When the Pacífico 3 toll road concession in Colombia reached financial close in February 2016, it included two long-term bond issues, one in dollars and the other in pesos. That the first project to close in the 4G program featured project bonds was remarkable. That the bonds included construction risk was doubly so. Another bond-backed 4G deal closed four months later.
Yet those two deals, with Goldman Sachs as the bookrunner, remain outliers. Colombia is a relative newcomer to project finance, but more mature markets have shown little enthusiasm for greenfield project bonds. No Chilean project bonds were sold last year, for example, and only one has come to market this year — for a largely brownfield project. Similarly, no Mexican project bonds have been issued this year, according to data from Dealogic, and none of last year’s deals involved completion risk.
Bonds covered 14.5% of project financing in the first half of 2017, up from 12.7% in the same period of 2013. Project bonds are on an upward trend, but one of fits and starts. Issue volumes have gone up and down in recent years. Now, some 18 months after the Pacífico 3 deal, a marked rise in the appetite for project bonds has not yet materialized.
“The key for us in the development of all these project bonds is who takes the construction risk, and we are not seeing institutional investors really taking the construction risk in capital markets,” says Gema Sacristán, CIO at the Inter-American Investment Corp (IIC). The debt funds that have formed to invest in infrastructure projects in Latin America have a decidedly different risk appetite from institutional investors that buy bonds directly, she says.
The matter of risk
The problem facing the bookrunners and the fund managers is familiar the world over: making institutional investors comfortable with infrastructure as an asset class. Long-time emerging market investors dominate the landscape in Latin America but they are more geared towards sovereign and large corporate debt issues. They lack the resources to handle a complex structured finance deal.
Not surprisingly, various markets in Latin America have tried to create infrastructure debt instruments that mimic sovereign bonds in some ways. Peru has allowed project sponsors to sell securitizations of government IOUs in the capital markets since the mid-2000s, first with the CRPAO and then with the RPI-CAO payment mechanisms. On the flipside, the government was not able to transfer completion risk or performance risk to the private partners.
Colombia took a different approach with the 4G program. Bond investors are exposed to construction risks — including a limited amount of cost overruns during construction — but the concession contracts ensure that lenders will be made whole in the event of termination, regardless of fault. Investors thus became comfortable with project risks despite the presence of midsized local sponsors with no international record.
“What we wanted to do was to effectively position the credit as Colombian sovereign payment risk. Once you worked through all the various structural mechanics and protections, you could ultimately come back and relate this as government payment risk,” says John Greenwood, co-head of project, infrastructure and principal finance at Goldman Sachs.
“If you compare Colombia and Peru, Peru probably had one of the longest and what was considered the most successful project bond programs,” he says. “Now, given some issues that Peru has faced on some of their PPPs, they’re now looking at aspects of the Colombian model as potentially best in class.”
The Peruvian procurement agency, ProInversión, has said it will introduce mechanisms that are more like availability payments and transfer more risk to the private sector. For Sacristán from the IIC, the shift is a sign of the fiscal pressures that government face across the region.
“[The Peruvian] model hasn’t really been replicated recently because of the cost it represents for the country. We don’t really think this kind of support is sustainable. The issue is to really find that balance of risk with the private sector,” she says.
Striking the right balance is set to be crucial for the project finance market in Brazil, where the national development bank BNDES is cutting financing for energy and infrastructure projects. The bank will also phase out the TJLP long-term corporate lending rate and replace it with the TLP, which will approach market rates over the next five years.
Besides BNDES and multilateral lenders like the IIC, few banks provide long-term loans in Brazilian reais. The debt capital markets can possibly fill the gap, but investors will need to see stronger construction contracts before they take on the completion risks, says Bruno Pahl, director of infrastructure and project finance at Fitch Ratings in São Paulo.
“All the construction companies [in Brazil] usually offer a weaker contract compared to other countries. Because of this, it’s very hard to take this completion risk,” he says.
The Brazilian government created tax-exempt infrastructure debentures as a financing tool in 2012, but the market reaction has been muted. Infrastructure debenture issues came to 1.92 billion reais ($613 million), according to the local capital markets association Anbima, and that number is expected to fall this year. The demand for infrastructure debentures comes mainly from the retail side, with little or no interest from institutional investors.
“The problem with retail, of course, is that it’s relatively small in size, relative to insurance and pension money, and relatively short in tenor,” Greenwood says. “Most infrastructure debentures you’ve seen in Brazil go out five to seven years. There really needs to be a significant increase in participation from pension funds and insurance companies.”
In the meantime, as one emerging markets investor notes, Brazil’s family offices and private wealth managers are becoming more interested in financing infrastructure projects.
Over the hump
As international lenders face increasing restraints from Basel III capital requirements, long-term financing for infrastructure projects has become increasingly restricted to small and midsized deals that require only a handful of banks. In Mexico and Chile, banks have offered competitive pricing with bonds for long-term debt. Now more project sponsors across the region are weighing bond financing as an alternative.
Astra Castillo, director of Fitch’s infrastructure and project finance group in Mexico, says the rating agency is evaluating two bond deals in Chile and Mexico, where the sponsors have asked them to assign ratings for two different scenarios, with and without completion risk.
“What they are trying to assess is what the risk perception would be with and without completion, then try to make a valuation about whether it is convenient to go out to the market… or to wait until completion is over or more advanced,” she says.
Even for sponsors anxious to avoid refinancing risk, issuing a project bond can be a daunting prospect, says Gianluca Bacchiocchi, a partner in the Americas energy and infrastructure practice at the law firm Clifford Chance. “Every time someone experiences it, they become a believer. But for a lot of sponsors, it takes a bit of effort to get them over the hump to want to even do it to begin with,” he says.
But as more projects go to the bond market for long-term financing, more sponsors will join in, he says. One question, however, is how much debt will come from dollar-denominated bond deals. Argentina, according to Bacchiocchi, presents a prime opportunity for the cross-border bond market.
“There are no pension funds to speak of. The banks can only lend on very short terms in pesos at high interest rates,” he says. “So Argentina is a perfect example where many of the projects will need to be funded in dollars.”
Bacchiocchi points to Argentina’s sale of a 100-year bond in June as proof of investor appetite. He also points out that RenovAr, the country’s renewable energy investment program, includes revenues in dollars but he adds that it is still unclear if the planned toll road public-private partnerships (PPPs) will have dollar payments.
Governments across the region are trying to limit their exposure to foreign exchange risk, so developers could turn to institutional investors from abroad to provide funds in dollars, sources say. If interest rates in developed economies remain low, and investors remain on a global hunt for yield, the institutional money could come to see the value of infrastructure finance, they add. But it will not happen quickly.
“Most of the investors in public bonds are more comfortable entering into deals where the project has been de-risked for the construction period, and I don’t think it’s going to change in the short term,” says Carlos Muñiz, the global head of project finance at Santander.
Given the difficult nature of development risk in Latin America, Muñiz adds that he expects to see most project bonds in the brownfield market for now. LF