Article

Project Bonds

An alternative source of financing infrastructure projects

The global financial crisis has resulted in stricter regulations on banks and their lending requirements which mean that infrastructure projects can no longer be funded by traditional debt alone. Other more innovative ways of funding need to be considered and implemented such as project bonds.

Project Bonds vs. Traditional Debt

Recent surveys suggest that infrastructure is beginning to be viewed as an asset class of its own and the allocation to this investment class is expected to increase significantly. However, the global financial crisis has resulted in stricter regulations on banks and their lending requirements which mean that infrastructure projects can no longer be funded by traditional debt alone and other more innovative ways of funding need to be considered and implemented.

Advantages of Project Bonds

Project bonds open up an alternative debt funding avenue to source financing for infrastructure related projects. Traditionally, deals have been financed through banks, however the implementation of Basel III regulations requires stricter monitoring and disclosures, ultimately leading to higher costs and higher capital requirements. These higher costs will be passed through to the project developers translating to diminished project IRR’s (internal rates of return). By accessing the institutional bond market, companies are potentially able to reduce the project funding cost.

Government and the banks alone cannot fund South Africa’s R3,4 trillion infrastructure program. The use of bonds allows project developers to tap into R3 trillion worth of assets under management by South African institutional investors. In addition, Sovereign Wealth Funds are beginning to invest directly into infrastructure projects, so this may also provide an additional source of funding for capital projects into the future.

Project bonds offer an opportunity for institutional investors to participate in infrastructure projects through listed, tradable securities that can offer superior risk-adjusted returns.

Challenges of using project bonds as a source of funding

The use of project bonds as a funding mechanism may be unattractive to investors with a lower appetite for risk which is inherently higher in the construction industry. Before the financial crisis, capital markets were seen to be less stable than debt markets, which have now changed given the reduction in global liquidity. Local institutional bond investors, while happy to take on performance risk, generally are not prepared to take on any form of construction risk.

Not all debt portions of these deals will be able to take advantage of this source of funding, but this mechanism will certainly provide benefits to the project developers in the form of potentially enhanced returns due to the lower cost of capital.

Project bonds issued by corporates in the rest of the world

Thus far, project bonds have been successfully utilised in Europe and America to fund infrastructure projects. In Europe, corporate bond markets continue to grow in spite of the increase in market volatility and it is anticipated that the use of corporate bonds to fund infrastructure projects in Europe will play a significant role in boosting the Economy.

In Africa, both Kenya and Nigeria are examples of where project bonds have successfully been implemented. Both countries have a growing institutional investor base. In Nigeria, corporate bonds are tax exempt while Kenya has specific exemptions for infrastructure bonds which encourage the use thereof as an alternative funding mechanism.

The rest of Africa is still in the early stage of development of project bonds, and while the need for infrastructure development is clear, it will require investors to collect more funds, borrowers to gain a higher confidence in the bond market and governments to create an environment which will encourage the issuance of project bonds.

South Africa’s first listed project bond by a corporate: CPV1

April 2013 saw the first listing and investment-grade rated infrastructure project bond, held entirely by institutional investors. The bond was listed on the Johannesburg Stock Exchange in June 2013. Professional services firm Deloitte & Touche, in association with Trident Capital, were the lead transaction advisors with Standard Bank acting as lead arranger, book runner and debt sponsor. The bond was issued by CPV Power Plant No.1 Bond SPV (RF) Ltd, a Soitec Solar GmbH affiliate. The proceeds were used to finance the construction of a 44 MWp Concentrated Photo Voltaic Plant. The plant, located in Touwsrivier in the Western Cape, will be the largest CPV plant in the world. Soitec, a French company listed on Euronext Paris, is a global leader in the manufacture of semiconductor material for electronics and more recently energy.

The Touwsrivier Solar Project, that the bond proceeds were used to fund, is one of the 28 round 1 projects which were awarded preferred bidder status under the Department of Energy’s REFIT Programme on renewable energy on 5 November 2012. Renewable energy project developers will enter into 20 year Power Purchase Agreements with Eskom, backed by the Department of Energy.

The plant is to be built in the impoverished town of Touwsrivier, which is situated along the N1 highway in the Western Cape. The community suffers from an unemployment rate of over 65% and is affected by a high percentage of alcoholism. Although Soitec would have benefitted from a higher solar resource in the Northern Cape, being fully committed to social and economic upliftment, they chose to erect their plant in Touwsrivier, which is still a high solar resource region.

The bond’s attractiveness lies in its design. The bond has been assigned a long-term Baa2.za South African national scale rating by Moody’s Investor Service.

The bond’s most impressive feature is its repayment terms. It offers an attractive fixed coupon rate of 11% over a 15 year period, based on an amortizing profile as opposed to a bullet structure. This effectively gives the bond a modified duration of 7 years. This structure allows for both the principal and interest to be repaid at the same time in contrast to a conventional bond where investors receive the capital repayment at maturity. This makes it comparable to a 7 year swap instrument. The yield of 11% is 450 basis points above that of a 7 year swap.

The project is housed in special purpose vehicle called CPV Power plant 1. The SPV is 60% held by Soitec, 35% by empowerment partner Pele Green Energy and 5% is held by the Touwsrivier Community Trust.

To be able to successfully deliver a bond of this nature affirms the sophistication of the South African bond market especially given technology is still untested on a utility-scale. The successful issue of the bond opens up an alternative debt funding avenue to source financing for infrastructure-related projects.

 

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