What recent changes have happened in the project finance market and what has been their impact?
WM: There has been growing complexity of project finance transactions as a result of more credit constraints in today’s financial climate. Many bank lenders have pulled back because of capital requirements related to Basel III and concerns emerging from the credit crisis. To satisfy the capital requirements of large transactions, today’s borrowers must raise debt from a number of sources, including banks and institutional investors. As a result, transactions have become more complicated with multi-tranche structures combining syndicated bank loans and bonds steadily becoming standard practice for large, capital-intensive projects. Deals happening around the world are following this new paradigm.
GM: In Europe, public debt has reached a new level as a consequence of the euro crisis. As a result, each government is facing a smaller budget for handling financings in areas such as infrastructure and renewable energy projects. Therefore, it is becoming more important to bring innovative financing forward. Project finance can be the right instrument to bridge this gap and to enable the market to complete financings/investments for the renewable energy or infrastructure sectors. However, budgets are tight and not every bank is interested in making this investment. While each crisis creates challenges for the future it also shows how things can be done better. We can structure financing where the government is not in a position to do so. For example, the European Investment Bank Project Finance initiative is developing a guarantee structure for bond financing to make that type of financing available for life insurance companies and pension funds in Europe.
TD: There have been a lot of changes in recent years as well as regulatory and political uncertainty in the project finance market, many resulting from the financial crisis. In general, project financing in both North American and Latin American markets have been impacted by the reduced availability of long-term debt and the constraints faced by public sector budgets. There are less commercial bank providers and shorter tenors as well as new players becoming more prevalent, including Japanese and Canadian banks
How has the industry been handling the challenges in today's environment?
GM: Banks are under pressure and the number of banks willing to arrange, to invest and to grant financing has decreased. It is up to the industry to accept the challenges and to come through with new structures that are in line with current regulations. For example, it is possible to restructure products so that insurance companies can invest in project finance for a steady stream of income for a longer period of time.
WM: There was a time when banks were willing to lend money for 15 to 18 years but today many banks are seeking to offer loans for about half of that time. As a result, banks have been handling the front end, shorter term of the debt, and institutional investors, such as insurance companies, will do the back end. Out of this relationship came the “hybrid” structure where there are two types of debt with two types of lenders. With these new complex structures, lenders need to hire an experienced provider of administrative solutions.
TD: The challenges facing the markets resulted in a move towards new funding sources and structures alongside continued growth in capital markets funding. With structural innovation furthering deal complexity, there is growing demand for high-quality deal management. A third-party administrative agent can be useful to act as a central point for all of the lenders to help these structures work smoothly through one central resource.
Where do you see new opportunities for project finance?
WM: In Europe there is a huge backlog of transactions in the energy and infrastructure space, especially around transportation as European roads, tunnels and bridges are aging – similar to the situation in the US. Those types of transactions work to solve a number of problems. These aging assets need to be upgraded and improved – either by building new or upgrading existing infrastructure. At the same time, this is creating an opportunity for countries or states in the US to monetise these capital-intensive assets to bring in private capital, removing the burden from states and countries that do not have the budget to make sweeping infrastructure improvements. There is a public benefit with people enjoying the use of improved assets and at the same time removing burden from governments. They would otherwise have had to raise debt on balance sheet or pay out of the government’s pocket, which would funnel down to the taxpayer. Project finance can reduce that capital and yield a benefit. For all of these reasons, there are a lot of opportunities for continued growth.
GM: As mentioned, public debt is an important driver. Governments are under pressure to reduce their public debt. Additionally, there currently are low margins for investors in the market so there is big interest from investors to earn higher fees. There are new opportunities to invest in infrastructure, but lenders and borrowers alike have the challenge of bringing available liquidity to the project finance world. However, it should be noted that there are major discussions around Basel III as it will require more underlying capital from the banks. As a result, there could be the need to increase the junior/mezzanine element in each financing by inviting investors to do the financing for the gap that banks are unable to cover. If Basel III comes to the conclusion that project finance supports the economy then they may release the requirement to the banks with small amounts of risk-weighted assets so that less junior/mezzanine will be needed for these financings. Whatever the case, banks such as Deutsche Bank have the network and experience to offer this to the market and our clients with an opportunity for them to make money.
TD: The bond industry is picking up and it is now more commonplace for borrowers to attract debt from multiple sources, including banks, institutional investors and export credit agencies (ECAs). ECAs are seeing growing opportunities in financing, partaking exclusively in cross-border transactions, which are intrinsically more complex than their domestic counterparts. Additionally, there are increasing numbers of new players looking at investing in project finance such as pension funds, insurance companies, and sovereign wealth funds.
Why have hybrid bank loan and bond transactions as well as public-private partnerships (PPPs) become more popular?
