Project financing has substantially dropped due to the financial crisis. The project finance market has also seen a number of changes including a shorter tenure and maturity terms and a tighter loan structure, senior executives told a conference in Dubai yesterday.

This happened because of a significant decline of active banks in the market fuelled primarily by a lack of liquidity in the financial system, said Thomas Waterhouse, Joint General Manager and Head of Energy and Natural Resources at Sumitomo Mitsui Banking Corporation Europe. In addition, the disappearance of regional banks in the project finance sector, the lack of foreign currency and the impact of the correcting real estate market aggravated the problem.

The project finance pie in the Middle East is further dwindling because of a mismatch in the ongoing infrastructure projects and lack of funding.

"There is a strong need for infrastructure funding in this region – be it transport, wastewater or power – which has been pretty much developed with project finance," David Wadham, Managing Partner at Ashurst, told Emirates Business on the sidelines of Fleming Gulf's fifth Project Finance Forum.

"There is a need for a project finance and if there is not enough volume in the market in terms of liquidity. Alternative structures have to be used," he added. "We have seen people tweak the model and bring in banks; we have seen some drop their tenors so what we see is that people are trying to get as much source of liquidity to enable projects to get done."

Michael Cooper, Director of Infrastructure Mena at HSBC, said the market has come to a standstill in the last quarter of 2008 and first quarter of 2009, adding that project finance deals have almost dried up. The only ones progressing were the legacy deals, which have been discussed a few months/years before the crisis blew up.

"It is interesting to see how the legacy deals of 2008 get done in the next six months and on what terms the new deals are brought to the market," Wadham said. "Dolphin refinancing is critical so is the Zayed University. Then we have the Shuweihat S2, which is one of the deals from last year, which had a $900-million [Dh3.3 billion] bridge facility and they are in the stage of finalising the long-term financing for that."

"People are beginning to look forward again, people are beginning to lend again but I don't think that we will return to the same terms we used to have. Definitely this time, pricing and tenor are going to be different in order to attract the bond market and Islamic products. Sponsors are witnessing tough days."

Greg Fewer, Advisor to Mubadala Development Company, agreed. He said time remains tough for borrowers and banks alike in the project finance arena.

He said despite the capital rationing, regional project pipeline remains strong and they need to be financed.

"Banks are shrinking and they cannot be relied on to provide balance-sheet capital," he said, adding that the important next step is to enable regional currency issuance by developing the appetite of insurance and pension funds to be involved in project finance.

"Dolphin, Aldur and S2 financings have sent a strong signal to the market in terms of recovery but how do we interpret this information?" Waterhouse said.

"Underwriting is unlikely to return to the market for the foreseeable future and the self-arrange model will continue to be the norm. Book running strategies will need to adopt to attract commitments."

He said there is now flight to quality and only top projects will succeed.

"The Middle East will remain a key region for energy project finance given high credit quality of transactions and low regulatory risk but banks will need to identify both shorter and longer term solutions to keep themselves in the market," he said.

Project finance involves financing of long-term infrastructure and industrial projects based upon a complex structure where project debt and equity are used to finance the project rather than the balance sheets of project sponsors.

The loans are most commonly non-recourse that are secured by the project assets and paid entirely from project cash flow, rather than from the general assets or creditworthiness of the project sponsors, a decision in part supported by financial modelling. The financing is typically secured by all of the project assets, including the revenue-producing contracts. Project lenders are given a lien on all of these assets, and are able to assume control of a project if the project company has difficulties complying with the loan terms.

Unlike derivatives – a similarly highly-structured product – Fewer said project finance offers yield premium and although stuctured are nevertheless safe.

He said the sector is hoping that the market will pick up this year.

"Banks will be slow as they will have to raise capital back and as they earn more money then they will start lending again, but not now," he added.

Currently, a multitude of uncertainties is still plaguing the region, thereby making the investment outlook bleak. But the region will still maintain its attractiveness, said Rajesh Ramanathan, Vice-President of Apicorp's GCC Business Group. The development of projects, however, will undergo a "dramatic" shift in financing strategy.

For one, the possible collapse of oil demand is increasing the investment uncertainty. Ramanathan said there is a strong correlation between the world oil demand and the GDP of the main growth engines – OECD and China – and based on growth projections of IMF, recovery is unlikely before 2010.

Opec has had three output cuts signalling a slowing demand and the petrochemical industry is also undergoing a shaky phase with most of the projects either cancelled or on hold. And again, the outlook will depend upon GDP growth, oil price and production capacity expansions, he said.

This uncertainly, he said, has been caused by the liquidity crisis, which has also created havoc in the bond issuance and syndicated loans in the Mena region. "The contraction is continuing in 2009," Ramanathan said, adding that the cost volatility is still experienced in the market.

The only light in a gloomy environment, he said, is the fact that material costs have gone down and industrial recession constitute substantial deflationary decline on EPC costs. "Decline is tampered by delays in completing projects currently under construction. There has been a 15-20 per cent decline since September 2008 and it is expected that it could go up to 40 per cent," he said.

Given the current conditions, it is now debated whether energy projects in the Mena region are still viable. The shortage of gas adds on to the liquidity crunch that is already hampering millions of dollars worth of projects. There are vigorous efforts to find more gas supplies but in the absence of the so-called fuel of choice, future projects are likely to be based on liquid feedstock such as naphtha.

"Is it the right time to develop energy projects? Short-term outlook does not support that proposition," Ramanathan said.

"From a medium- to long-term perspective, viability exists but it will depend on the availability of feedstock, level of capital costs and medium- to long-term supply and demand outlook."

But the question today is if the right funding is available.

He said to secure funds for energy projects, a strategic shift is needed. These project would now need to access all potential of finances including international/regional/local bank market, export credit agencies, international capital markets and Islamic financial institutions, among others.

Islamic institutions, however, are not yet that developed to cater to long-term financing schemes.

According to Tarek Bachnak, Assistant Director at Calyon's Islamic banking team, Islamic finance is maturing and has begun to be involved in large deals. However, it is too early for Islamic finance to embark on mega project finance deals.


Trends

Project selection

- Strong sponsors/core clients only

- Avoid market risk/price/volume

- Host government support and rationale project

- Club deals and co-financing

- Shorter tenors

Project Structure

- Shorter tenors

- Re-financing risks to sponsors / hosts

Economics

- Rebalance risk/reward between equity and debt

- Banks will require full economic return on PF activities to equal/exceed return on capital

- Cost of funds to be recalibrated:

- Libor

- Reference rates

- Cost of funds

Funding trends

- Increase in local currency financing, but, mismatch between local currency funding and credit capacity

- Increase in central bank/monetary authority support for PF market

- Development of local capital markets

- Increased co-operation between sponsors and host/government authorities

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