Deals: Eiffel 1, FTC corporate securitization;
Essential Public Infrastructure Capital (Epic) collateralized loan obligation
Sizes: e256.5 million; £397.1 million
Arrangers: Deutsche Bank; Merrill Lynch International
Dates: October-November 2004
Europe's two most developed public-private partnership (PPP) programmes produced a brace of innovative capital markets deals at the end of 2004.
Portugal has built more than a third of the 2,850km motorway network planned under its PPP road programme, attracting ?5.7 billion of long-term bank debt. Eiffel enables four Portuguese construction consortia (agrupamentos complementares de empresas ? ACEs) to raise money against the security of revenues from contracts for four of the country's road projects with total expected payments of ?1.293 billion. The main members of all four ACEs are three non-investment-grade construction companies.
The ACEs sell their construction contract payments to the issuer, Eiffel 1. Eiffel 1 issues fund participation units to investors. Each month, the ACEs submit signed invoices for work done to the construction concessionaires. Payments made in return for the invoices go into the issuer's account.
?Eiffel has effectively bought construction cashflows, partly through an upfront payment of ?257 million, and it will pay the remainder as the money passes through,? says Mike Redican, managing director in debt capital markets at Deutsche Bank. ?With base-case over-collateralization of 4.85 times, supposing Eiffel's debt service is ?10 million a month, once that debt is serviced, ?38.5 million goes to the ACE as deferred consideration.?
Eiffel is structured under Portugal's new securitization law and it enables the construction contractors to borrow through an investment-grade vehicle. But, says Redican, ?it is not a conventional securitization structure. It's more akin to a structured project finance bond that uses some securitization techniques. The structure works by taking full construction and performance risk on non-investment grade consortia members and structurally mitigating it by over-collateralization and by a technical assessment of the construction risks and liabilities of the principal sponsors, which we dealt with through appropriate contractual protection. We also closely examined the terms of the underlying loan agreements to ensure that our structure didn't cut across them or require consents from any of the bank consortia.?
At their peak of activity, the four ACEs were generating e80 million of cashflow a month last summer. Constructors tie up working capital in projects that are under way, so Eiffel boosts short-term liquidity and cuts credit risk.
The Epic deal
Meanwhile, Depfa Bank has closed a partly funded synthetic CLO of 24 UK infrastructure loans ? the first PPP loan securitization. Depfa buys credit protection on the reference pool from KfW, which in turn buys credit protection from banks and institutional investors under a super-senior swap. Ambac has wrapped the £355.7 million ($688.6 million) AAA super-senior tranche. The Epic SPV sells the remaining tranches in the form of floating-rate credit-linked notes.
The weighted average life of the reference portfolio is just over 14.5 years. Depfa can replenish loans that are refinanced and pre-paid in the first five years.
Epic will reduce Depfa Group's risk-weighted assets by about ?500 million. ?Our natural territory is low capital weighting business,? says Andrew Bride, managing director in Depfa's infrastructure finance unit. ?This deal is like a standard KfW Promise or Provide synthetic securitization, but you're dealing with lumpier assets.?
PPP loans are often bespoke and heavily negotiated. And a default on a mortgage or credit card repayment is easy to identify. Project finance is more complicated. ?The way banks control project finance loans means you can have a default in theory ? when management accounts are delivered late, for example,? says Bride.
The capital markets have been nervous of project finance assets, associating them with high-risk deals like telecoms or merchant power projects. ?Project finance loans may be under-rated,? says Bride. The high quality of Epic's underlying portfolio got Depfa a 1% first-loss piece.
Recovery rate assumptions are higher on a PPP loan than on loans to larger corporates or SMEs. With only 24 loans in the pool, and with UK PPP most advanced in education and healthcare, Epic doesn't achieve as much diversification as a typical CLO. But higher concentration needn't mean higher correlation.
?Correlation numbers were assumed to be lower than for a typical CDO,? says Paul Hawkins of sole arranger Merrill Lynch. ?And for much of the portfolio, concentration by sector was considered less important than concentration by contractor.?
The junior tranches went to banks and insurance companies. ?We wanted to prove there is an institutional market for restructured project finance loans,? says Bride. Pricing ranged from three-month Libor minus 40 basis points on the £250,000 AAA-rated senior tranche to three-month Libor plus 500bp for the BB-rated junior tranche.
?The credit-linked note issue was relatively small so we had to engage in some quite selective marketing,? says Ashley Kibblewhite, director, global principal investing and secured finance syndicate at Merrill Lynch.
Now that it has its template, and with so much money seeking euro and sterling assets, Depfa will look at repeating Epic, possibly using European loans. As well as freeing up capital, Depfa has told KfW that, in return for its intermediation, the bank will continue to help develop European infrastructure.