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ADB Manilla

Recent developments in the Project Bond Market
for the development and refinancing of PPP
Transport infrastructure

May 2014
Michael Redican, Managing Director, Structuring - Deutsche Bank


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Factors currently driving capital market interest in
project bonds


! Basel III is affecting the appetite of banks for providing long dated project finance globally.
Many traditional players have left the market or are only providing finance on a short term basis
although we still see strong demand from Japanese banks and some recent returning interest
from some French and other European banks but on a selective basis
! We suspect that this interest from the banks is driven by the low level of infrastructure PPP
activity across the continent as a result of the continuing austerity measures of European
Governments which is stifling deal flow
! We are however seeing renewed interest in project bonds from investors and new
developments such as the European Project Bond Initiative are designed to facilitate this
! Elsewhere such as the US, there is a huge amount of interest in funding infrastructure through
bonds and the muni, PABS and private placement markets are very active. Sovereign credit
quality is the key driver for investors to look at certain markets and even them notably the
middle east some of the more conservative investors are cautious
! Developing countries will continue to struggle to attract sufficient bank liquidity in the current
environment unless there is substantial mitigation of sovereign and currency risk and pricing
will be more expensive. Capital markets are not available at present because these risks are
not mitigated to the level that could reach investment grade
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Investor demand in last 12 months for infrastructure is
growing
! Presently we see increasing interest in infrastructure as an asset class from investors who have
long term horizons and a requirement from pension funds and insurers to adequately match
their assets and liabilities.
! The recent readjustment in pricing of PF as a result of the financial crisis has seen a greater
convergence in pricing for certain types of deals at particular rating levels. This has resulted in a
more attractive landscape for the capital markets to compete
! Due to the essentiality of Infrastructure to its people and that many of the cashflows emanate
from Government, many investors are perceiving infrastructure as a higher yielding access to
Government risk, although accepting that construction risks in particular lead to a higher risk
profile and many investors are still adverse to construction risk unless properly mitigated.
! Operating risks ( brownfield risks ) are generally more acceptable and provided these are well
understood and Sponsors are well known deals are attracting a lot more interest.
! Volume risks generally are not favoured unless there is substantial operating history
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Investor demand in last 12 months for infrastructure is
growing
! In November 2013, DB completed the !1.3bn refinancing of the R1 road PPP in Slovakia on
behalf of Sponsors Vinci and Meridiam Infrastructure. The Slovakian government took a majority
share of the refinancing gain in the form of reduced availability payments.
! We issued and sold !1.3bn of 26 yrs amortising bonds with an average life of 16 years at a price
of mid swaps+235 b.ps.
! This was unthinkable even 12 months ago.
! The bond was 16 years longer than the longest sovereign for Slovakia. The bond had only one
rating of BBB+ from S&P.
! There were 29 different investors from all parts of Europe including UK although German and
Austrian investors were the majority of the book.
! Given the country, the tenor and the currency ( very long dated for !) the demand and price was
unexpected at this level and was at the tightest end of our most optimistic predictions.
! More and more accounts want more product and are looking at different types of infra related
deals to get it.
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EU 2020 Project Bond Initiative a model?

! In Europe, DB (and a small group of other banks) have worked to develop the Euro 20/20
project bond initiative used in PPP structures. The facility is now known as the Project Bond
Credit Enhancement facility.
! Essentially this can be compared with a normal structure as follows

Conventional Model EU 2020 Model
Senior Debt
80-90%
Equity
10-20%
Senior Debt
80-90%
Equity
10-20%
15-25%
PBCE Guarantee
Rating BBB- Rating A-
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EIB / EU 2020 Project Bond Initiative

! There are three elements to the PBCE
i. Construction Facility
ii. Debt Service Facility
iii. PBCE Injection
! The aggregate outstanding under any of the facilities cannot exceed [20]% of the bond amount
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Construction Facility

! The PBCE construction facility provides up to 20% of liquidity support to a project if there are
cost overruns and/or the Contractor is unable to meet his obligations under the contract for
liquidated damages or overruns. In some cases the Contractor will be terminated and his
performance bonds called, however as the aim is to get the asset into operations, then
provided there is not an event of default in the event there is a delay to the construction the EIB
will advance monies to ensure the project gets built
! Once in operations any amounts advanced subject to a cash sweep after debt service
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Debt Service Facility

! This is sized to a maximum of [3] months debt service and can only be utilised once the debt
service reserve has been fully drawn
! It is meant to act as a facility which provides for an extended cure period to remedy serious
operational difficulties
! A maximum of 4 semi annual drawings are made after which the EIB will fully utilise the PBCE
injection and repay bondholders 20% less amounts utilised under the debt service facility
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PBCE Injection

! This facility is really a first loss guarantee for bondholders and reduces the principal amount
outstanding
! EIB together with bondholders will vote to either inject the funds in to repay the bonds (and
improve coverage ratios) so that the project may continue or default the project and
bondholders will enforce their security and recover amounts
! Any shortfall up to 20% will be met in full by the PBCE injection unless there has been
drawings either under the construction facility or debt service facility which have not yet been
repaid
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Ratings Benefit

