Transcript Using Capital Markets in the Financing of infrastructure

Using Capital Markets in the Financing of Infrastructure:
The Use of Liquidity Facilities
Inter-American Development Bank Business Seminar
Capital Markets for Development
Tuesday, June 3, 2003
Washington, DC
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Discussion Topics
•
Types of Liquidity Facilities
•
Capital Markets Financing for Developing-Country
Infrastructure Projects: Current Issues
12
•
Conceptual Structure of a Foreign Exchange Liquidity Facility
17
•
Implementation of a Foreign Exchange Liquidity Facility:
The AES Tietê Transaction
27
•
Applicability and Benefits of Foreign Exchange Liquidity Facilities
31
•
Status of Liquidity Facilities as a New Financial Product
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Types of Liquidity Facilities
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Liquidity Facilities: Examples
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Debt Service Reserve Accounts
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Foreign Exchange Liquidity Facilities
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Contingent Partial Credit Guarantees
•
Merchant Power Market Floor Price Facilities
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Debt Service Reserve Accounts
•
Self-funded:
– In cash, with a portion of the project’s senior debt,
– With a letter of credit provided by the sponsor, or less frequently,
– From project cash flow
•
Typically sized at an amount equal to six months debt service
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Drawn upon in the event of a debt service shortfall
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Replenished from cash which would otherwise be available for distribution to the
sponsor
•
Used to cover the risk of:
– Temporary operating problems which can be fixed within the short-term
– Insufficient cash to pay debt service until an insurer or other third-party
provider of support can determine that it should provide funding (e.g., OPIC
capital markets inconvertibility policy)
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Foreign Exchange Liquidity Facilities
•
Liquidity facility is provided by a third party:
– Bilateral or multilateral agency
– Private political risk insurer
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Size of the liquidity facility depends upon:
–
–
Historical volatility of real exchange rates in the project’s host country
Prospective debt service coverage ratio of the project
•
Drawn upon when the project’s cash available for debt service, converted into
US dollars, is below a pre-established “floor value” and is insufficient to permit
payment of scheduled debt service
•
Draws are evidenced by a loan subordinated only to the project's senior lenders,
repaid as soon as free cash flow allows
•
Used to mitigate the risk of fluctuations in the real exchange rate of the project’s
host country
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Contingent Partial Credit Guarantees
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Contingent Partial Credit Guarantee (which functions as a liquidity facility) is to
be provided by the IFC
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Size will typically equal two years debt service
•
Guarantee becomes effective in the event of a major devaluation
•
Applicable to both US dollar and local currency financings
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Used to mitigate
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the risk that an infrastructure project will not be allowed to raise prices adequately
following a major devaluation:
•
•
–
IFC analysis indicates that after two years, economic recovery is usually sufficient to permit
price increases
Springing guarantee improves credit quality of the project and facilitates sale of securities
denominated in local currency to investors in the project’s host country
the risk of higher interest rates on floating-rate local currency securities
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Merchant Power Market Floor Price Facilities
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Liquidity facility is provided by a third party:
– Financial institution
– Private insurer
•
Size of liquidity facility depends upon independent market consultant’s estimate
of:
– Downside value of pure capacity
– Maximum duration of market overcapacity
– Prospective debt service coverage ratio of the project
•
Drawn upon when the market price falls below a pre-established “floor price”
and is insufficient to permit payment of scheduled debt service
•
Draws are evidenced by a loan subordinated only to the project's senior lenders,
repaid as soon as free cash flow allows
•
Used to mitigate fluctuations in the market price of electric power
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Rationale for the Use of Liquidity Facilities in
Infrastructure Project Financings
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Infrastructure financings are particularly suitable for liquidity facility providers to
take a long-run view
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High coverage ratios provide a large margin for error in changes of the values of
the risk factors covered by the liquidity facility
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Long tenor provides a long time for economic forces to return to equilibrium
•
Long useful life (both physically and economically) of the assets of an
infrastructure project provides the basis for repayment of any claims outstanding
at the final maturity of the senior debt
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A Comparison of Derivatives, Insurance, and
