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Investment bankingOctober 4 2009

Infrastructure splurge will not be blown off course

The credit crunch may delay Turkey's extensive plans to upgrade power supplies and road networks, but it has certainly not derailed them. Writer Philip Alexander
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Infrastructure splurge will not be blown off course

The selling points for investment in Turkey have always been clear - a strategic location at the crossroads of Europe, the Middle East and Asia, plus the sizable domestic market provided by a population of more than 70 million. Its EU applicant status brings potential for flows of official funds to help economic convergence.

However, for investors to commit funds to the long-term business of project finance, the greater political and economic stability ushered in by single-party majority government since 2002 has brought a vital change.

"When I was involved in my first project finance deals in Turkey in 1996, there were always large amounts of political risk insurance involved. That is much less likely among the current generation of foreign commercial lenders; they take great comfort from co-lending with a multilateral, even if the multilateral is going in through an uncovered tranche," says James Douglass, partner and head of the Turkey desk at law firm Linklaters in London.

Mr Douglass worked on the €220m Osmaniye Rotor Elektrik project financing for Turkish conglomerate Zorlu, which closed in May 2009. This deal included €130m in financing from the European Bank for Reconstruction and Development (EBRD), European Investment Bank (EIB) and International Finance Corporation, with guarantees on the €30m EIB tranche provided by HSBC and local firm DenizBank.

While Turkish gross domestic product is forecast to decline by about 6% in 2009, this comes after five years when economic growth averaged about 6.5%. Such expansion has placed a serious strain on Turkish infrastructure, which was blighted by decades of underinvestment before the current government began to entrench greater fiscal stability.

Growing pains

As a result, the pipeline for project finance is substantial. The government is in the process of privatising electricity distribution, with buyers including the Czech Republic's CEZ and Austria's Verbund. "A lot of the current activity is refinancing the original short-term bridge finance on those bids, with a project finance take-out on a non-recourse basis," says Mr Douglass.

About 20,000 megawatts in electricity-generating assets are also being divested from October 2009, and there is a round of toll road concession tenders in 2010 to enable the upgrade of the existing network. To this must be added 420 kilometres of new motorways, the railway infrastructure for the Marmaray Bosphorus tunnel (on which mandates for financing are currently under preparation), plus the Izmit Bay bridge and a third Bosphorus bridge for Istanbul. Mr Douglass estimates the total needs for so-called "brownfield" developments - privatised or concessioned assets - could top $20bn over the next two to three years.

Turkish banks may be prominent in funding this activity, not least because the revenues of many projects will be in lira. It makes sense to obtain local currency financing. The capital and funding position of Turkish banks is strong, even for making five- to 10-year project loans, says Sergun Okur, head of corporate finance at Turkish investment bank Global Securities, which is 20% owned by Intesa Sanpaolo group.

"Syndicated loans to Turkish banks are typically only one or two years, but even during the worst of the crisis late last year and early this year, they have still been able to roll over these loans. This was sometimes at a higher cost, but rates are already coming down, so they are comfortable about sustaining their project lending," says Mr Okur.

He adds that local syndicates can put together project finance packages of up to $500m without needing to bring foreign banks on board. The top three - Akbank, Isbank and Garanti Bank - are especially active, together with mid-tier banks such as Denizbank, Bank Asya and Turkish Industrial Development Bank (TSKB).

But they have adopted a very conservative strategy over the past year. Blue-chip energy and construction companies with well-established cashflows have been able to obtain funding, but it has not been easy for smaller project sponsors, because banks have preferred the security of short-dated Treasury bonds.

"In the first half of 2009, we have seen a classic crowding-out effect, even though the government has expressed its dissatisfaction with the banks for not lending to the private sector," says Mr Okur.

He expects this to change going into 2010, as the central bank has steadily cut rates, bringing down the yields on Treasury bonds. This makes them a less appetising investment, and oversubscription rates at Treasury auctions have declined to between four and five times, from eight to 10 times at the start of the year.

Greenfield power

Just as they dominate the brownfield developments, electricity projects are also central to the greenfield pipeline, as new power generation is vital to avoid looming shortages. This generation will include conventional thermal plants plus wind turbines, hydropower and possibly solar farms as well.

For the larger projects, foreign banks will be involved, especially those that own stakes in local subsidiaries. These include UniCredit, which owns just over 40% of Turkey's Yapi Kredi, and BNP Paribas, which owns 42% of Turk Ekonomi Bankasi. Mr Douglass expects multilateral agencies, especially the EBRD and EIB, together with European export credit agencies (ECAs) will also remain active in some of the larger projects until global banks have completed their own deleveraging process.

Ilisu controversy

However, the withdrawal of cover by three ECAs - Germany's Euler-Hermes, Switzerland's Export Risk Insurance and Austria's Oesterreichische Kontrollbank (OKB) - from the Ilisu Dam project in July 2009 has cast a shadow over foreign sources of project finance. The three foreign banks financing the $1.1bn reservoir hydropower plant - DekaBank, UniCredit and Société Générale - were contractually obliged to pull out after the loss of export credit insurance.

This was the first time that a group of export credit agencies had sought to co-ordinate the implementation of World Bank and World Commission on Dams guidelines on a responsible dam development, by making a systematic and comprehensive review procedure. A series of reports were written and published by World Bank staff, academics, environmental scientists and independent engineering experts.

The three areas of concern were environmental protection, resettlement of the local population, and preservation of cultural heritage sites. Werner Schmied, head of project analysis at OKB in Vienna, says the Turkish project sponsors had made significant progress on these criteria since OKB first considered the project in 2000.

"There was good reason to assume development benefits for the region, so we had incentives to continue. But there were some aspects on resettlement and cultural heritage that had not been fulfilled, even though we had been urging for some time," says Mr Schmied. This resulted in a suspension of work in December 2008 when the first ECA commitment to the project fell due, followed by a further period of review and consultation with interested parties, including local non-governmental organisations (NGOs), ending in July.

Learning the lessons

Mr Schmied says that while most of the NGOs and public stakeholder groups consulted were opposed in principle to damming the Tigris, OKB remains willing to support exporters on sound hydropower projects where any potential problems such as resettlement are well mitigated. He adds that, given the unprecedented efforts to implement World Bank governance guidelines, this was a learning experience for all involved, and ECAs might in future seek to work with a higher authority in the buyer country to supervise more difficult projects.

"I am personally sorry how this process ended, because it could have been a symbol of renewable energy and regional development, as it included building new schools, job provision, extra irrigation, fish farming and so on," says Mr Schmied.

Alexander Schwab, spokesman for Austria's VA-Tech Hydro, which is acting as the Ilisu construction consortium co-ordinator, says in principle the communication of the review process was good.

"But for us as a consortium, the final decision was disappointing. The Turkish side had certain delays, but in the past few months made extremely hard efforts to reach all the targets. The staying in of the ECAs would have pushed forward the process of fulfilling the necessary steps, so stepping out was not really the right solution," says Mr Schwab.

Mr Schwab says his company will be keeping a closer handle on the governance aspects of large dam projects in future. However, the Turkish government has stated publicly that it will continue with Ilisu, and Mr Schwab says he understands that it has established financing for about 70% of the project cost already.

There is a consensus that Ilisu may well be a one-off, especially given the nature of the heritage site and the scale of resettlement needed. Mr Okur says most energy projects seeking financing are in the smaller 16 to 20 megawatt bracket, which could be domestically financed. And Mr Douglass says the multilaterals and ECAs are more usually involved in 'run-of-the-river' schemes that do not require large reservoir flooding.

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