Sponsors are increasingly sourcing project debt in the capital markets rather than from banks, according to the latest data from Dealogic, which is good news for financial institutions with private placement desks.
Among them is MUFG, which tops Dealogic’s league tables of both project finance loan arrangers and project bond bookrunners for the first three quarters of the year (PFR, 10/19).
One of the largest U.S. private placements of the year so far was a $1.475 billion transaction as part of a debt package raised by AES Corp. for a portfolio of contracted assets in California (PFR, 7/6).
Matt Odette, director in project finance, and Frederick Echeverria, executive director on the private placement desk, discussed the trend toward financing projects in the bond market
PFR: The AES Southland offering was one of the biggest deals in the private placement market this year, and highlights a trend of private placement investors looking for yield in the power sector. How has the private placement market evolved in the last few years with respect to power, and what is driving those deals?
ECHEVERRIA: Project bonds have been around for quite a while, so I don’t think it’s necessarily anything new, but in the power space, over the last 18 months to two years, what you have seen is a pullback in banks willing to lend on a long-term basis, which was a pretty competitive capital source to the project bond. As you’ve seen less willingness for banks to offer long-term financing, it brings the project bond more to the fore as a financing tool. You’ve got that duration that the investors can provide—it’s a natural fit—as well as, you noted that the Southland transaction was rather large, so even with banks’ willingness to lend long-term, there’s a maybe $500 million to $800 million pool of capital that was competing at the top of that demand.
ODETTE: We’ve seen this unfold in real time. As you know, we’re very active in the bank space as well, so when we pitch projects, we show a menu of options from a mini-perm to a long-term bank loan, to a bond, and we have seen in the last 18 months, when we lay out the numbers and the pricing, in terms of what we think is achievable in the market, the bond is becoming more and more competitive. Once you get to north of $2 billion of raise, it makes sense to look at both, which is similar to what AES did here on Southland, where there was both a bank and a bond tranche but they were optimized in terms of the duration preferences of these two different investor classes, where the bank was shorter and the bond was longer. PFR: You mentioned banks pulling back from long-term lending. Is that a regulatory-driven thing primarily, or what is driving that?
ODETTE: There are obviously different, overlapping regulatory regimes that affect different banks. One thing we hear a lot about here in the U.S. is the liquidity premium, which does make longer-term financing more expensive. It’s a combination of overall cost of capital and then some regulatory developments that have made long-term capital a little bit more expensive than perhaps it used to be.
PFR: You mentioned the bond financing becoming more competitive on pricing as well. Are you able to give any ballpark figures on how much it has come in?
ECHEVERRIA: It’s evolved. Coming out of 2009, ‘10, ‘11, anything in the project bond space was priced on a coupon basis. That changed in probably late 2013 where we started to see bonds price again on a spread-to-Treasury basis. So, when we got back to spread-based pricing, you’d see a deal such as Southland, with a similar credit profile, probably with a credit spread of 225 to 250 basis points. Where that’s come now over the last two to three years is south of 200 bps, and we’ve seen deals price as tight as 160 bps over. So that’s—and each deal’s unique, each deal’s specific, so this is just generally what we’ve observed in the market—anywhere from 75 bps to 100 bps of tightening on the spread, coupled with historically low Treasury rates over the same time period. So we’re seeing financings which used to be in the 6% to 8% are in the low 4% area and in some financings below 4% on an all-in yield basis to the issuer.PFR: How does that compare to the bank market? In the renewables space, we saw contracted projects getting bank loans last year at 175 bps over Libor or around that area.
ECHEVERRIA: On the bank side we have seen, for long-term contracted assets, down to Libor plus 162.5 bps. Matt touched on some of the pressures—return on capital, liquidity premium—so it’s maybe 175 bps to 187.5 bps now depending on the size of the project. The project bond investor is a different investor base than the banks, and I think they’re looking at a different relative value dataset than the banks as they look to ascribe value. I think there are more and more investors that are comfortable in infrastructure broadly and power projects in particular than there were two to three years ago. I think people got involved because it was a way to pick up incremental yield, but as you bring in more demand with the same limited supply it tends to bring down the price, so it’s really a function of too many dollars chasing too few deals. Even with such a large bond component as we had on Southland, nearly $1.5 billion, there was over two times demand for the amount of paper that was on offer.
ODETTE: One other trend we’ve seen around the same time frame is relevant to construction projects: Traditionally, investors in the bond market weren’t particularly excited about putting out unfunded commitments. They wanted all the dollars to be in day one, which, if you take that approach, that can be pretty inefficient for construction projects, where your money is sitting there earning low interest from day one when you haven’t spent it. But what we’ve seen a little more recently is a willingness among private placement investors to do delayed draws, and the price of that has come down a lot over the last two or three years, to the point where, apples to apples, banks are probably still a little more efficient and competitive in terms of providing construction financing and unfunded commitments, but that gap has narrowed a lot, which has made the bond market a lot more interesting for construction projects like Southland.
PFR: Are you able to say anything about the premiums for delayed draws now? Can you get an 18-month delayed draw for 50 bps?
ECHEVERRIA: In general terms, in the current market environment—and this would be under the 4(a)(2) private placement format, where you can get the delayed funding—the market will generally provide the first three months free—no incremental cost for a three-month delay. After that, it’s 2bps to 4bps per month, so an 18 month delayed draw, to your example, that’s 30 bps to 60bps. That would be for the 18 month draw—each draw has its own price, and you can put that in a spread sheet, do the math and come in with the weighted average cost. It’s a little more nuanced than that, as each project will have its own funding and draw schedule, so depending on the timing and amount of those draws, the percentage of the funding which is delayed can play into what those premiums are.
PFR: So it’s like an amortization schedule in reverse?
ECHEVERRIA: Absolutely.
Check back next week for the second part of this interview.