Liquidity Facilities
Risk Mitigation
Technique
Structural
Approach
“Recovery”
Opportunities
Liquidity
Facilities
Derivatives
Insurance
Risk intermediation
(running a “book”)
Pooling of
uncorrelated risks
Risk analysis and
transaction
structure
Portfolio
Portfolio
Individual
transactions
None
None
Repayment of
draws
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Applicability of Different Risk Mitigation
Techniques to Currency Risk
•
Insurance products are seldom used to mitigate purely economic risks
•
Derivatives frequently are not offered for tenors sufficient to mitigate the most
significant risks in project financing
–
–
Power markets
Currency markets
•
If derivatives with a sufficient tenor to use in project financing exist for the
currency of a developing country, the country will have a long-term fixed-rate
local currency debt market and is likely to have investment-grade foreign
currency debt ratings
•
Liquidity facilities are likely to remain the best option for dealing with currency
risk in countries for which currency risk is an issue
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Capital Markets Financing for DevelopingCountry Infrastructure Projects:
Current Issues
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Financing Developing-Country Projects with
Local Currency Revenues: Old Model
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Project sells its output for local currency
•
Output prices contractually linked to US dollar exchange rate
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Project contractually shifts devaluation risk to output purchaser, but remains
exposed if, following devaluation, purchaser should default and attempt to
renegotiate output contract
•
To gain protection from devaluation / renegotiation risk, project may be
structured with co-financing from ECAs, OPIC, or multilateral agencies
•
To gain protection from inconvertibility risk, political risk insurance and/or cofinancing with a preferred creditor are likely to be used
•
Rating of the project’s senior debt is limited by sovereign ceiling of the host
country
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Problems with the Old Model for
Infrastructure Finance
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Examples of Argentina and Indonesia highlight the limitations of the old model:
–
–
–
•
Currency mismatch risk limits transaction rating to the sovereign ceiling
–
–
•
Regulators may deny output purchasers sufficient tariff increases to avoid default on
US dollar debt
If devaluation is sufficiently severe, output purchasers may default regardless of the
consequences
Renegotiation process, even if successful from the project’s point of view, may interrupt
the project’s cash flow so as to prevent timely payment of interest and principal
Fewer investment-grade developing countries than in the mid-1990s
Fixed-income investors reluctant to purchase low investment-grade debt issued by
developing-country infrastructure projects
Linkage of project output prices to FX rate stresses credit capacity of the output
purchaser
–
–
Output purchaser’s ratings are likely to cap the ratings for their suppliers
Foreign currency rating is a more appropriate measure than local currency rating of
output purchaser’s ability to honor FX-indexed contractual purchase obligations
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Limitations of Co-Financing
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Co-financing is better received in the bank markets than in the capital markets:
–
–
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Co-financing will not induce capital markets investors to purchase a transaction which
they would not purchase without co-financing
Some capital markets investors appreciate the security of being pari passu with ECAs,
OPIC, or multilateral agencies, but
Other investors feel that the presence of agencies in a financing increases the
likelihood of contract renegotiation and debt rescheduling
•
Capital markets investors believed that co-financing structures would protect
issuers from adverse regulatory actions and were disappointed when this did not
occur in Argentina
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Co-financing structures consume significant capacity from governmental and
multilateral agencies:
–
–
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Pari passu financing tranche likely to represent 25% or more of total debt
Agency participation likely to be disproportionately weighted toward longer maturities,
either in direct funding or put structures
Partial risk structures designed to upgrade ratings likely to require support equal to at
least 40% of principal amount of project debt
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Need for New Approaches
•
Project output contracts which link prices to the FX rate contain an inherent risk
of default / renegotiation
•
The most significant risks to lenders are inconvertibility, devaluation, and
regulatory risk (which tends to be linked with devaluation)
•
Failures of FX-indexed output contracts to cope with major devaluations will
greatly limit their future use
•
Currently-available political risk insurance can mitigate currency transfer and
convertibility risk
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New approaches must be able to mitigate devaluation risk:
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Foreign exchange liquidity facilities for US dollar debt
Greater use of local capital markets to avoid currency mismatch risk between revenues
and debt service
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Conceptual Structure of a Foreign Exchange
Liquidity Facility
