Fitch, the ratings agency, is not very optimistic about the success of a European project bond market – even as it recognises that decreasing bank appetite for long-term funding is, in theory, creating a bigger opportunity for capital market involvement in infrastructure.
“Institutional investors may not be fully ready to step up their investments on the debt side, even if the shortage of bank funding now favours a significant development of the bond market for project finance. The unclear long-term future of this new market, the complexity of transactions, and the expected Solvency II capital charges are weighing negatively on the market's development,” Fitch wrote in its report.
The creation of a European project bond market has been the ‘El Dorado’ of post-Crisis project finance. The most noteworthy initiative has been the European Investment Bank’s (EIB) take on project bonds. The latter aims to credit-enhance private sector infrastructure bonds by using either a fully funded subordinated debt tranche or an unfunded subordinated debt guarantee covering up to 20 percent of a project’s debt.
But despite the EIB’s heft, Fitch sees as a best case scenario the development of a “small yet not insignificant” project bond market by 2015, propelled by the bank. This market would allow investors to get acquainted with infrastructure financing and start developing preliminary benchmarks. The prize would be the creation of a market where sufficiently educated investors become comfortable with investing in lower-rated bonds – the majority of infrastructure debt.
If such a market fails to gain traction, though, then project finance would be “back to square one” with banks dominating the funding landscape, with a twist: “Banks have resumed their lending activities to the sector, with higher pricing, stronger covenants and shorter maturities. Refinancing risk has become a common feature of project finance, and relationship lending takes precedence, favouring the stronger sponsors at the expense of new entrants,” Fitch says.
In the rating agency’s opinion, “the most logical outcome is the first one, although how long it will take to move towards a deep and liquid project bond market is highly uncertain”.