The limited availability of long-term commercial funding for Gulf infrastructure projects has dogged the industry for around five years.
So when the region’s leading power and water utility, Abu Dhabi Water & Electricity Authority (Adwea) hinted last August that potential bidders on its planned 1,500MW, 53 million gallon-a-day Mirfa independent water and power project (IWPP) could have the option to finance it using short-term debt, the industry was quick to take note.
Adwea’s decision to offer bidders on Mirfa the option of a seven-year financing – a so-called mini-perm structure – alongside the traditional 23-year debt financing, represents a potentially significant shift in the region’s project finance market.
Lack of appetite
With a diminished group of lenders willing to commit to long-term financings demanded by Gulf infrastructure sponsors, appetite for tenors in excess of 15 years has been tepid since the outbreak of the financial crisis in 2008. The advent of more flexible funding mechanisms promises to widen the pool of lenders and, in turn, encourage cheaper bids.
The reduced list of banks willing to provide long-term lending commitments has forced pricing margins for tenors beyond eight to 10 years to well above the pre-crisis norm.
“The pool of international banks that are keen or able to participate in financing projects on a long-term basis has definitely shrunk and that is the reason why Adwea has allowed potential developers to bid on a mini-perm basis for Mirfa,” says Richard Keenan, a Dubai-based partner at US law firm Chadbourne & Parke. “The aim is to open up the pool of liquidity to bidders, who otherwise might not be able to find banks prepared to commit or fund their bids on a long-term funding basis.”
|Selected power projects and debt tenor|
|Project||Country||Cost ($bn)||Debt tenor||Financial close date|
|Ras Laffan C IWPP||Qatar||3.9||25 years||Q2 2008|
|Salalah IWPP||Oman||1||15 years||Q4 2009|
|Al-Dur IWPP||Bahrain||2.5||8-year mini-perm||Q2 2009|
|Shuweihat 2 IWPP||UAE||2.6||Bridge loan, refinancined in late 2009. Currently being refinanced again||Q4 2008|
|Rabigh 2 IPP||Saudi Arabia||2.5||26 years||H1 2013|
|Mirfa IWPP||UAE||2||Bids can be 7-year mini perm or 25-year||Early 2014|
|IWPP=Independent water and power project; IPP=Independent power project. Source: MEED|
The offer of a mini-perm fits with a shift in Adwea’s strategy, which is also trying to refinance a portion of the debt on the Shuweihat 2 power project, just four years after the original 22-year $2.6bn debt component was arranged.
Adwea had in 2009 pulled together a $400m “soft” mini-perm with a tenor of 20 years on the utility’s ISTP2 wastewater project (the project to build two new wastewater treatment plants in Abu Dhabi and Al-Ain), giving it a taste for short-tenor financings.
The first major deployment of a mini-perm in a Gulf project financing also came in 2009, when the Al-Dur IWPP in Bahrain achieved financial close.
The $1.7bn ‘hard’ mini-perm carried an eight-year tenor, compared with the 20-year debt originally sought. It managed to rescue the deal with the offer of shorter exposure at the height of the banking crisis. The deal comprises an 80 per cent balloon repayment, which must be refinanced at the end of the tenor to forestall default.
Despite a growing receptiveness to short-term lending, this clutch of deals should not deceive that Gulf project sponsors are ready to tear up the funding model of the past 20 years. Pointedly, bidders for Mirfa are still expected to rely on long-term financing, despite the client’s offer of mini-perm facilities.
Al-Dur’s experiment with mini-perms has not established a benchmark for other power and water deals to follow the same route. Rather, the use of short-term lending reflected the unusual circumstances of the time.
Lenders caution whether the time is ripe for a speedy uptake of mini-perms in Gulf project financings. Recent bellwether transactions such as the $7bn Barzan gas project finance deal for Qatar Petroleum, or the $20bn Sadara petrochemicals financing for Saudi Aramco and Dow Chemical, have been oversubscribed on long-term bank debt, says Jonathan Robinson, head of project finance at HSBC Middle East ,which is advising Adwea on the Mirfa project financing.
“With mega deals like Barzan and Sadara, sponsors are going out for huge slugs of bank debt and they appear to be getting it all,” he says. “While local and regional banks are taking up a greater proportion along with ECAs [export credit agencies], the tenor doesn’t seem to be a problem.”
However, the current model is to employ long-term investments for which long-term debt will be needed. Despite the increased capacity of local and regional players to step up to the plate, they could struggle to meet these long tenors.
“The current model will suffice in the context of the current range of deals, but something has to change,” says Robinson. “It’s premature to suggest that this is the dawn of mini-perms, but people need to be thinking about where the market might be heading.”