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Conceptual Structure of a Foreign Exchange
Liquidity Facility: Basic Assumptions
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Project Structure
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Revenues are received in local currency
Revenues are contractually committed to increase with the host country’s inflation rate
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The project will promptly convert all local currency cash available for debt service into
US dollars at the then-current exchange rate
Financing Structure
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Project is financed with US dollar-denominated long-term debt
Debt is fixed-rate or floating, swapped to fixed
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Conceptual Structure of a Foreign Exchange
Liquidity Facility: Draws and Repayments
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Coverage is based on purchasing power parity, rather than hedging changes in
nominal exchange rates
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The coverage establishes a “floor” for the value in US dollars of the company’s
cash available for debt service
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Draws may be made when the project’s cash available for debt service,
converted into US dollars, is below the floor value and is insufficient to pay
scheduled debt service
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Draws from the liquidity facility will give rise to claims against the project,
evidenced by a loan subordinated only to the project's senior lenders, repaid as
soon as free cash flow allows
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Draws are subject to a maximum facility amount; recoveries through the
subordinated loan mechanism will be available for payment of future claims
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Conceptual Structure of the Devaluation
Coverage: Currency vs Operational Risk
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Coverage is structured to separate currency risk from operational risk
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Changes in the real exchange rate are measured by valuing the project’s
expected cash available for debt service based on actual inflation and current
exchange rates, rather than the projected (PPP) values used to create preclosing proformas
•
Value of the project’s cash available for debt service is measured on a per-unitof-output basis
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A proforma calculation is performed to determine the extent to which a cash
shortfall is a result of fluctuations in currency values (which give rise to a draw
under the liquidity facility) versus negative operational results (which do not give
rise to a draw under the liquidity facility)
•
Senior lenders are exposed to all operational risks, just as if the liquidity facility
were not in place
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Basic Structure of a Foreign Exchange Liquidity Facility
Value
in US$
Debt Service
Coverage Ratio
Line 3
Line 1: 100%
1.50
Amount repaid to
Liquidity Facility
1.0
Line 2: 67%
Debt service shortfall amount to
be paid from Liquidity Facility
0
Time (in years)
15
Line 1: Projected value in US$ of cash in local currency, indexed to host country inflation rate (base case projection)
Line 2: Annual debt service requirements in US$ (principal and interest)
Line 3: Actual value in US$ of cash in local currency, indexed to host country inflation rate
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Sizing a Foreign Exchange Liquidity Facility
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Appropriate size of a foreign exchange liquidity facility depends upon:
–
–
The historical volatility of the real exchange rate of the project’s host country
The project’s debt service coverage ratio
•
Exposure created by historical volatility of the real exchange rate of the host
country depends upon where the floor value is established for an individual
transaction (i.e., how far the real exchange rate must decline before the project
is eligible to draw from the liquidity facility)
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The debt service coverage ratio for a project can be increased by:
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–
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Improving the project’s economics, e.g., by charging more for the project’s output
reducing the amount of debt in the project’s capital structure
Lengthening the tenor of the project’s debt (which is likely to occur as a result of the
use of a liquidity facility)
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Volatility of Real Exchange Rates: Brazil
500
450
400
350
300
250
200
150
100
50
0
Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1
1977 1980 1982 1985 1988 1991 1993 1996 1999 2002
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Reduction in Exposure as a Project’s Debt Service
Coverage Ratio Increases
Value
in US$
Debt Service
Coverage Ratio
Line 4
Line 1: 100%
1.50
Line 2: 67%
1.0
Line 3
0
Time (in years)
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Line 1: Projected value in US$ of cash in local currency, indexed to host country inflation rate (base case projection)
Line 2: Annual debt service requirements in US$ (principal and interest)
Line 3: Actual value in US$ of cash in local currency, indexed to host country inflation rate
Line 4: Line 3 shifted upward to illustrate a higher DSCR than that of Line 3
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Establishing the Floor Value for a Foreign
Exchange Liquidity Facility