GM: The success of PPPs depends on the relevant terms and conditions required by the respective government. In Europe, it is challenging as there are many different governments to consider and some have more experience with these types of arrangements. The popularity of PPPs in the US is growing, successfully taking a page from the European model, especially in the transportation sector. In Europe, one has to consider the conditions in each country, which may differ. However, the euro crisis is likely to bring countries together and they will have a more common approach in terms of economic scale in the future.
WM: Companies that are building these large projects need to raise a lot of capital. The only way to do that is to reach into multiple pockets. You might have short- or medium-term financing from bank loans and construction financing in bank loans and long-term financing from bond deals. You may also have government support in ECAs that are doing more direct lending coming in to fill in that gap in funding.
TD: Hybrid bank loan and institutional note transactions come into play as some of the banks are looking for shorter maturities. The banks are providing the front-end arm, a shorter term of debt, and institutional investors are coming in for the second back-end arm of longer-term financing. Aside from the hybrid loan and note transactions, we are beginning to see multi-tranche transactions more frequently as projects have to look at using multiple sources of financing.
What opportunities do you see in renewable energy?
WM: In spite of global economic challenges, renewable energy stands out as a strong sector within the project finance industry. Deutsche Bank has a strong focus on clean energy and sustainability and a long history of working on wind, solar, hydro and other types of renewable energy deals. Deutsche Bank Trust & Agency Services will be holding its fourth annual Renewable Energy Forum in October 2013 where we will lead discussions on developments in the renewable space.
TD: Deutsche Bank remains committed to “Banking on Green” and is a supporter of renewable energy in our own initiatives. As part of the bank’s corporate responsibility programme in the area of climate change, Deutsche Bank achieved its target of making its operations carbon-neutral by the end of 2012.
GM: While there are many opportunities, there has been a lot of change in renewables. On one hand, the public sector has reduced its support due to the ongoing crisis, yet on the other there have been advances from a technology perspective, including new opportunities in wind and solar as well as for shale gas extraction. There has also been more discussion about climate change and this is an area where we expect further developments supporting project finance.
Why is it important, in your view, to hire a third-party administrative agent?
WM: Given the ever-increasing complexity of project finance, lenders should make sure to hire an experienced, trusted and well-renowned provider of administrative solutions. The administrative agent must have the necessary skill set and capabilities to not only manage the complexity of multi-tranche deals, but also the challenges of the project finance sector as a whole. There is mounting demand for high-quality deal management.
GM: A third-party administrative agent remains neutral. Today’s more complicated structures require the expertise of an impartial administrator. With complex structures it is beneficial to have an entity that is outside the structure so that all parties to the deal receive equal representation. A professional third-party administrative agent links together the various pieces and brings much-needed stability to the closing table.
TD: The global nature of project structures means that the administrative agent must have people on the ground in all major financial centres. Outstanding client service means providing local teams that are familiar with their regions. Having one point of contact for deal administration is ideal. There are real benefits when the administrative agent, collateral agent and account bank functions are administered by the same team.
What should be considered when selecting an administrative agent?
WM: You need to choose an agent that understands project finance structures and the framework in which the deal is being formed.
GM: The most important factors are experience, staff quality and reputation in the market. In our view, Deutsche Bank is able to offer all of the above.
TD: An administrative agent has to have the right systems to track all the agency functions, including compliance tracking and booking systems for the loans. You need a strong infrastructure platform and a provider that is committed to the business on a long-term basis. These are long-term deals and you want the administrative agent to remain throughout the life of the transaction.
What, in your view, is Deutsche Bank’s advantage?
TD: Deutsche Bank’s Trust & Agency Services offers comprehensive administrative services for an extensive range of project financings for lenders and borrowers that would like to outsource this role. The bank has years of experience in providing high quality project finance services with a current portfolio of over $50 billion in financing across more than 450 projects.
GM: Unlike many of our competitors, Deutsche Bank has defined the third-party agency business as a separate line of business, not an add-on or a nice to have. If you go to Europe, the US and Asia, we have a good reputation in the market and global deals. Deutsche Bank has offices around the globe, and within Europe specifically, the bank has a deep understanding and experience dealing with the intricacies of coordinating with different governments and working with their own rules and regulations.
WM: Deutsche Bank is committed to offering world-class solutions and expertise, demonstrated by our 25 “Deal of the Year” awards over the past three years and our being the recipient of the 2012 Infrastructure Investor Global Corporate Trust Services Provider of the Year award – our third year in a row winning this accolade.
Will Marder is global product manager for project finance, Deutsche Bank; Gerd Meyer is head of international loans & agencies, Deutsche Bank; and Thalia Delahayes is team leader for project finance administrative agent services, Deutsche Bank