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In a year of record international bond issues, one unusual recent offering attracted little attention. In August, the Chinese coastal city of Zhuhai raised $200 million through a private placement backed by municipal highway revenues. Modelled on a technique often used in US local government finance, it was the first Asian revenue bond and the first Chinese bond issue with a high-yield tranche, according to sole manager Morgan Stanley. The proceeds will be used to help finance infrastructure development. Hailing the transaction as a milestone, a spokesman says the firm sees “select opportunities” to use the technique elsewhere in the region. Multilateral agencies such as the World Bank estimate that Asia needs around $1.5 trillion of power, telecommunications and transportation capacity over the next decade to cope with rapid population growth and remove bottlenecks to economic expansion. Unable to foot the bill themselves, governments are turning to the private sector for help, encouraging local and foreign investors to provide services which until recently were considered the exclusive responsibility of the state. They, in turn, are tapping the domestic and international markets for debt and equity capital to finance these projects. Some have encountered problems getting off the ground, notably a power plant in Dhabol, India, and mass transit systems in Bangkok, Thailand, partly reflecting the highly political nature of many infrastructure developments. But these well-publicized hiccups have done nothing to curb the appetite of governments, lenders or investors for new transactions, even in countries new to international financial markets such as Burma (Myanmar), Laos and Vietnam. “There’s so much demand,” says Will Liley, managing director of Asian Infrastructure Fund Advisers, a Hong Kong investment management firm. “Over the next 15 to 20 years, we can build as much as we possibly can and the market will still beat a path to our door.” International banks have jumped on the bandwagon, attracted by the prospect of lush fees for advisory work and higher spreads on loans than they can achieve at home. “Ten years ago, international banks in Asia were mainly providing dollar loans for resource development; today, all the leaders are trying to advise, arrange and finance infrastructure development,” says Malcolm Clark, NatWest Markets’ project advisory director for Asia. However, the business appears to be increasingly dominated by perhaps a dozen major US, European and Japanese commercial banks, operating mainly from Singapore and Hong Kong, with US investment banks nibbling at the edges for related underwriting deals. Competition is clearly driving profit margins down, judging by the squeals heard in some quarters. One project finance official at a major US bank complains that “the Japanese are trying to grab the business, going for market share by doing deals at half the price we can”. It is not only the Japanese. Deutsche Morgan Grenfell, ANZ and Dai-Ichi Kangyo Bank recently arranged $480 million of floating-rate debt financing (including a standby facility) for PT Mitra Global, one of the successful bidders for Indonesia’s five regional telecom concessions, at just 135 basis points over Libor, excluding fees and the cost of the standby, despite some market nervousness about Indonesia’s political future and the fact that the project has not even begun operations. Rivals attribute the tight spread to aggressive bidding for the deal by the arranging banks. Rollo Prendergast, ANZ’s regional head of global structured finance for the Asia-Pacific region, prefers to put it differently: “I’d say that the advisers [JP Morgan, acting for the winning consortium] had very good control over the process; they looked after the sponsors well.” Noting that the project is robust enough to stand on its commercial merits, without any political risk cover, he adds that the business should benefit from its favourable location in central Java and the track record of the investors involved, which include Australia’s Telstra and NTT of Japan. Seller’s market More recently, a syndicate consisting of one German and seven Japanese banks is said to have priced a 15-year floating-rate credit for an independent power project (IPP) in Thailand at “significantly below” 100bp. The loan would help finance the construction and operation of a power plant by Unocal, Westinghouse and Thai Oil, which are thought to have won the bidding for the project in the face of competition from about 40 other consortia. Thai banks will also provide local currency financing for up to 17 years. “This was probably the most competitive IPP bidding in the world,” says a banker who monitored the process. In addition to aggressive pricing of loans by competitors, some bankers bemoan the tougher bargaining stance adopted by governments lately. Private power development has become “a seller’s market”, one gripes, in which “host governments now feel they can play hardball because they think the programmes they put in place recently in an effort to kick-start private power generation were too investor-friendly”. China has always taken a fairly hard line over the conditions it will approve. Now Taiwan, new to private electricity development, seems to be taking an inflexible position. In negotiations over 11 possible power projects on the island, the state electricity company is offering “take it or leave it” terms, several bankers say. Bankers themselves have played hardball at times, rewarding countries which were most accommodating. A few years ago, for example, the Philippines was so short of electricity generating capacity that the capital, Manila, was frequently subject to brownouts. Determined to solve the problem, the Philippine government embarked on a crash IPP programme and agreed to accept many of the terms demanded by lenders and investors, including an explicit government guarantee that the state electricity company would meet its