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If the floor value were to be established at a level equivalent to a 1.0 debt
service coverage ratio, a small operational problem could cause the project to
default
–
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Liquidity facility provider would reduce its exposure to project operational risk, but
Fixed-income investors and rating agencies would put little value on the structure (it
would resemble a US project with a 1.0 debt service coverage ratio)
The floor value should be established at a level sufficient to provide an adequate
margin for deviations of operational performance from the performance levels
projected at closing
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Structure of a Liquidity Facility with a Floor Value
Equivalent to a DSCR of 1.20
Debt Service
Coverage Ratio
Value
in US$
Line 3
Line 1: 100%
1.50
Amount repaid to
Liquidity Facility
Line 4: 80%
1.20
Line 2: 67%
1.0
Potential amount to be paid from
Liquidity Facility (payments at this
level of real exchange rate will be
made only if necessary to pay debt
service; i.e. only if the project is
operating below projections)
0
Line 1:
Line 2:
Line 3:
Line 4:
Debt service shortfall amount to
be paid from Liquidity Facility
Time (in years)
15
Projected value in US$ of cash in local currency, indexed to host country inflation rate (base case projection)
Annual debt service requirements in US$ (principal and interest)
Actual value in US$ of cash in local currency, indexed to host country inflation rate
A line showing the level of cash at which the project has a debt service coverage ratio of 1.20 (“Floor Value”)
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Implementation of a Foreign Exchange
Liquidity Facility: The AES Tietê Transaction
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A Summary of the AES Tietê Transaction
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Issuer:
Tietê Certificates Grantor Trust, a NY grantor trust which made
a back-to-back loan to the Brazilian parent of AES Tietê
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Securities:
US$300,000,000 aggregate principal amount
•
Tenor:15 years / 10 year average life
•
Ratings:
Baa3 (Moody’s) / BBB- (Fitch)
•
Assets:
10 hydroelectric generating facilities operated by AES Tietê in
the State of São Paulo, Brazil, with 15-year PPAs
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Flow of Funds: Dividends from a 44% economic interest in AES Tietê go to the
Brazilian parent, which pays debt service to the Issuer
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AES Tietê Transaction: Inconvertibility
Coverage and FX Liquidity Facility
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Country Risk mitigated through:
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Inconvertibility Coverage:
–
–
–
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OPIC Capital Markets Inconvertibility Coverage
FX Liquidity Facility, which protects against risk of devaluation
Standard OPIC capital markets policy covering inconvertibility and transfer risks and
expropriation of funds
US$85 million policy limit, with policy limits which may be re-instated
Claims may be made simultaneously with draws under FX Liquidity Facility
Foreign Exchange Liquidity Facility:
–
–
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Provided in the form of the FX Liquidity Facility, a revolving credit facility
US$30 million FX Liquidity Facility amount
The FX Liquidity Facility insures that a devaluation of Brazil’s currency will not cause
the Issuer to be unable to meet is debt service obligations
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Significance of the AES Tietê Transaction
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First electric power project financing in a below-investment grade country to
achieve an investment-grade rating
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Longest tenor ever achieved by a Brazilian corporate issuer
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Priced at a level equivalent to 237 bp less than Brazilian sovereign debt (vs. 150
bps for the 7-year Petrobras transaction which priced one week earlier)
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Applicability and Benefits of Foreign
Exchange Liquidity Facilities
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Applicability of Foreign Exchange Liquidity
Facilities
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Asset Types: Infrastructure projects with revenues in local currency
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–
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•
Countries: Most Emerging Markets Countries
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Electric power generation and distribution facilities
Water supply and distribution companies
Oil & gas pipelines
Any type of facility in which a “capacity” payment is typically used
Exchange rate should be either floating or managed, but subject to a reasonable
amount of market pressure
Only countries with “pegged” exchange rate regimes should be avoided
Market Conditions: Value of the host country’s currency is not decisive
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Coverage may be prudently offered if the price of the project’s output is increased to
compensate for overvaluation and to increase debt service coverage ratios
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Benefits of a Foreign Exchange Liquidity
Facility: Sponsor Perspective
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Ability to sell project’s output with pricing linked to host country’s rate of inflation
