Munish R Varma, Deutsche Bank

1
International Financial Markets and
Infrastructure Financing Tools

• Munish R Varma, Deutsche Bank
• September 2005

2
Introduction
3
Introduction

• Since the late 1990s capital markets have become
  an important component of infrastructure
  financings in both the UK and Europe, with more
  than a doubling in value of infrastructure bonds
  issued globally from 2002 to 2004
• Early infrastructure financings in the 1990s
  consisted mostly of bank debt limited to 25yr
  tenor
• Until 2000, capital markets involvement was
  largely restricted to health and road/rail sector
  infrastructure deals in the UK however volumes
  were small and sporadic
• Since then, infrastructure projects have used
  capital market solutions at an ever increasing
  rate with more than 6bn infrastructure type
  bonds issued across a wide range of sectors in
  the UK alone
• Capital markets solutions have been used to
  provide longer tenor debt and hedge specific
  risks associated with projects
• Further movement towards more structured
  financings and providing finance for
  infrastructure projects across Europe
• Main developments in the US for bonds have
  largely been in the power and utility sectors,
  but recent developments indicate growing trend to
  use more privately funded concessions (e.g.
  recently announced Texas roads)

Source Thomson PFI International
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Changing nature of Infrastructure Finance (1)

• UK has been pushing PFI/PPP structure for
  infrastructure procurement to provide new public
  facilities with minimal balance sheet impact
• Drivers also include the desire to improve
  service quality and accountability
• In Europe, budgetary pressures and requirements
  of Stability and Growth Pact for Euro membership,
  are forcing changes to methods of procurement
  with adoption of PFI/PPP models
• PFI/PPP programs launched in France (hospitals,
  prisons), Spain (hospitals, roads), Portugal
  (hospitals, roads), Germany (roads) but progress
  has been patchy
• In addition TENs (Trans European Network)
  requirements will require large amounts of
  private funding in addition to EU funds

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Changing nature of Infrastructure Finance (2)

• New accession countries will also move towards
  PFI/PPP models but progress may be slow due to
  certain bureaucratic and legal constraints
• However, demand from the public for improved
  services will not diminish and more countries are
  constrained. Accordingly growth prospects for
  PFI/PPP funding are excellent
• Capital markets will be required to meet needs
  and differing risk profiles of projects across
  Europe as the market develops

6
Developments in UK and European Markets
7
Overview of UK Experience

• 1990s Predominantly bank finance
• Healthcare
• Dartford Gravesham (108n term loan, UK, 1997)
• Royal Edinburgh Infirmary (250mn term loan, UK,
  1998)
• Accommodation
• Joint Services Command Staff College (109mn
  term loan, UK, 1998)
• MOD Main Building (550mn term loan, UK, 2000)
• 2000 present Increasing use of capital markets
  for refinancings and new transactions
• Healthcare
• Dartford Hospital Refi (127mn index linked bond
  issue, 2003, UK)
• Derby Healthcare (411mn fixed rate bond issue,
  2003, UK)
• Rail
• Metronet London Underground (1.3bn index linked
  and fixed rate bond issue, 3bn total financing,
  2003, UK)
• Tubelines Financing (1.5bn bond financing, 2004,
  UK)
• Defence
• MOD Colchester Garrison (680mn fixed rate bond
  issue, 2004, UK)
• Road
• Connect M77 (150mn fixed rate bond issue, 2003,
  UK)
• Structured Financings

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Overview of UK Experience

• Since 1996
• Total number of project bonds to date 46
  transactions
• 18 Transport
• 6 Accommodation
• 16 Healthcare
• 2 Defence
• 4 Water

UK Issuance by Year

• Cumulative issuance circa 7.8 bn

UK Linked Market by Sector
UK Fixed Market by Sector
Transport
Healthcare
Transport
Accommodation
Healthcare
Defence
Water
Water
Defence
Accommodation
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Overview of UK Experience

