With international capital markets awash in liquidity and global syndicated lending expected to exceed $1 trillion this year, prospects for project finance in Latin America look good.
However, according to Simon Collins, head of debt advisory services at KPMG corporate finance, “Gone are the days when you could throw an inappropriate risk at a banker and, if you put in a few more basis points, they would buy it.”
The Inter-American Development Bank estimates that Latin America needs to spend at least $60 billion a year on infrastructure. But before committing to a project financing, lenders are scrutinizing sponsors’ investment records in the region, country risk and sovereign rating, the long-term value of the assets, the reliability of the offtake agreement and external factors such as market sentiment.
Sponsors with strong track records offer what Collins describes as “imported credibility” to projects in a countries with weaker ratings.
Karen Chang, Latin American analyst at Duff&Phelps, agrees, but adds that a sponsor taking on the cost of the construction phase in a non-recourse project financing lends even more credibility to a deal. “Bond holders shouldn’t take [construction] risk,” she says.
Lenders’ attitudes towards pricing are also hardening. Where credit committees once might have overlooked other issues for a higher price, lenders are now favoring projects with higher proportions of equity, often requiring greater initial equity investment and restrictions on dividends until the debt to equity ratio improves.
The increasing frequency of large cross-border projects, such as the $2 billion Bolivia-Brazil gas pipeline, requires analysis that goes beyond sovereign risk to an examination of the relative stability of one country to another. Often the sponsor, through guarantees on the offtake agreement or other legal recourse, must absorb more risk to secure financing. In Brazil, the difficulty sponsors have in securing financially sound, legally reliable power purchase agreements has delayed financing for several thermoelectric power plant projects.
Strong offtake agreements are not only important as cash flow, but also as collateral for project investors. Lenders take into account the offtaker’s track record, the transparency and duration of the offtake agreement, and whether the contract establishes a fixed price and minimum purchase amounts. Collins emphasizes that end users should be convinced of the project’s necessity and accept the costs that filter down to them.
Security in the physical assets of a project is not as durable as the offtake agreement because, as Collins points out, “You can’t just dig up a pipeline and use it somewhere else.”
The success of project finance also depends on macroeconomics. In Brazil, which needs to invest about $90 billion over the next three years in telecommunications, power and sanitation projects, the upgrading of the sovereign risk by Moody’s to B1 from B2, sustained growth and reduction in unemployment make it “one of the best profit/risk ratio opportunities in this market in the world,” according to Márcio Lutterbach of KPMG corporate finance in São Paulo.
Investors must still be wary of any unresolved issues in a deal-including tensions between national and regional governments. In one highly publicized example, Itamar Franco, quixotic state governor of Minas Gerais and former Brazilian president,tried to strip operating control of the state’s electric utility, Cemig, from its US minority investors and threatened to divert rivers supplying the company’s hydroelectric dams to protest the federal government’s energy privatization program. LF