At first glance, one can’t help but gasp when reading a headline like “RBS to exit project finance amid £24.1bn annual loss”.
But on a closer look, it should not surprise anyone that RBS – for nearly 20 years the leader in global project finance league tables – is following in the footsteps of Citi and countless other banks that have either axed or scaled back their project finance lending. The difference between RBS and the others is that RBS made a big announcement about its exit.
As any banker will confess, project finance – a form of asset-backed lending where the loan is secured solely by the revenues of a project, typically for periods of 15 years or longer – was a difficult business even in the good days. Now that capital is scarce, banks everywhere are shortening their tenors on these kinds of loans and gradually exiting the business.
Why? The answers are fairly obvious.
The payoff for project finance loans relative to the resources they require was never that compelling. Why tie up capital for 15 years or longer instead of making shorter-term loans over that period that allow you to collect more fees and require fewer resources, time and effort?
In previous years, with the economy booming, it still made sense since default rates were low and project finance loans helped banks get other business. “Give me that project finance loan, and the next time one of my portfolio companies does an asset sale or an IPO, you’ll be our first point of contact,” one could hear GPs saying then.
Now, with a lot of those higher-margin business lines drying up, project finance isn’t a loss leader; its just a losing proposition – especially when banks are posting eye-popping quarterly and annual losses.
Other factors are also slowing demand.
“The product markets that are largely in the emerging markets are also in recession and that has a knock-on effect on all the sectors that project finance is involved in, like power plants, road, rail and ports,” explains Barry Machlin, co-chair of Mayer Brown’s global project group.
But if project finance is going away, what will replace it?
In emerging economies, multilateral lending institutions, such as the International Finance Corporation, and export credit agencies are stepping up to the plate to fill the void. That’s good news for cash-starved projects, but sponsors should keep in mind that it usually takes longer to close a deal with these types of agencies on board.
In developed markets, governments are offering long-term lending incentives for select sectors. In the US, for example, the government has introduced loan guarantee programs for renewable and alternative energies. There is also hope that the reauthorisation of the TIFIA credit program and expansion of private activity bonds will help fill the void being left by project finance.
In the meanwhile, there is little reason to gasp at headlines like the one about RBS.