There is now a broad consensus across the banking industry that liquidity available for project finance lending is shrinking. At the same time, demand for capital is increasing. This leaves regional project developers with a conundrum for which no one really has an answer yet.
The situation will need to get worse before people start to focus on finding a solution for this problem, says Jonathan Robinson, head of project finance for the Middle East and North Africa region at the UK’s HSBC.
As an adviser or a lender on almost every significant transaction in the region, Robinson has a unique perspective on the market. He has advised Abu Dhabi Water & Electricity Authority (Adwea) on its independent power plant scheme, the Abu Dhabi government on its $30bn nuclear power project, Saudi Aramco on its PetroRabigh expansion plan, and has lent on projects such as Qatar Petroleum’s Barzan gas deal in 2011 and the Saudi Aramco Total Refining and Petrochemical Company deal in 2010.
“The reality is that there is a growing constraint on bank capital used for the purposes it is most needed for in this region,” says Robinson. He points to international banks becoming more risk-averse in the wake of the financial crisis and increasing regulatory constraints, as well as regional lenders facing constricted funding as indications of this. “The supply and demand of capital should be more of a concern than ever because demand is growing, but supply is not.”
This should not detract from the region’s strong investment case, he says, it is just a questioning of the ability of traditional sources of liquidity to meet those needs. “The Middle East is not buying itself out of problems, and it is one of the most compelling investment stories in the world,” he says.
A recent survey of about 100 of HSBC’s regional clients and other lenders found that 75 per cent thought project finance would remain the key funding tool for large infrastructure projects. However, Robinson says the survey also found that the same number of respondents thought financing conditions would remain worse than before the financial crisis for the next three years.
When demand outstrips supply, the winners will be the ones who are already thinking about [alternative options]
Jonathan Robinson, HSBC
For many people in the industry, this is why alternative sources of funding such as project bonds will become more important. But Robinson says things may not yet be bad enough for attention to shift to areas such as project bonds. “Potentially we may be reaching that tipping point, but at present, big borrowers in the region can still get all the money they need at fairly advantageous pricing for the usual long tenors,” he says. “So they are asking ‘what crisis?’”
“It will not be until they hit the inflexion point, where suddenly they can’t get all the money they need, that we will see genuine development of the capital markets. I applaud firms such as Abu Dhabi’s Mubadala that are pioneering this, but as a realist I don’t expect it to be a panacea in the coming years.”
Even then, he cautions that project bonds make up less than 10 per cent of the global project finance market, so to expect them to suddenly play a more significant role in a region where capital markets are still maturing is optimistic.
“When, and not if, demand outstrips the supply of traditional capital, the winners will be the ones who are already thinking about [alternative options],” he says.
He also suggests that the role of export credit agencies (ECAs) in stepping in to fill the funding gap left by banks has been overplayed. “Have the ECAs overall been on the front foot in stemming the gap in private sector liquidity? No. Some ECAs have, notably the Korean and Japanese, but I don’t think from a macro perspective that ECAs have stepped in to stem the impact of the financial crisis.”
In the short term, borrowers in the region will probably be able to continue to get the money they need out of banks and ECAs, even if the deals often look unattractive for lenders.
“We have to look at relationships holistically now, as do the region’s big corporates,” says Robinson. “One project finance deal may not make sense for us in isolation, but when you include the overall relationship and add up the income for cash management, acquisition finance, and credit cards for staff, it becomes a hugely important relationship for us.”
“Global banks also play an important role in supporting these companies and their strategic investments as a lot of them almost begin to operate at a geopolitical level when they do projects with companies from the Far East, for example,” he says.
This shift in how lenders view deals is an important one, he says, and will continue to shape the industry in the coming years.
Robinson even expects pricing to go up this year and tenors to remain long. “I believe pricing will go up in 2013 from where it is today and that will be a reflection of an increased cost of capital for banks,” he says. “But I don’t see tenors getting shorter.”
75 per cent: Of firms surveyed by HSBC think that funding conditions will remain tough
10 per cent: Representation of project bonds in the global project finance market