The return to market

30 November 2001

For those willing to see beyond the immediate, the closing months of the year may have seen some of the rules drawn up for an important new financing game. Although properly structured project finance is still in its infancy in the region, some early markers of how refinancings might be conducted have been laid down.

The work done on the refinancing of Oman LNG and Equate Petrochemical Company was distorted to some extent by the events of 11 September. But there are still a number of important pointers as to which other transactions might find a way to the refinancing market, and just how these deals might be done, and by whom.

The first question revolves around which projects are fit for refinancing. 'Put simply, the development of projects - either positive or negative - can lead to altered risk profiles that can prompt refinancing,' says a banker active in the region. 'You also have refinancings provoked by market movements. For example, if pricing patterns are trending down, old debt can be refinanced to the benefit of the borrower, or alternatively they might want to push out the tenor of a deal, or loosen some of the terms and conditions.'

Beyond this, the very manner in which a number of deals were originally structured builds in triggers for refinancing. For example, step-up pricing moves in the opposite direction to the risk profile of the project: the older a liquefied natural gas (LNG) project grows, the less inherent risk there is. Yet, the price of the debt increases encouraging the borrowers to refinance.

'This is no accident,' says another banker. 'One of the purposes is to get round the difficulties associated with banking long tenor.' This is a particular issue in the Gulf where recent deals have seen tenor pushed out far beyond what is seen elsewhere in the world: the senior debt facility for Abu Dhabi's Shuweihat independent water and power project (IWPP) is 20-year money, while in Western Europe and the US there is little bank lending beyond 10 years.

'Neither the regional nor the international banks really want to have 12-year or more assets on their books so when the teams are structuring the deals they are letting participants say to their credit committees: 'Look, this may say 12 years-plus but the cash sweep or the step-up at year x means it will be refinanced way before then',' he says.

The $1,300 million refinancing of Oman LNG and the $900 million deal for Equate could prove to be the tip of the iceberg. 'As the number of project-financing deals inexorably rises in the GCC, the number of potential refinancings also grows,' says the second banker. 'But this raises a whole new set of questions over appetite for regional project finance.'

The most likely source of refinancing deals will be Qatar, not least because more project finance deals have been done in Doha than anywhere else in the region. First to market next year will probably be a $300 million refinancing for Qatar Fuel Additives Company (Qafac), for which BNP Paribas is expected to be appointed as financial adviser before the end of December. Also prime candidates for refinancing over the next 12-18 months are four other Qatari projects with total debt worth just under $3,000 million (see table).

'The situation faced by the authorities in Doha is a familiar one,' says a third banker interested in the refinancings. 'They have a scheduling issue. Just as in the past they had to be careful with their primary deal timing. Now they have to make sure that refinancings don't get in the way of fresh deals that need to come to market. There could be some very delicate juggling ahead.'

One issue that borrowers will have to address is the full extent and nature of international appetite for these transactions. Close examination of the lists of participants in the Equate and Oman LNG deals makes for interesting reading. A number of the first-division international banks seemed happy to walk away from the refinancings. Will this become a trend?

'There are two important factors at play,' says the third banker. 'The very nature of refinancings is that they are less about heavy fee-generating structures: the projects are more mature, the cash flows are visible and the process is generally more simple. As a result, those banks chasing fees will be less interested in underwriting and arranging refinancings, though they will still want the advisory mandates. We could see a situation in which the second-division players find they can pick up refinancing lead arranging mandates more easily than they can primary deals. The overall impact of this on the regional finance market could be considerable.'

The sword is double edged. Some of the banks that lent into the original projects, and have kept some of the exposure on their books, will be unwilling to be driven into accepting lower margins, longer tenor and relaxed covenants. However, at the back of their minds will be the thought that if they leave the transaction, the up-front fees originally earned look even fatter on what ends up as short-term lending, and exits from deals frees up balance sheet for the potential underwriting of new projects.

There is also the question of how deals will be refinanced. Overdependence on bank markets is a cause of concern, though only Qatar has made a serious attempt to diversify its funding base by using project bonds and insurance-wrapped debt.

'Bank finance is not a bottomless pit and alternative sources of finance will have to be found,' says the second banker. 'The development of refinancings will only serve to accelerate the process. Perhaps more importantly, the very fact that refinancings are for established projects that have passed construction and technology risk and are only really faced with market risk, make them far more suitable for capital market solutions.' But in the absence of any proper regional bond markets, developers will have to look to Europe and the US.

It is no coincidence that, prior to 11 September, both Equate and Oman LNG were examining bond components for their refinancings. Turmoil on international capital markets saw the window firmly closed, but it would be unwise to rule out bond-based refinancings in the future. 'There is a clause in the original documentation saying that the refinancing could go to the bond market,' says a senior official at Qatar Vinyl Company. 'We have gone through a rating exercise. But we have the option to do it on a commercial basis.' There are also good reasons to think that Oman LNG may come back with a bond component to its refinancing if market conditions are suitable in the not too distant future.

There is another school of thought that warns against too many conclusions being drawn from the Equate and Oman LNG experiences. 'These will both end up being seen as atypical deals,' says the first banker. 'Appetite for Equate was very strong among local banks, but most of the original international participants were not attracted by 80 bp [basis points] and extensive relaxation of covenants. And Oman LNG was moved from pillar to post and rushed through. The terms were too tight on both deals. But that is about all that can be learned.'

That may well prove to be the case, but it is impossible to ignore the fact that a new line of credit demand is opening up. The region's bankers, international, regional and local, will have to decide how they wish to respond. The old interests of relationship banking might clash with prime yield-based lending, and the dictates of balance sheet management and appetite for fee income might lead some institutions to rethink their strategies. The wavering of institutions such as HSBC Investment Bank and Royal Bank of Scotland over their participation in the Oman LNG deal could be an early indicator of these considerations. The detailed rules of the new game will have to be worked out before the players will show their hands.

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