• Monolines continue to provide
• Ability to wrap bonds and EIB
• Credit arbitrage over unwrapped issuance
• Very-long term maturities
• Over 5 billion worth of PFI/PPP paper expected
  to be issued in 2005
• Utilities (SNIP, FGIC, G43 A/A1 15 yr average
  life)
• 10 hospitals,
• Schools (North Lanarkshire),
• 2 MOD accommodation (Main Building refi circa
  700mn plus Allenby circa 1.5bn)
• Market is increasingly competitive amongst
  monolines on both price and terms

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Current Issues for Sterling Market

• Index linked bonds still popular in health sector
  but demand from investors is limited
• Considerable spread differential between index
  linked and fixed rate
• Increasingly tight credit spreads in fixed rate
  market due to supply/demand imbalance
• Use of fixed rate bonds RPI swaps as an
  alternative to index linked
• Poses challenges to certain monolines and swap
  counterparties
• Index linked issue is easier to execute and
  favorable pricing advantage of using fixed RPI
  swaps may disappear
• Larger deals are on the horizon (M25, FSTA) with
  up to 32.5bn required. Can the market take much
  larger issues?
• Multi-monoline deals may be the solution (e.g.
  Metronet FSA/Ambac)
• Capital Market solutions need to be devised to
  handle programs such as Building Schools for the
  Future where a large number of smaller schemes
  need to be set into a framework which can be
  easily funded
• Use of eligibility criteria and standard contract
  and risk profiles can assist

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Euro Infrastructure Bonds

• History . first mainland-Europe project bond
• 1993 Fl 575 mn (342mn) Wijker tunnel outside
  Amsterdam raised a substantial amount of its
  funds in the form of bonds sold to Dutch
  insurance companies and pension funds.
• Market took / has taken much longer to develop
  due to lack of supply
• Issues have been tailored to meet investor demand
• 6 Euro-denominated infrastructure project bonds
  have been completed to date
• 126.5 mn bond issue for Algarve SCUT road
  (Portugal, September 2001)
• 460 mn index-linked issue for A28-E402 road
  (France July 2002)
• 210 mn bond issue for Bina Istra (Croatia
  January 2003, rated BB)
• 875mn, 215mn bond issues for Aeroporti di Roma
  (Italy, February 2003)
• 64.1 mn bond issue for Autovia de Los Vinedos
  road (Spain, October 2004)
• 257 mn bond issue for Project Eiffel SCUT roads
  (Portugal, October 2005)
• European investor interest in long dated, high
  quality paper is increasing

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Capital Markets v Bank Debt
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Capital Markets v Bank Debt

• Capital Markets
• Bonds are ideally suited for infrastructure
  financing
• In the UK, investors have long-term liabilities
  which need to be matched. Growing trend for
  longer maturities from European investors
• Deals are typically rated in the BBB range but
  are enhanced to AAA/Aaa by the use of monoline
  insurers
• Many sponsors favour capital markets for
  refinancings of bank deals rather than employ at
  the outset of the transaction
• Pricing is generally cheaper than bank, even
  after inclusion of monoline premium
• Capital markets able to go out to longer tenor
  then bank debt (30yr)
• Bank liquidity is declining at these tenors and
  pricing is increasing, but strong competition for
  deals below 100mn / 150mn

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Capital Markets v Bank Debt

• Banks
• More flexible drawdowns and no negative carry
• Often are aggressive cover ratios and terms
• Aggressive pricing (but rising) if not
  investment grade is risk/reward criteria correct?
• Perceived as easier than bonds
• Less credit support required
• Future concerns for banks
• ROE considerations
• BIS rules
• Liquidity in hedging for low investment grade
  counterparties
• Some participants disappearing from the market

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Financing comparison Project Bonds vs Bank debt
1 Based on UK Infrastructure Deal, fixed rate
issue 2 Based on European Infrastructure Deal,
fixed rate issue
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Financing Opportunities for Thai Projects
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Financing Elements

