The pattern of project finance funding has shifted in the post-Crisis era. From 2008 to 2011, project finance from banks sharply declined as they became risk-averse and sought to repair their balance sheets.
Yet in 2013, something of a bank lending resurgence has occurred in the market, even if deal flow still remains quite limited. Many banks, having restored their balance sheets, now appear keen to return to their core business of lending when the right opportunity arises.
Certainly, the increase in project finance syndications, even in Europe, shows that banks are looking to re-establish their project finance lending credentials. The £1.6 billion (€1.9 billion; $2.5 billion) Siemens-Cross London Trains (XLT) Thameslink deal, with 19 banks providing the £1.43 billion debt facility, is a good example of this growing appetite.
Regulatory requirements impact long-dated loans
So does this mean we are back to the pre-Crisis era of project finance lending? In fact, a full return is unlikely to take shape any time soon – mainly due to the post-Crisis regulatory reforms now underway and being phased into adoption.
Indeed, given the nature of the 2008 crisis and the ongoing regulatory response, it is understandable that banks remain cautious and more selective when deploying their balance sheets for project financings. Increased capital requirements, for instance, will likely induce banks to limit their exposure to long-dated infrastructure loans. And, due to the structural requirements of such new regulations, this trend looks likely to survive the current optimism.
Meanwhile, a second post-Crisis trend is taking a more permanent shape. Among institutional investors — such as pension funds and insurance companies — appetite has grown for long-dated infrastructure assets. The low interest rate environment since 2008 has resulted in many such institutions diversifying their fixed-income asset base in order to find incremental yield. Certainly, with liability-matching characteristics and lower volatility than long-dated investment-grade bonds, infrastructure financings have become an increasingly attractive proposition for institutional investors comfortable with project risks.
The growing number of specialist infrastructure funds will also play a role in the future of infrastructure financing, not least because they combine an understanding of complex structures with accurate risk assessment. Lending alongside institutional investors and banks, such funds can help with aligning stakeholder interests.
Working together: banks and alternative financiers
Arguably, banks will remain the principal investor group, playing a vital and major role in project finance. Their skill in understanding the complex risks and structures inherent in infrastructure financing, particularly during the early phases of a project, generates a strong partnership role — irrespective of their funding status — which allows them to originate and structure deals likely to win debt appetite in the wider financing arena.
As a consequence, many leading banks are re-examining the “originate to distribute” model, with their aim being to include a wider group of investors in their distribution of financial assets, while simultaneously holding fewer debt assets on their balance sheets. Conveniently, this mirrors the growing appetite among non-bank lenders (institutional investors) for infrastructure finance assets.
At the same time, the structures of infrastructure financing models are changing. A well-established model in the UK, public-private partnerships (PPPs) are becoming increasingly popular globally. Meanwhile, so-called “club deals” are bringing together groups of varied financiers to source investment capital to support project or infrastructure finance.
A further example of this changing landscape can be seen in the UK, which has seen the recent launch of the Pensions Infrastructure Platform as another potential source of funding. This joint initiative, set up by the National Association of Pension Funds (NAPF) and the Pension Protection Fund (PPF) with UK government support, has so far pooled £2 billion from a number of major UK pension funds, with the purpose of investing in both the debt and equity of core infrastructure projects.
Increasingly, there are two distinct types of investors emerging – operating along different timescales. There are the short-term investors which are comfortable with early-stage project risk. This category includes strategic investors, such as construction and supplier companies, as well as specialist funds and bank lenders.
And there are long-term investors such as insurance and pension companies. This latter group is less willing to accept the construction risks associated with a project’s early stages and are more interested in the stability of liability-matching infrastructure investment returns once a project has reached the operational phase.
An important role for banks is to understand the different requirements of these investor groups and package deals they can support. In the interim, as the market absorbs these structural changes, uncertainty remains as to how these groups – banks and individual institutional investors – will collaborate on financing projects.
The developing role of captive solutions
This is an environment where captives have a role to play. Although they won’t ever necessarily be the major funding source of a project, captives are in a respected position, because they understand all aspects of a project’s financing (technological, operational and financial) yet can also be flexible financial contributors – including both debt and equity investment. With this toolkit at their disposal, they can work to find solutions that are in the best interests of all stakeholders.
Captives can also perform a key strategic role. As well as being an investor, they can act as a catalyst for other stakeholders, helping them to become comfortable with risks, particularly early-stage technology risks in situations where the captive’s parent company is the supplier. Siemens Financial Services (SFS) – the captive financing arm of engineering conglomerate Siemens – for instance, has a track record of assessing early-stage project risk and can therefore act as a significant driver for other investors’ buy-in to deals.
Acting as catalyst not only plays to a captive’s strengths, but also helps lay solid foundations for long-term consortium partnerships. Innovation is also critical – especially with respect to technology risk. An increasingly popular structure is the use of Managed Equipment Service (MES) contracts for major projects.
Under MES contracts, major equipment suppliers undertake to manage the entire equipment requirement on a project for the life of the concession including: ownership; provision; purchase; installation and commissioning; user training; asset management; maintenance; and on-going replacement.
This is achieved via a “sale of receivables” between the supplier and a financier – in the case of Siemens, via SFS. Such arrangements ease suppliers’ cash management concerns while bringing their technical expertise to the fore.
In the UK, for instance, Siemens operates 12 MES contracts with NHS trusts and has further agreements in the pipeline – the latest being a 14-year deal with the University Hospital Southampton NHS Foundation Trust signed in September 2012. SFS finances the deal — involving more than 150 pieces of equipment and revenue in excess of £100 million — via the purchase of receivables from Siemens Healthcare.
Of course, project finance is not a singular world and SFS is never the sole decision-maker or financing source on any large-scale project. But, as a captive, SFS can offer flexible and innovative financing solutions, as well as comprehensive risk analysis.
That said, the most important thing captives can provide is the assurance that, by committing to and becoming a long-term investor in a project, they believe in a project’s long-term viability: thus giving others the confidence to invest.
The Siemens Financial Services White Paper — “Making the Difference: Why the changing financial landscape is creating an expanded role for captive financing institutions” — is available online at www.siemens.com
Johannes Schmidt is CEO project & structured finance infrastructure cities & industry at Siemens Financial Services