Perfect storm raises project finance costs

23 March 2016

Developers need to diversify sources of finance

Multiple banking sector trends are converging to push up project finance costs, according to panellists at MEED’s Financing Projects in New Oil Era conference in Dubai on 23 March.

These include falling liquidity due to lower oil prices and the withdrawal of government deposits from local banks, ratings downgrades and the implementation of Basel III standards globally.

“NBAD [National Bank of Abu Dhabi] was hit by the government deposit crisis,” says Frank Beckers, head of project finance advisory, global banking at the state-owned bank. “Fortunately we started two and a half years ago on our international strategy from West Africa to Asia, and we replenished with new deposits from Asia and the US, these international markets, but obviously the pricing changes.”

Since 2010, local banks have taken the largest share of project finance deals but they will increasingly struggle with long tenor finance. But international banks will struggle to reprise their leading role due to regulatory changes.

“Basel III coming in raises costs further,” says Sikander Zaman, head of the specialised finance division at Saudi Arabia’s National Commercial Bank. “Central Banks are asking banks to apply Basel on capital adequacy and there are different risk ratings – if a project is not rated then it is 100 per cent risk so you then have to put up quite a lot of capital, which raises costs.”

This encourages banks to do less project finance, or charge much higher interest rates.

The need to improve balance sheets through market funding is growing, but with liquidity tightening and bank ratings being downgraded, this is pushing up banks’ funding costs.

One option is to bring in long-term institutional investors such as pension funds.

“The institutional investor market fits the Middle East model perfectly, with its long-term lending,” says Steve Perry, global head of debt markets and syndication at Abu Dhabi’s First Gulf Bank. “But you would need to price the debt much higher, spend months educating European and US investors, or get a rating which is difficult in the construction stage.”

Rating and tapping capital markets requires sponsors to open their books and disclose financials, which some are reluctant to do.

Export credit agencies (ECAs) are another option, but require forward planning.

“Into order to be eligible for ECA support, government bodies need to plan from the outset and think about finance earlier,” says Beckers. “Contractors from different countries can bring significant ECA support or not and that means they have to think about who they prequalify.”

Other solutions are to look at shorter tenors.

“Either bank will do a charge a lot more, or do a lot less, or use mini-perms to reduce capital requirements,” says Zaman. “They have to diversify.”

A mini-perm structure is refinanced after six or seven years with new pricing. While the lack of construction risk and operational performance records can bring the cost of finance down at this point, developers and equity investors dislike the uncertainty. The conditions when they are forced to refinance could be poor, unpredictably raising costs.

“I wish it [mini-perms] would go away and die,” says Nizar Qallab, investment director at the UAE’s MENA Infrastructure.

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