Project Finance Investment Banking
Project finance is one of the most popular but least understood groups in investment banking. Sometimes PF is a standalone product group and sometimes PF is under the corporate banking umbrella (as there is a large lending component). Closely tied to project finance may be an infrastructure advisory arm (under investment banking/coverage) and an investment banking infrastructure DCM team.
Project finance is a staple for banks that have good access to low cost of funds (for example, banks with very large deposit bases such as the major Japanese banks) and banks with good structuring professionals. The low cost of funds needs to be long-term money as well – so cheap money for as long as the project finance is active. State owned banks are naturally big players in project finance as they are mandated by their governments to provide financing for important projects with social benefits such as railroads and pipelines.
As such, the league table leaders in project finance are not necessarily the banks that you would suspect – instead of Goldman Sachs and Morgan Stanley leading the league tables, prominent private PF firms will include:
- French banks (SocGen, BNP Paribas, Credit Agricole, Natixis) – Europe is a project finance heavy jurisdiction with a well planned engineering culture – also an emphasis on power projects from nuclear to renewables
- Japanese banks (Mitsubishi UFJ, Mizuho, Sumitomo Mitsui Banking Corporation) – Japanese banks are advantaged by a very savings based society with long life expectancies and a lack of capital deployment opportunities domestically
- JP Morgan – largest private universal bank
- Australian banks (Macquarie, National Australia Bank) – keep in mind that Australia is a world leader in public-private partnership models or P3s with an emphasis on shifting infrastructure spending to private capital while allowing acceptable returns on equity
- RBC Capital Markets
Project finance is a space where a balance sheet is required. Including state owned players makes the list much more robust – the State Bank of India, China Development Bank, Bank of China and ICBC. Especially for countries with larger infrastructure ambitions, indirect support from the state can come through project finance lending.
China is unique in that it participates heavily in infrastructure buildout of developing nations to expand its global reach and to lubricate world trade in the future via its One Belt, One Road initiative. Project finance from the state owned banks is one conduit for this.
Project Finance Overview
When investors think of project finance what do they associate it with? Large infrastructure projects, power generation, gargantuan liquefied natural gas projects, pipelines, airports, natural resources – projects that undertake large construction mandates before leading to long-term, predictable cash flows that can satisfy all stakeholders.
Large example mandates for 2019 so far include the Rajasthan Refinery in India, Minera Los Pelambres in Chile and Jera Power Yokosuka in Japan.
Do these projects have to be project financed? No, a corporate can easily decide to fund large projects out of their own money and fundraise for it if necessary. Project finance debt is more expensive than investment grade bonds if a corporate chooses to fund it out of its own treasury operations – however, the risk is much higher. Returns to equity are also conmensurately higher. Any problems with a project that is funded by the broader corporate will spill over to the corporate.
So even for the largest companies such as the supermajor oil and gas companies as well as large US independent power producers, project finance is widely used. For large enough project finance vehicles, there will be many equity investors as corporates look to spread the risk. For projects that have a large societal benefit (clean energy, infrastructure, or anything that creates jobs), returns may be enhanced by government incentives either via subsidy or tax breaks.
Project finance is aptly named – the debt is non-recourse to the equityholders and only has claim to the project that is being financed. Naturally, it will also have priority claim above everything else.
Project finance generally does not require as big of an equity cheque as something that is not project financed would require. This is because the project is planned meticulously and structured around debt service. When project finance professionals discuss terms, debt service coverage and debt service coverage ratios are key. In a way, project finance serves the needs of creditors as much as it does equity.
Banks and other creditors need to make sure that they are paid for project finance. Cash flows from the completed project once it is in commercial operation need to service interest and principal and should the project fail it needs to be salvageable – ideally sold to a new equity investor at a stage where the project has been already derisked (so for instance, when things go wrong, the project has progressed enough where it can be sold at a higher multiple to future earnings as cash flows are more likely).
Project Finance Loans and Bonds
Similar to normal corporate debt, PF encompasses both loans and bonds. Countries that have more developed capital markets can include bonds in the capital structure – recourse bonds with an attractive yield have a decently large investor base. Countries that do not lean more heavily on project finance loans from banks with large balance sheets.
Recall that for countries and jurisdictions without deep debt capital markets, bank debt is commonly used and a lucrative business for lenders. As such, expect that project finance in Pakistan is financed by loans and US developments may have a combination of loans and bonds.
Bank debt is more flexible and is much more useful during construction. After the project is in commercial operation and cash flows are derisked, term debt via bonds may become the more appropriate option.
Project Finance DCM desks that have been bookrunners include:
- JP Morgan
- RBC Capital Markets
- TD Securities
- Swiss Re
- Morgan Stanley
- Wells Fargo
- Royal Bank of Scotland
Project finance lenders that have been bookrunners/lead arrangers include:
- Mitsubishi UFJ
- Bank of China
- Overseas Chinese Banking Corp
- China Construction Bank
- ANZ Bank
- Deustche Bank