obligations to pay for the power generated. In Indonesia, however, the government was not prepared to provide such a guarantee; after long delays, the Indonesians finally issued a “letter of support” instead, which foreign banks accepted. “The Philippines needed the power and were more realistic,” says a European banker in Hong Kong. “Those countries which have held out for better terms have had to wait.” But mounting competition among banks has given such countries more leverage. “One or two years ago, only a few banks were prepared to look into project financing [relying on the project’s cash flow for debt service and repayment] rather than the guarantee approach; now it’s a few dozen banks,” says Christopher Chen, director of international finance at ANZ. As a result, Indonesia has been able to arrange financing for four major power projects since it established the basic model last year, with a fifth expected to close by the end of this year and several others in advanced stages of development. Since 1989, the Philippines has approved around a dozen IPPs, gradually developing and refining its original model. So far, all have involved the state electricity company as the buyer of the power (or “offtaker”) with the full guarantee of the republic. Now, negotiations are under way to arrange the first Philippine IPP in which a privately owned company will be the offtaker (Meralco, an electricity distributor serving Manila) without any government guarantee; current plans call for several plants to be built and operated by groups of local and foreign investors in order to supply Meralco with more than 1,500MW of new power. Meanwhile, the Philippine government is looking at possible ways of limiting its own exposure in future deals, such as making its guarantee available only as long as the relevant financing is outstanding or providing for the guarantee to terminate if the state electricity company’s credit rating reaches investment grade and stays there for two consecutive years. Pakistan has also been carrying out a successful IPP programme since it invited proposals from private developers in 1994. It received many more applications than expected and has chosen enough to meet its initial target of 5,000MW in extra generating capacity. Like the Philippines, Pakistan had little choice but to offer favourable terms. “The political and economic situation was such that they could only do it by making it investor-friendly,” says a British banker who took part, adding that the government was also influenced by World Bank advice. Another important reason for the programme’s success was the approach taken to pricing, he notes, using a tariff schedule rather than trying to stipulate a rate of return which the project can earn. “If the plant can produce at an average price of x, then the profit is up to you,” giving investors a clear incentive to reduce costs and operate more efficiently. “And they even allowed some front-loading and fast completion bonuses.” The cap didn’t fit By contrast, the Chinese authorities let it be known that they thought project developers were earning too much and suggested they might impose a 12% cap on the return sponsors could achieve in future, although there has been recent speculation that 15% is acceptable. Regardless of the number, China’s approach was universally scorned by foreign bankers and slowed the pace of infrastructure development there. “Nobody who’s in this business does projects in China for 12% to 15%,” says one veteran. “You can assume that if something goes ahead they’re getting more than that.” In fact, this observer maintains that the Chinese are now adopting a tariff-driven approach and have implicitly tied rates of return to operating efficiency. “They’ll say you can make 15% for delivering so much power, which requires plant availability of 63%. But if you can increase plant availability to 88% to 92%, which is world-scale best practice, you can get a 21% to 22% cash return.” Despite China’s enormous need for new power plants and other infrastructure, arranging projects there has been notoriously slow and difficult. The country’s embryonic and unreliable legal system is a major obstacle in a business which revolves around the performance of tightly drafted contracts and the enforcement of security. All transactions must be priced in local currency, but the renminbi is not yet a freely convertible currency, exposing lenders and investors to additional currency risk. And it is often difficult to assess the credit of the offtaker or other local counterparty, because Chinese enterprises do not use western accounting methods, most are not profitable by western standards and in some cases even their ownership is murky. To complicate matters, provinces are competing fiercely to attract foreign project sponsors, in some cases even offering “ludicrous” fuel prices to entice investors, according to one banker. Nevertheless, projects are being arranged, approved and financed in China, some of them breaking new ground. “Both the transparency and speed of final government approvals has remained an issue this year,” says Joseph Casson, a project finance director at Citibank. But, he adds, “things are moving constantly in the right direction”. Recently, for example, Bovis and Thames Water of the UK concluded a build-operate-transfer (BOT) agreement with Shanghai to install a water treatment plant at Da Chang and supply the city with clean water at agreed prices for 20 years, when they will hand over the plant to the city free of charge. Attracted by the prospect of lending to Shanghai and by the fact that the city will bear much of the project risk, international banks will provide 70% of the project’s $75 million total cost in the form of 10-year floating-rate debt at Libor plus 190bp. Da Chang is “one of the first limited-recourse project financings in China”, according to one banker involved. In another recent transaction, Sithe Energies of the US (which is 61%-owned by Compagnie Générale des Eaux of France and 