concessions, but lower exports have affected foreign reserves, and therefore countries’ ability to sustain these initiatives. While such dollar payments were always intended to be reduced over time, once the international community felt more comfortable working in the country, the recent economic slowdown may make the reductions more urgent. Colombia has long been held as an example of how to go about attracting international funds because of such provisions, but the reduction in the dollar component of concession repayments is causing concern.

“If you’re a government and want your public-private partnership [PPP] programme to be successful, the best thing you can do is grant concessions in hard currency. The number of financiers and investors who can bid for your assets increases massively,” says Mr Muñiz. “That’s one of the challenges Colombia will face in the future as it is reducing payments in hard currency and shifting to local currency.”

The appearance of international infrastructure bond deals in the country, however, such as Conexión Pacífico 3’s $260m highway issuance, is encouraging. The bond is the first overseas issuance for a Colombian toll road and the project is the first financed under the country’s ambitious fourth wave of PPP projects.

Latam infrastructure

Cloud of corruption

Currency volatility is a bigger problem still in Brazil, which, after the ongoing corruption scandals centred around state-owned oil giant Petrobras and real estate conglomerate Odebrecht, is now facing fresh political turmoil, with president Michel Temer allegedly caught on tape endorsing bribe payments. As the news emerged in May, reported by newspaper O Globo, the Brazilian real dropped to its lowest value since 1999. This aggravates the suffocating effect of existing corruption scandals on investments. Talking to The Banker before the latest scandal broke, Citi’s Mr Collins said: “The elephant in the room in the infrastructure space is the Odebrecht fallout. It represents an enormous challenge. Infrastructure is about growth and if this corruption cloud continues it will slow the spend in infrastructure and slow the confidence of the legal, accounting and banking community to get more done.”

Furthermore, Latin America’s largest economy presents some financing peculiarities. Brazil has traditionally relied on local funds and institutions to finance transport and energy projects. This was made possible thanks to large interventions by the Brazilian Development Bank (BNDES). It was necessary because energy tariffs are set in local currency – unlike the Andean countries, which link theirs to the dollar – limiting Brazil’s ability to finance projects in a foreign currency.

On the other hand, the country’s local currency infrastructure bonds, debentures, have proved successful and can count on tax exemptions. Brazil has also been a local game for construction firms, notes Mr Muñiz. “In Brazil, for foreign firms, it was nearly impossible to enter the infrastructure market because local firms have the relationships, the on-the-ground knowledge, the experience in managing the contracts granted,” he says.

These peculiarities and the ongoing scandals might yet have a positive outcome for Brazil. Insiders believe that because of the scandals, local firms may become affordable targets. And BNDES’s realisation that it must promote private sector participation to create a more sustainable finance market, coupled with expectations on lower interest rates in the country, may begin to open up Brazil’s infrastructure to a wider pool of international investors.

In a recent interview with The Banker, BNDES president Maria Silvia Bastos said: “We talk to [international players] all the time. Brazil has lots of investment opportunities. There’s lots of interest and our view is that financing is available for good projects. The question is how to deliver good projects.” Ms Bastos noted how past rates of return were not adequate to project risk and predict the complexities of the country’s legal framework, which the bank is trying to improve by providing advice to the federal government and technical assistance to local administrations.

New sources

Expectations of reduced BNDES funding and further guarantees provided by the bank to reduce currency risk would help attract larger private sector attention to infrastructure financing in Brazil.

International players hope BNDES will be able to provide hedges or take some of the foreign exchange loss, according to Arthur Rubin, head of Latin America debt capital markets at SMBC Nikko Securities America, part of Sumitomo. Foreign currency risk remains a deal-breaker because of the high volatility of the Brazilian real; this has no immediate solutions.

“With the reduction in the amount of financing provided by BNDES, one way or another Brazil will need to find new sources of financing,” says Mr Rubin. He adds that there have been suggestions that Brazil may want to consider following Chile and Peru by linking tariffs to the dollar to facilitate raising long-term debt in dollars. However, there is a widespread view that such a move would be politically challenging. An alternative could be the re-opening of an offshore real-linked bond market to bring in more international investors in local currency.  “We've seen such international real-linked bonds in the past, but not in the past few years, given the volatility of the [Brazilian currency],” says Mr Rubin. “I think the re-emergence of a real-linked market offshore may be more likely to happen in the near to medium term than a dollarisation of tariffs.”

International and regional banks’ views on how to play the infrastructure market have changed, while Latin America’s ability to retain their interest remains patchy. It would be a shame for all – lenders and investors searching for returns on one side, and governments needing to improve connections on the other – if the region’s vast and urgent infrastructure needs remained unmet.

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Silvia Pavoni is editor in chief of The Banker. Silvia also serves as an advisory board member for the Women of the Future Programme and for the European Risk Management Council, and is part of the London council of non-profit WILL, Women in Leadership in Latin America. In 2019, she was awarded an honorary fellowship by City University of London.
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