! The effect of this guarantee structure improves both the probability of default measure as well
as the loss severity both of which are important to the Ratings Agencies and result in an uplift
in the bond ratings. In the A11 project ( see below) we have obtained a rating uplift of 3 notches
from Baa3 to A3 by Moodys
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A11 !577mn greenfield road project in Belgium
structured by DB using PBCE was sold in March 2014
! First bond using construction phase PBCE instrument. Highly successful transaction that won
lots of plaudits
! 20% L/c underpinning during construction phase was reduced to 10% in operations phase due
to Moodys perceived view that operating phase risk on an availability based PPP road project
was lower. If there had been real traffic risk then debt:equity ratio would have been lower and
PBCE would have been maintained at 20%.
! We continue to believe that deals with traffic/volume risk will remain more expensive, have lower
ratings and will be more difficult to sell
! The PBCE provided a 3 notch ratings enhancement from Baa3 to A3
! Bonds were sold to two investors on a drawdown basis to minimise cost of carry at mid swaps
+187 b.p
! We do not think this was optimal as public market would have delivered a better spread which
would have more than eliminated negative cost of carry but Flemish Govt were unwilling to take
any market risk in their procurement. This issue will remain with Public Authorities in Europe
outside the UK
! Disadvantage was that many investors who wanted the paper could not get access to the bonds
and in any event may have had issues on buying bonds on a deferred basis
11
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A11 !577mn greenfield road project in Belgium
structured by DB using PBCE was sold in March 2014
! DB worked with investors and EIB to structure intercreditor agreement and voting rights
! Role of Project Agent to deal with day to day matters, Discretionary Matters
! Use of electronic voting through Clearing platforms ( such as Euroclear) for more serious issues.
! During any voting, investors become insiders and cannot trade the bonds. Have a dedicated
password access for restricted website. Results of votes and consequences are published on
public website and trading can resume
! Majority and Extraordinary Voting concepts applied
! No acceleration of Senior Bonds permitted whilst PBCE still available
! Structures developed determined to be robust by Moodys
! Role of TA reporting important in construction. Electronic platform enabled investors to make
enquiries of Project Agent on specific matters
! Disclosure of financial and project is done by way of public websites with format agreed
between investors, Sponsors and Ratings Agencies ( no monoline black box risk) .
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Could we see Project Bonds for Developing Countries?
! Most projects have two principal problems in developing countries
! Sovereign risk itself
! Underlying project risk
! In order to facilitate project bonds it is likely that the Sovereign risk must be substantially
mitigated by Political Risk Insurance such as those provide by the ADB. This should cover
appropriation of assets , contract repudiation and retrospective legislation that adversely affects
the project etc
! Currently these instruments are not on-demand and are paid out only at the end of an
adjudication process. This has been the case with most PRI cover. They are therefore not fit for
purpose for investors or Ratings Agencies who rate probability of default, timeliness of payment
and ultimate recovery.
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Could we see Project Bonds for Developing Countries?
! Recently in September 2013 MIGA provided a Non-Honoring of Sovereign Financial Obligation
(NHSFO) cover to Magyar Exim Bank which enabled the bank to issue bonds at AAA. No
adjudication is required in this cover but the guarantee is only issued on the basis that the
obligation is absolute on the Sovereign. Nevertheless the insurance does cover all shortfalls in
principal and interest on an ongoing basis, it may be a basis for further development
! Most projects are not as clear cut but providing ADBs products ( and others) could be designed
so they would pay out in advance of a lengthy determination process of adjudication. There may
be a small grace period but it would have to be short.
! By combining with a PBCE type structure at the Project level to meet the underlying level risks it
may well be possible to lift the deals into the IG territory and attract investors willing to buy.
There is potentially a huge pool of money available if this can be done
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Suggested ADB Model for Capital Market Funding of
Infrastructure ( discussion)

ADB Public
Country
BBB--/Baa3
Project
Company
Finance SPV Bondholders ADB Private
Negotiate risks to be
covered
Insurance
Premium
On-loan Proceeds Gtees
Gtee Premium
ADB PBCE Facility
New Insurance
Policy
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Conclusions

! Europe is seeing rapidly growing interest in the use of Project Bonds for both primary deals and
refinancings. Investor appetite is huge but deals are in short supply.
! A11 demonstrates how partial credit enhancement by use of PBCE is accepted by market and
Ratings Agencies. Full guarantees and AAA ratings are neither required nor wanted as
investors want better returns
! Investors like long-term nature and essentiality of infrastructure projects but need specific
criteria to be met. Demand for product is continuing to grow and there is a willingness from
investors to consider new areas of the World in return for yield providing that key risks can be
structured mitigated
! Investors cannot access nor do they have the resources to analyse these credits and country
risk element is traditionally off-putting
" ADB and other multilaterals may be able to resolve associated issues
! Changes to policies provided by ADB (and others) may be challenging but would provide
investor confidence and enhance willingness to buy
! ADB in offering credit enhancement may be able to facilitate more transactions and utilise less
capital
! Given that ADB would not be required to enhance to AAA, unlikely that bonds enhanced in this
manner would affect pricing of ADBs own credit curve
! Real potential if ADB and other multilaterals take up the challenge
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