28%-owned by Marubeni of Japan) agreed to build a $174 million, 100MW coal-fired power plant in Tangshan, Hebei province, and to operate it for 20 years. Sithe’s foreign partners in the venture are an infrastructure fund organized by American International Group and the Government of Singapore Investment Corporation, with the foreign partners owning 60%, while the local partner is the municipality, owning 40%. Deutsche Morgan Grenfell advised and arranged the deal, with international banks providing $128.4 million of 10-year debt at about Libor plus 200bp. “The interesting thing about this deal is that it’s probably the first to achieve a less one-sided allocation of risk,” says a banker involved in the transaction. “The problem in China is finding counterparties to contractual arrangements whose credit risk is comprehensible and acceptable to the banks. Typically, if there’s one creditworthy party involved, all the risks end up being parked on its doorstep.” In this case, local contractors will supply the equipment and carry out construction work, so there is no export credit agency involvement. But Raytheon of the US will act as the effective prime contractor and supervisor, guaranteeing plant completion and performance, reducing performance risk with its know-how and experience and financial risk with its strong balance sheet. Lenders also took comfort from the quality of the sponsors and their shareholders and the reputation of the offtaker, the North China Power Group, which is the ninth-largest power utility in Asia. Fuel supply is not an issue; the coalfield in and around Tangshan reportedly has more coal reserves than all of Indonesia. The lenders agreed to accept currency risk, reassured by the size of China’s foreign exchange reserves and the fact that the price received for the power will be indexed. As this example illustrates, China has not yet developed a model for IPPs. Instead, foreign and local companies have usually set up ad hoc joint ventures, negotiated agreements with provincial governments and power authorities and then sought the necessary approvals from the central government. That may be about to change. In the case of the Laibin B power project in Guangxi province, the State Planning Commission (SPC) has for the first time written guidelines specifically designed to attract international participation. It has opened up the process to competitive bidding and will even allow a foreign company to own 100% of the operating company. Moreover, although the project enjoys the SPC’s strong moral support, it will not be backed by central government or state bank guarantees. “It will still be far short of classic BOT, because the risk will be local government, not true project finance, but it will be a very significant landmark,” says a Hong Kong banker. “This will be a test case.” The plan is to build a $600 million, 700MW coal-fired power plant in one of China’s poorer interior provinces, which has received little foreign investment to date and lags far behind the southern coastal provinces in development. Beijing wants to begin correcting that imbalance by attracting investment to the interior. Although the results of the bidding had not been officially announced as Euromoneywent to press, it was widely believed that Electricité de France would be chosen as the operator, with GEC-Alsthom as the equipment supplier. Bankers have expressed reservations about Guangxi’s remote location and relative poverty, the tight construction schedule called for and the absence of central government or state bank guarantees. “It’s extremely unlikely that banks or export credit agencies will accept the credit of the plant or even the province itself,” says one. In response, Guangxi has asked for a letter of support from Beijing. Roads to revenue Zhuhai is a Chinese coastal city of just over a million people in fast-growing Guangdong province near Hong Kong. Partly bounded by the sea, it has seven main access roads which vehicles must use to enter or leave the city, paying either a toll (for non-locally registered vehicles) or an annual fee (for locally registered vehicles). Morgan Stanley recently arranged a $200 million international bond issue for the Zhuhai city government, effectively securitizing these highway revenues. Modelled on a technique commonly used in US municipal finance, it was the first revenue bond by an Asian borrower and the first bond issue from China with a high-yield tranche. The issuer was a city-owned highway company and the offering consisted of two tranches; an $85 million senior tranche of 9.125% 10-year notes (with an average life of 7.5 years) and a $115 million subordinated tranche of 11.5% 12-year notes (with bullet repayment). The senior notes received an investment-grade rating of Baa3/BBB and were priced at 250bp over US treasury notes, while the subordinated notes were rated below investment grade at Ba1/BB and priced at 475bp over treasuries. According to Morgan Stanley, the offering was oversubscribed and achieved broad distribution among about 40 investors in the US (75%) and Asia (25%), many of them first-time buyers of Chinese debt. The proceeds will be used to help finance city infrastructure projects. Morgan Stanley says the financing is unique in not having any central government guarantee or other implicit support, unlike all other Chinese debt financings to date. It attributes the deal’s success to strong fundamental credit quality and several debt service support mechanisms. Annual vehicle registrations in Zhuhai are growing at double-digit rates and the highway tolls and fees are automatically increased every year or two. To reduce the risks surrounding debt service, a city-owned conglomerate has provided certain limited hard-currency back-up commitments and offshore debt service reserve accounts have been established. The transaction took 18 months to arrange, due to the slow approval process in China, but a Morgan Stanley spokesman describes it as “a very important benchmark for Asia”. * |