shortens development time for new projects
•
Access to capital markets shortens time to achieve financing for new projects
•
Longer tenor financing may enable some projects to be developed which would
otherwise not have been economically feasible (local market in host country
cannot absorb output pricing at levels necessary to cover debt service for shorttenor debt)
•
Longer tenor financing can increase the Net Present Value of investments in
projects which could be financed with shorter tenors by traditional structures
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Benefits of a Foreign Exchange Liquidity
Facility: Lender / Rating Agency Perspective
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Credit profile of rated transactions is improved as a result of significant reduction
in risk of default or renegotiation of Project’s output contract
•
Local currency rating of output purchaser is not stressed by contractual
commitment to purchase Project’s output at prices indexed to the US$ FX rate
•
Project rating is not constrained by the sovereign ceiling
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Project rating is de-linked from sovereign rating
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All previous capital markets financings in the electric sector have been downgraded as
sovereign ratings have dropped
Mexican power sector transactions were upgraded when Mexico’s sovereign rating was
upgraded
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Benefits of a Foreign Exchange Liquidity
Facility: Economic Development Perspective
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Linking project output prices to the local inflation rate rather than the US$ FX
rate avoids price shocks for consumers of basic services provided by
infrastructure projects and enhances long-term sector stability
•
Use of devaluation coverage to obtain investment-grade ratings for infrastructure
projects will result in lower cost financing and lower costs to consumers:
–
–
Investment-grade issues will price at narrower spreads than sovereign debt of a below
investment-grade host country
Cost of inconvertibility coverage and liquidity facility for capital markets issues will
compare favorably to costs incurred using other approaches:
•
•
Inconvertibility coverage will be purchased in reduced amounts
Cost of the liquidity facility is much less than the cost of a currency swap (in the rare instances
in which such swaps are available for a tenor sufficiently long to contribute to a successful
project financing)
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Benefits of a Foreign Exchange Liquidity
Facility: Economic Development Perspective
•
Capital markets transactions require less inconvertibility coverage than bank
market financings:
–
–
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Bank market financings typically require 100% coverage of principal
Capital markets financings may require coverage for only 18-24 months (i.e., only 25%30% of the amount required by banks)
A foreign exchange liquidity facility will require a smaller commitment than other
forms of credit support traditionally provided by governmental and multilateral
agencies
–
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In the AES Tietê transaction, a US$30 million liquidity facility supported a US$300
million financing
Sizing of the liquidity facility will vary depending upon the host country and the project’s
coverage ratios, but should range from 10% to no more than 25% of the principal
amount of the capital markets issue
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Status of Liquidity Facilities as a New
Financial Product
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Status of Liquidity Facilities as a New
Financial Product
•
The concept has been successfully implemented in one transaction (AES Tietê)
in one country (Brazil); however
–
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AES Tietê has been downgraded for as a result of conditions in the Brazilian electric
sector and the effect of macroeconomic factors on its ability to distribute cash
Further use of liquidity facilities within the Brazilian electric sector was impeded by the
rationing which occurred in 2001-2002
•
Rating agencies have recognized the enhancement provided by coverage
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The initial transaction utilizing a foreign exchange liquidity facility received
favorable press coverage and industry awards:
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–
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Infrastructure Journal: Global Deal of the Year
Project Finance: Latin America Deal of the Year
Project Finance International: Latin America Deal of the Year
Euromoney: Best Structured Bond, Latin America
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Status of Liquidity Facilities as a New
Financial Product
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Two institutions are currently offering to provide foreign exchange liquidity
facilities:
– OPIC, using its FX Liquidity Facility structure
– Sovereign Risk Insurance, with its Real Exchange Rate Liquidity product
•
IFC is developing a Contingent Partial Risk Guarantee which is functionally
equivalent to a liquidity facility
•
Report of the Panel on Financing Global Water Infrastructure (the Camdessus
Panel) endorsed the use of foreign exchange liquidity facilities as a means of
facilitating financing for the water sector
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Robert Sheppard
Managing Director
(704) 363-9304
J. R. Sheppard & Company, LLC
2910-365 Selwyn Ave.
Charlotte, NC 29209
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