• Regardless of project location, certain elements
  of infrastructure financing are universal across
  international capital markets
• In non-recourse financing, debt providers are
  repaid primarily through the cash flows generated
  by the infrastructure asset being financed
• The structure of these cash flows can take
  several forms with each representing a different
  degree of risk
• Payments direct from the government
• Payments from quasi-government agencies
• Payments from the private sector
• As the market becomes more comfortable with Thai
  infrastructure projects, there will be more
  flexibility with the cash flow mechanisms and
  their respective elements of risk

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Payment Mechanisms

User charges
Payment received by the contractor directly from
private users of the infrastructure or service
(e.g. road tolls)
Usage payments
Payments from the contracting authority to the
contractor varying according to usage level
Risk transfer to private sector
Performance payments
Payments from the contracting authority to the
contractor that vary according to the quality of
service provided
Availability payments
Payments from the contracting authority to the
contractor for making infrastructure or services
available for use at an acceptable standard
regardless of actual usage
-
Payment mechanisms can be used in isolation or in
combination and reflect the level of risk
allocation between Public and Private Sector
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Objectives of a viable payment mechanism
Bankability
Lenders must be comfortable with the level of
revenues and the level of risk inherent in the
realisation of these revenues
Incentives
The private sector must be sufficiently
incentivised to (i) maintain the project/asset to
a satisfactory level (ii) grow volume (iii)
achieve efficiency gains
Practicality
Required data should be easily collectable, at
reasonable expense
Risk transfer
The level of risk transferred to the Private
Sector needs to be considered in the light of the
premium
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Risk Allocation

• Infrastructure Finance, regardless of project
  location, is about optimal risk allocation
  between project participants in order to achieve
  minimum cost of risk
• Bankability of project finance depends on final
  risk allocation
• The party who can best assess and manage the risk
  should bear it
• Key instruments will be the terms conditions of
  the respective project agreements

21
Further Development and Growth
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Further Developments and Growth

• Eastern Europe and EU accession countries
• Initial projects are likely to be roads and
  transport concessions
• Transport Infrastructure
• Rail (TGV Portugal)
• Airports
• Healthcare
• France, Portugal, Spain
• Roads (Europe US)
• Shadow Tolls and Real Tolls
• Accommodation

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Challenges

• Government
• European governments are implementing at
  different speeds
• e.g. bidding process for hospitals in Spain vs.
  UK
• Many governments lack sophistication in
  understanding financing aspects
• Unrealistic views on risk transfer and effect on
  ability to mobilize large amounts of capital
  which are off balance sheet for govenrment
• Rating Agencies
• e.g. negative views on toll roads and traffic
  risk though structural mitigates can help
• Ongoing conservative approach and some
  transactions are underrated
• Political ambitions vs. Political considerations
• EIB will continue to be a large player in
  European development and intercreditor positions
  will need to be negotiated to meet needs

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Capital Markets Positives

• Increasing investor appetite for infrastructure
  deals and tenor in all major markets
• Monoline risk increasingly understood and
  accepted
• New entrants have increased competition and
  lowered pricing
• Certain banks e.g. Deutsche Bank also act as an
  investor through access to own funds on a
  relative value basis increasing liquidity and
  improving certainty of execution (e.g. sterling
  index linked market)
• Increased used of derivatives to manage inflation
  and interest rate risk
• Size and capacity increasing
• More ability to deliver mezzanine and junior
  tranches through capital markets (e.g. Tubelines)
• Possible to sell and structure Emerging Market
  risk
• Innovation will continue to develop and address
  client needs and deliver varied infrastructure
  solutions

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Conclusion

• Market will continue to grow as PPP/PFI
  techniques widely adopted
• Increased demand for paper from investors
• Continued need to structurally innovate and
  ability to move down the rating spectrum will
  ensure critical development of capital markets
  and widespread use in infrastructure financing

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• Munish R Varma
• Deutsche Bank AG
• (44) 207 545-3575 / (44) 7768555574
• munish.r.varma_at_db.com