Mixed financing solutions: The best way forward for large scale limited recourse projects

Not all transport or infrastructure projects are best served by limited recourse project financing (or hybrid project and corporate financing) solutions but a large number of them are. The characteristics of many of these projects means that promoters and their financial advisers are increasingly looking to both the commercial bank and the bond markets to raise the significant amounts of debt financing that these projects require. Invariably the project economics and therefore the practicality of deliverability can materially be enhanced by a mixed funding solution. Nevertheless, a mixed funding solution creates a considerable number of 'challenges' that are not readily apparent or for which market standard solutions have yet to be developed. However, to ensure that a project successfully reaches financial close within a timetable which is realistic and achievable, all these issues will need to be addressed.

Metronet and the LUL-PPP

The latest significant transport project to reach financial close with a mixed bank and bond financing solution was the Metronet portion of the London Underground PPP. Metronet was successful in its bids for the BCV (Bakerloo, Central and Victoria) network and the SSL (subsurface lines) network, which together comprised two out of the three businesses into which the London Underground infrastructure and asset base had been divided. Metronet funded the two bids separately but used the same combined or mixed solution of 'wrapped' fixed rate and index linked bonds, EIB funding and commercial bank debt supported by a package of interest rate hedging. The total debt package for the two projects was approximately £2.6bn.

Logistics should not be overlooked

Not all the issues encountered in delivering a mixed funding solution are unique to a bank and bond financed project but can equally arise where there are different bank groups or a bank group and a development bank such as EIB or similar. However, the bank versus bond dynamic gives rise to additional matters too. One point not to be under-estimated is the logistics of managing a large and diverse group of funding institutions. The Metronet core funding group comprised four lead arranging banks, two monolines, the EIB and three bond lead managers. Fortunately some institutions fulfilled more than one role, but nonetheless there was a core group of eight institutions involved in all the commercial negotiations and who needed to participate in a full analysis of the economics, the risks and the documentation associated with the project. Achieving a consensus within a large group is not always straightforward, there are clearly risks of a 'lowest common denominator' approach and a funding group of that sort of size inevitably needs time to consider issues and turn them around. Also, when the negotiations get to the 'hard yards' effective project management becomes even more crucial in ensuring that negotiations do not simply spiral out of control.

Intercreditor angst

All that said, it is the intercreditor issues arising between the various different finance parties that are enormously time consuming, complex and, at inception, uncertain in many respects as to their outcome. A key dynamic of these discussions arises for two reasons. Firstly, the bonds all fund up-front and invariably have long dated maturities, whereas the banks provide their funding over time and maybe for shorter periods. Secondly, in a mixed funding solution, the most economic approach is for no bank funding to be drawn down until all the bond proceeds have been exhausted. In these circumstances, who should bear the losses if a project goes into default in the early years? Should it be the bonds alone, or should the banks share in those losses? If the banks do share in those losses, are they, in effect, guaranteeing part of the bonds' position in the early years and so entitled to a full margin rather than simply a commitment fee and, if so, what does that do for the project economics? Other related key issues include how should voting rights be determined when one key finance creditor is fully drawn and one is not and, if voting is based on exposure rather than commitment, can the bonds waive defaults which the banks could otherwise rely on as draw stops? Also, as the hedging will usually be in place from the outset, do the hedging providers have any right to vote and if so when?

Sponsor/shareholder concerns

Furthermore, it is not only the finance parties who have an interest in these discussions, but the sponsors too, as neither paralysis amongst the funders in a default situation, nor a voting on enforcement regime where the interests of one funder or group of funders can destabilise the whole project, will result in a happy outcome.

Precedents are emerging

The Metronet debate on various of these issues was in part informed by discussions that had already been taking place on the D47 road project in the Czech Republic (although that concession was recently terminated by the Czech Government, albeit for other reasons) and also benefited from similar discussions that had taken place on the TubeLines Project, where there were no bonds issued but two monolines wrapped a portion of the commercial bank debt with, it is understood, a view to a refinancing with a bond issue in due course. Also, the parties took note of the discussions and solutions that had been put in place on the Anglian Water financing, where a highly leveraged structure comprising both wrapped and unwrapped bonds, bank debt, finance leases and other senior and subordinated debt had been put in place. Indeed, as other water companies and regulated or non-regulated businesses with a strong concession or licence-based cash flow look at options for fundamentally increasing the amount of debt and reducing the equity on their balance sheet, these types of intercreditor issues will become more commonplace there too.

