Project bond market hangs on credit enhancement initiatives


Louise Bowman
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“Infrastructure is not naturally a bond market product. Bonds will account for only 10% of the market at best.” There are plenty of people like this banker who believe that without the comfort of a triple-A monoline guarantee, the risks inherent in funding infrastructure will be too great for the bond market to bear. Considerable time and effort has therefore been spent to find a replacement for the monoline wrap that was the linchpin of the project bond market before 2007.

Hadrian’s Wall Capital in the UK is behind the most high profile initiative so far. It draws on the A/B note structures that became popular in the real estate financing market before the crash under which the senior debt is sourced in the bond market with the junior B loan sourced in the loan market. Under this scheme the B note will be funded by Aviva Investors Hadrian Capital Fund 1, a subordinated debt fund managed by Aviva Investors. The fund provides a first-loss cushion for bond investors in the senior part of the structure of between 8% and 12% of the debt financing. By providing long-term cash-based credit enhancement for up to 35 years the fund addresses the main deficiency of the monoline wrap – that it was an insurance product and investors were therefore exposed to the entire portfolio of the firm, including structured finance. Hadrian’s Wall is targeting greenfield and brownfield availability-based public private partnership projects.

The firm was originally targeting £500 million and €500 million investments, but this is a tough sell. It achieved first close in March last year with just £150 million. Aviva is the core investor and the European Investment Bank committed £50 million in March 2011. It was hoping to achieve first close on a European sub-fund in late 2012 but so far has not. The firm did not return Euromoney’s calls for this article.

In November last year the pilot phase of the European Commission’s Project Bond 2020 initiative was launched in Brussels. This will advance €230 million of EIB seed funding to between five and seven infrastructure projects either as a subordinated/mezzanine loan or as a subordinated guarantee. It will also provide project bond credit enhancement (PBCE) of up to €200 million a project, either via funded subordination or an unfunded letter of credit that could improve a project’s credit metrics from a triple-B to a single-A rating.

The pilot projects include several offshore transmission owners (OFTOs) in the UK, the A11 motorway PPP between Bruges and Knokke in Belgium and the A7 Bordesholm-Hamburg PPP motorway project in Germany. "If you are looking at the mitigation of construction risk, an unfunded letter of credit can provide enhancement to credit quality," says Federico Gronda, analyst at Fitch Ratings. "The subordinated option does not enhance the liquidity position of projects and is beneficial only during the operational phase through the reduction of senior debt leverage and the consequent improvement in financial coverage."

But the rating agency does see this as a positive development. "This can be a useful improvement to credit quality," says Dan Robertson, head of European infrastructure at Fitch. "One of the challenges is generating investor interest. The pool of investors for construction risk will be smaller, and they will need to understand the mechanics of the credit enhancement."

Not everyone in the market is so keen, however. "The EIB initiative is a complete and utter waste of time because the execution plan is fundamentally flawed," claims one banker. "Infrastructure and project finance debt is a partnership between the debt, the equity and the concession partner. A lot of things can happen over 25 years, and you will need to change terms and maturities and you cannot do that in the bond market. How can you get 100% bondholder consent?" He says that the EIB taking the subordinated tranche will not work as it entails bondholders giving up control to the EIB and being confident that it will always act in their best interests.