Financing Mirfa on a mini-perm basis does not mean that Adwea is not confident of securing liquidity on a 20-year basis. But it does enable the sponsor to see if a better deal could be had through refinancing.
“It’s about going and seeing what the markets tell us,” says Robinson. “If they say, yes we are up for it, we might give you more competitive debt pricing, which translates into a better tariff and into a better deal for Abu Dhabi in terms of the cost of power, then great. And if market says we’ll bear the full brunt of the refinancing risk, then even better.”
Another reason why mini-perms may feature more prominently in future Gulf project financings is the capital constraints that international banks have to deal with under Basel III regulations.
The latest measures to strengthen the regulation, supervision and risk management of the banking sector are expected to yield a significant rise in the banking industry’s capital requirements, which will limit liquidity for long-term lending to projects.
“Banks are saying, if we have to sign up for a 20-year deal, our Basel ratios will be really affected so we are either going to have to charge an arm and a leg, or we’re simply not there,” says one Gulf-based project financier. “On the other hand, by making this a refinancing structure whereby after seven years you refinance a portion – perhaps lump it into three seven-year deals over that period – you overcome the Basel problem.”
Additional support for mini-perms comes from the emergence of the Gulf’s bond market, which is potentially a source of alternative liquidity.
Adwea has been encouraging bidders to ensure that there is flexibility post-construction to refinance the scheme through the project bonds market.
“With the Shuweihat 2 IWPP refinancing, a significant proportion of the debt is going to be refinanced through the issuance of a project bond. That will open the door for further refinancing, which is where the mini-perm comes in,” says Keenan.
However, refinancing does carry risks, even if a seven-year asset should receive better treatment from a regulatory perspective than a 20-year asset. “Theoretically, seven years should be easier and cheaper, but not measurably so because Basel III starts to bite after three years,” says Robinson.
“One of the drawbacks is that it introduces refinancing risk and that can be quite significant. Gone are the days when you could feel comfortable predicting what financial markets will look that five or 10 years ahead.”
Power plant agreements tend to last for 30 years. But if these are financed on the premise of seven-year deals, this could introduce refinancing risk for an asset that might still have another 23 years to run.
“In that case, you are saying that in five years’ time the market will be there and conducive on both liquidity and pricing. That to me is a question mark,” says Robinson. Borrowers may find that when they go to refinance, the deal is 300 basis points more expensive than they anticipated. “Are they going to be happy or will they look back and wish they locked in for 20 years?” says Robinson.
Not all project sponsors will want to follow the example of Al-Dur, particularly those Gulf states that are less advanced in arranging large infrastructure financings. Kuwait, backing its first IWPP at Al-Zour, is unlikely to experiment with mini-perms.
“With Al-Zour, the sponsors want to see 100 per cent financing and repayment through the tenor of the concession, so there is not going to be any refinancing scenarios,” says one Kuwait-based banker. “Bidders have to show that the financing is going to be in place throughout the tenor of the concession.”
Although more mature markets such as Saudi Arabia might be better suited to mini-perms, there are other hurdles that will have to be overcome. One is that several Saudi power and water projects have been financed with large volumes of Islamic funding. Refinancing an Islamic component though the project bond market could add another layer of complexity.
Adwea has set a March deadline for consortiums to submit bids for the Mirfa IWPP, the results of which will determine whether there is wider scope for mini-perms in the region.
Even if Mirfa proceeds with long-term debt, few doubt there will be increased opportunity for short-term financing as the region’s project finance market matures.
But the priority now is to factor in the refinancing risk, say experts. “Banks have to be confident that the refinancing risk is properly apportioned between sponsors, banks and procurers,” says Robinson.
“Is it properly priced and do they understand the ramifications of not being able to refinance, or more likely not being able to refinance on terms and conditions that we are projecting today?.”
8 years: Tenor of the mini-perm used for the Al-Dur IWPP in Bahrain in 2009
7 years: Tenor of Abu Dhabi’s mini-perm option for the Mirfa IWPP
IWPP=Independent water and power project. Source: MEED
Mini-perms The two types of short-tenor loans
Under a hard mini-perm (as with the Al-Dur IWPP) the loan has a short legal maturity of about seven or eight years, at which point sponsors face default if it is not refinanced. In some jurisdictions, if the sponsors do not refinance at the end of the initial term, the government buys up the debt, meaning the refinancing risk is borne by the sovereign. On Al-Dur, a 100 per cent cash sweep applies during the last three years of the loan, with full dividend lock-up during this period.
Under a soft mini-perm, sponsors take the risk of the project not refinancing at the end of the mini-perm. However, they are incentivised to refinance. Should the refinancing not occur then they continue with the financing, although this is on less favourable terms as they are subjected to cash sweeps and increased pricing. Financers generally view soft mini-perms structures as another form of long-term financing.