Syndicated lending and financing projects
Syndicated lending is a vital tool in financing a wide variety of infrastructure projects such as road and rail or gas and electricity distribution networks. Globally, project finance syndicated lending volumes fell 12% to USD 193.2 billion for the first nine months of 2013 compared to the same period a year earlier. However, while detailed figures for CEE are not available, syndicated lending plays an important role in financing projects in the region.
By Ali Miraj, ING Syndicated Finance
Given the diversity of the economies of CEE countries, it is difficult to pinpoint broad regional trends as CEE countries tend to function independently of one another. Deals in each country differ because countries have different assets to finance and different regulatory environments. The dynamics of the local banking market also vary – some CEE markets, for example, are home to strong domestic banks that play a major role in project finance.
The scale of deals plays a large part in determining the involvement of international project finance banks and domestic players. The EUR 1.6 billion acquisition of Czech gas pipeline operator NET4GAS (formerly owned by Germany’s RWE) by Allianz and Borealis Infrastructure, which was completed in August, was sufficiently large to attract international banks whereas numerous recent smaller deals in Poland and Romania have been financed locally given their scale and the strong liquidity of local banks.
Changes in syndicated lending
In a typical acquisition transaction, companies or consortia bidding for an asset approach banks in advance to line up syndicated finance. In many instances, these bidders seek an underwritten commitment because it means they do not have to manage multiple banks and – more importantly – because it enhances the speed of execution, which may be crucial in order to meet a bid deadline.
Typically, underwritten risk might be held by a bank for up to six months during which time the debt is syndicated. While some banks sell down all of their underwriting risk, ING is relationship-driven and always retains a portion of the risk on its books, providing comfort to other investors and ensuring a supply of high-quality assets for the bank’s portfolio.
While underwriting remains popular for certain types of deals, one increasingly prevalent trend is the use of club-style deals using a large group of banks. The growth in the use of club-based lending is driven mainly by borrowers’ reluctance to pay underwriting fees. ING is willing to participate in club-style deals as the bank’s goal is always to act in the best interest of clients.
Around two years ago, there was a step back from project finance syndicated lending by some banks – especially at maturities over 20 years – because they had a need to de-risk their balance sheets in the wake of the financial crisis (and, to a lesser extent, to respond to Basel III). However, in 2013 many banks completed their de-risking while the cost of funds for banks also fell. As a result, many banks’ appetite for long-term lending is returning.
New lenders are emerging
The withdrawal of some banks from long-term syndicated lending in recent years prompted efforts to encourage non-bank financial institutions (FIs) to enter the market and fill the funding gap. A number of FIs, including pension and insurance funds, have begun to invest in project finance.
Different investors have adopted different approaches to project finance depending on their size and level of expertise. Some large institutional investors have set up teams of former monoline specialists and are therefore willing to take greater risk (including construction risk) in public private partnership (PPP) projects. Other investors have fewer specialist resources and their priority is to ensure that loans are robustly structured so that their risk is limited.
The requirements and expectations of investors vary widely. For some investors, prepayment protection – to eliminate the risk of early payment by the borrower or termination of the PPP – using ‘make whole’ provisions is critical. Other institutional investors may require an external credit rating (often investment mandates specify such a requirement) or for a loan to be structured with a fixed rate (rather than the floating rate commonly used in project finance).
In response to the needs of some investors for well-structured infrastructure assets, ING has developed a format called Pan European Bank to Bond Loan Equitisation (PEBBLE). PEBBLE works by providing a debt cushion – or first loss piece – during the riskiest phase of a project (construction and ramp up) where the commercial bank lenders respond to waiver and consent requests as controlling creditor and improve the credit quality of the more senior institutional investor tranche.
PEBBLE has been developed as an open format for broad market adoption, with documentation made public by the International Project Finance Association (IPFA) for market comment. By using standardised documentation (such as inter-creditor agreements), PEBBLE helps to overcome the administrative burden associated with project finance (in relation to cash management and waiver requests, for example) as well as potentially enhancing the rating of projects which are typically investment grade equivalent. The presence of experienced structuring banks putting together a PEBBLE financing and retaining a portion of the subordinated debt provides institutional investors with additional assurance.
PEBBLE has yet to be used in CEE but made its debut in the project financing of the Dutch Zaanstad prison in September 2013. Given the limited supply of similar projects in Northern and Western Europe and the scale of institutional investor appetite for such projects, it seems likely that PEBBLE and other credit enhancement tools may be used in CEE in the medium-term.
ING’s role in project finance syndicated lending
In CEE ING has a track record of more than 20 years as a project finance lender. It combines deal structuring experts in London with an on-the-ground presence across the region. This local knowledge gives ING an edge over its competitors and enables it to offer seamless execution that takes account of local nuances. ING also differentiates itself by the strength of its commitment to clients: the bank is prepared to follow sponsors wherever they operate.
Recently, ING coordinated the CZK 3.3 billion (EUR 130 million) refinancing of Aqualia Czech’s water utility SmVaK which was closed in March 2013. ING also took part in the European Bank for Reconstruction and Development B loan for a Romanian wind project.
In December 2012, ING acted as mandated lead arranger (MLA) for acquisition financing for Macquarie to purchase a 35% stake in RWE Grid Holding A.S - a regional gas distribution network in the Czech Republic. ING also acted as bookrunner and MLA for Czech energy company EPH’s EUR 2.6 billion acquisition of a 49% stake in Slovak gas utility SPP from Germany’s E.ON Ruhrgas and France’s GDF Suez in January 2013. Further, ING is acting as co-financial advisor for the offshore section of the South Stream pipeline to transport Russian natural gas through the Black Sea to Bulgaria in a project involving sponsors Gazprom, Eni, Wintershall and EDF. All in all, the PEBBLE credit enhancement product demonstrates ING’s history of innovative thinking in project finance.
Challenges to project finance
While there is a strong appetite among many banks to be involved in syndicated lending to finance projects in CEE, infrastructure projects in some markets face increasing challenges. In the power industry, for example, there is growing uncertainty in Poland, Romania and the Czech Republic. State support for renewable power will end in the Czech Republic in 2014 while in Poland there has been uncertainty about renewables for several years. Romania is considering reducing green certificates for renewable power projects and Bulgaria has imposed high grid access fees for renewable energy producers.
These changes in policy – prompted largely by efforts to control government spending and lower costs to consumers – make it difficult for equity investors to commit to projects. As a consequence there are likely to be fewer renewable power projects available for banks to finance in the future. Those that do make it to market will have increasingly conservative structures, with more equity (possibly as much as 50%) and shorter tenors for debt reflecting the reduced visibility that investors will have of the regulatory environment.