Simplification and solutions

There are a number of ways in which various of these issues can be simplified, although the sponsors (or utility or other business concerned) will need to consider whether in their particular circumstances there is a downside to any of these solutions. One of the most obvious simplifications is for all the funders to accede to a common terms agreement so that they all benefit from the same representations and warranties, covenants and undertakings, trigger events and events of default. The main issues then are whether any funding group has the right to unilaterally exercise, or indeed veto the exercise of any of those provisions, or whether they are only capable of being exercised on a majority basis. This is in principle much more satisfactory than all the funders having their own independent packages of these provisions set out in their own documents. It also provides a framework within which new debt of whatever nature, whether it be further bonds, new bank debt or otherwise, can be provided as the new debt providers will accede to the common terms agreement (and related inter-creditor arrangements) and make their funding available on the basis of it from time to time. This approach not only creates a high degree of certainty for the sponsors etc. but also can ensure that existing debt providers do not have the ability to veto the new debt provided that the specified accession criteria are met. The downside, arguably, is that having created a standard set of terms and provisions, it may be difficult for the borrower to improve them by easing both business and financial covenants and default and trigger levels even if the business improves. If the borrower wishes to do this, it will need to persuade all the existing funders or at least the requisite majority of them to make any such concessions. However, if all the terms were contained in bilateral agreements, then over a period of time, as old debt was refinanced and new debt on more favourable terms brought on board, the overall position could be improved.

Standstills, drawstops and tapering

Even when the issue of common terms has been resolved and recognising that a global security package for the benefit of all the senior funders will be a pre-requisite, the question of funders' voting rights and particularly how they impact on enforcement options, obligations to fund where there is a subsisting default and rights to close out swaps and other contingent liabilities, will always prove hard to resolve. A key issue is whether there should be an institutionalised standstill and/or, as mentioned earlier, whether majority senior funders should have the right to waive draw stops thereby obliging funders with unutilised commitment to continue to provide funding and liquidity to the project while a solution is being devised. Also, even if the 'new money' is given a priority ranking in any application of enforcement proceeds waterfall, for how long should such arrangements operate? Equally important is the extent to which minority creditors should be able to force a decision to be made by providing for the voting percentage in relation to any particular issue to taper over time if no enforcement or other decision can be reached beforehand.

'Wrapped' and 'Unwrapped'

A further concern in evaluating a mixed funding option, and not only from the point of view of the project economics and the like, is the distinction between wrapped and unwrapped bonds. Where the bonds are wrapped the relevant monoline(s) will be the controlling creditor and will be able to make decisions on the same sort of basis and within the same sorts of timescales as any bank or other equivalent funding institution. Where the bonds are unwrapped and any decision-making falls to the bondholders, the position is much less straightforward. The terms and conditions upon which the bonds are issued can seek to provide the bond trustee with a number of discretions which go above and beyond those that one would customarily expect to see in a straight corporate issue. However, it will not be possible to legislate for every circumstance and accordingly various matters are likely to need a meeting of bond holders in order to reach a decision, unless in some of those circumstances the bonds could specifically be disenfranchised. Clearly, though, the latter approach may well have considerable implications on pricing and investors' appetites for the bonds in the first place.

It's getting easier

So is it all too difficult? Certainly not. The Metronet common terms and inter-creditor discussions, while demanding, and no doubt at times frustrating, reached conclusions that were acceptable to all the different funding parties and the sponsors and similar results were achieved on the earlier TubeLines, Anglian and other transactions. In addition, there are other major transportation and infrastructure projects that are looking to use mixed funding solutions and will be building upon the experience gained and the solutions reached on these earlier transactions. Indeed, those banks and monolines that have now been through these issues on more than one occasion will undoubtedly be looking to make a point of their ability to deliver the financing more quickly and meet the sponsors' timetable due to their previous experience. Not only that, but as the market generally becomes more familiar with these issues, as has been the case in the past, standard solutions will increasingly emerge and the amount of debate will reduce. However, we are not quite there

yet!

This article originally appeared in the Transportation Finance Review 2003/2004 published by Euromoney Institutional Investor PLC, July 2003

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