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27 Nov 2012

The National Planning Commission recently identified a 30 percent fall in public sector spending since 2008.

Project bonds, an asset class that is still untapped in this country, could be a viable alternative means of financing infrastructure projects.

This is more bad news for many South African infrastructure groups who are battling to survive, especially considering that (according to Murray & Roberts) though government announced South Africa’s R4 trillion expenditure on infrastructure over the next 15 years, there were no tenders issued for a major infrastructure project.

With the infrastructure sector now waiting for the state to start spending on its 18 strategic infrastructure projects, outlined at the October 2012 Presidential Infrastructure Investment Conference, funding has become a real problem.

With banks, other financiers and major equity investors tightening their lending requirements for many infrastructure projects, an opportunity for non-bank money to fill some of the gaps being left by international banks scaling down on long-term lending is available.

Locally, the time is ripe for the injection of fresh life into South African infrastructure investment – but borrowers will have to start looking beyond the banks at alternative sources of funding.

Are project bonds the future of infrastructure in South Africa?

Around the world, governments have embarked on major infrastructure investments following the global financial crisis and the resultant economic downturn.

These initiatives are designed to cushion, if not reverse, the rapid slide into economic recession.

Governments are also attempting to fill the gaps that have emerged as banks, other financiers and major equity investors turn off the funding tap for many infrastructure projects.

Project bonds, an asset class that is still untapped in this country, could be a viable alternative means of financing infrastructure projects.

These bonds allow access to large international pockets of non-bank money and could potentially fill some of the gaps being left by international banks scaling down their involvement in the project finance arena.

Project bonds are typically debentures used to finance project and infrastructure transactions, and are issued with a long maturity, usually longer than 10 years.

Banks need to bear higher liquidity and capital holding costs as a result of Basel III, and this has pushed up the cost of lending.

This is in contrast to the tenure of five to seven years for corporate bonds and bank loans, the more traditional means of financing projects.

However, the tenure of project bonds would not appeal to all investors but specifically those with an appetite for long-term investments, notably pension funds and insurance firms.

Project bonds advantageous for borrowers and investors

At this particular point, project bonds could be advantageous for borrowers and investors alike as the capital markets are not contending with the same cost and regulatory constraints as the banking sector.

Banks need to bear higher liquidity and capital holding costs as a result of Basel III, and this has pushed up the cost of lending.

Additionally, faced with the Eurozone crisis, European banks’ credit committees have less appetite and are taking a much more conservative approach towards long-term lending.”

While the position of South African banks is more positive, local banks have a clear preference for shorter dated assets, typically of five to seven years, and so are unlikely to step into the funding gap left by international banks.

Also, the funding available from local banks may be stretched because of demand for financing from bidders in the renewable energy programme for independent power producers.

As an alternative source of funding for capital-intensive projects, project bonds are well worth looking at.

They have been used successfully in markets such as Europe, Latin America and the Middle East.

In South Africa, if transactions are properly structured to address the issue of construction risk, there should be significant potential and appetite for project bonds among investors.

Construction risk refers to the initial period when the project is built or constructed, usually the first three years, when the risk to investors is highest because no cash flows are being generated yet and construction could be delayed for whatever reason or ultimately fail.

Investor concerns about construction risk can be addressed through upfront credit enhancement in the form of subordinated debt, or through guarantees from third parties, whether government or development finance institutions.

I think there is a place in South Africa for project bonds – the expertise is available, there must be appetite and there is certainly a need for alternative sources of project finance provided that the bonds are structured in such a way as to minimise investor concerns. 

Project bonds could supplement existing infrastructure funding and help deliver the growth boost for which politicians and economists are looking at infrastructure investment to deliver.

The question is: who is going to be first to test the waters? - Richard Roothman

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