Amid the recent stampede to provide institutional investors with access to infrastructure debt, you could be forgiven for wondering where the banks were hiding. After all, with the exception of a pairing between French bank Natixis and Belgian insurer Ageas, they were nowhere to be seen.
No more. Last November, Dutch bank ING lodged documentation with the International Project Finance Association to gather feedback from the industry on a special initiative: PEBBLE. The latter is an ‘open source’ project that aims to provide a template to create bank-to-institutional investor debt solutions that can be used freely by third parties.
In a broad sense, PEBBLE shares some DNA with fund manager Hadrian’s Wall and the European Investment Bank’s Project Bond Initiative (PBI), in that it relies on credit enhancement to hopefully make infrastructure project debt palatable enough to mass swaths of institutional investors. And like those two initiatives, it is aiming to become a mainstream funding solution.
In essence, PEBBLE appropriates the credit enhancement concept pioneered by Hadrian’s Wall, builds on it, and arrives at a more flexible and open solution. It also puts a twist on it that might turn out to be its biggest draw: it brings back the banks, who are a known quantity.
Old friends die hard
“About a year-and-a-half ago, we decided to create PEBBLE as an open format [partly] to assist contractors to take advantage of hybrid bank / institutional investor solutions,” explains Alistair Higgins, a director at ING.
Following the financial crisis and banks’ retreat from project finance due to regulatory constraints, sponsors and procuring authorities have had to face the demise of long-standing working relationships with the banks.
It’s true that bank debt is still available for certain types of deals. But everyone knows that it’s not available in nearly the same quantity and terms as it used to be. For banks, the inability to participate in many deals, especially as long-term debt providers, has meant having to stand by while previously profitable relationships go to waste.
But what if there was a way banks could still leverage those relationships, participating in infrastructure financing, but on terms better reflecting the ‘new normal’? That’s the scenario PEBBLE is offering.
The way PEBBLE works is simple. As you can see in the chart below, PEBBLE proposes to finance infrastructure projects using a tripartite structure comprising an A note, a B loan, and a construction revolving facility (CRF).
The A note – as with Hadrian’s Wall and the PBI – ranks senior to the rest of the debt and will typically offer a long tenor. Its target audience is clearly the institutional investor market – pensions, insurers, family offices, et al – who are looking to match their long-term liabilities with long-dated, relatively safe sources of income.
However, Higgins points out there is nothing stopping a bank from buying into the A note portion.
The relative safety of the A note comes partly from the B loan, which is subordinate to it and is there to credit-enhance it. The B loan will typically have around a 10 year life and, again, while all types of investors are welcome to offer it, within the PEBBLE structure it looks clearly aimed at banks.
Here’s how ING describes the benefits of the B loan to lenders: “[The B loan offers] continued ability to support key infrastructure sponsors and procuring authorities [whilst providing] optimal balance sheet utilisation.”
Revolver: fully loaded
But PEBBLE introduces some idiosyncrasies to the A / B structure. Firstly, the gearing is fixed, with 85 percent of the debt being provided by the A note and 15 percent taken care of by the B loan.
Secondly, while the B loan is a typical first-loss piece, it is also a “first repayment” piece, with principal “paid down first to reduce average cost of capital,” ING explains.
“This results in the B loan providing targeted credit enhancement for the construction, ramp up and snagging period of the asset life, without the expense of a credit enhancing B loan during the more benign operational phase of the asset,” Higgins adds. Toward the twilight years of the B loan’s life, controlling creditor obligations are passed to the A note holders.
PEBBLE also innovates on the A / B structure with the introduction of a typical bank amenity: a revolving facility to cover construction costs.
“Institutional investors don’t like monthly drawdowns,” Higgins argues. “We can take direct construction risk easily. This way the revolver is drawn first and then on a six month basis, the A/B notes kick in. And because ING provides the revolver, institutional investors can park their money elsewhere [in between drawdowns]. Also, investors don’t have to pay commitment fees,” he adds.
But there is another advantage to having a revolver available. If disaster strikes and there are construction overruns, then the facility can serve as contingent liquidity facility for up to 10 percent cost overruns, further protecting A note investors. In effect, if worst comes to worst, PEBBLE offers a 110 percent financing solution.
In addition to all the securitisation wizardry running in the background, PEBBLE has one last trick up its sleeve, which we will call ‘relationship-based credit enhancement’.
“We can leverage our long relationships with contractors, whom we know pretty well and who are our clients for other lines of business. This means we will rate them differently from rating agencies, and have confidence in their ability to finance themselves,” Higgins offers.
It’s easy to see how advantageous this can be. Just imagine a PPP project being procured by a regional authority somewhere in the Netherlands, whose winner is a small Dutch contractor.
Imagine, also, that the credit enhancement provided by a Hadrian’s Wall or a PBI is still not enough to convince rating agencies to overcome their reluctance to this small contractor. In the end, they decide not to rate the senior debt within the much-cherished A-range.
Now enter PEBBLE, let’s say with ING arranging the financing. ING knows said Dutch contractor for several years, has financed its projects, and lent to it on a corporate basis. The bank’s comfortable with it, and can transmit this confidence to the institutional investors taking part in the deal.
Since PEBBLE is open source, other banks can also use it, “with the advantage for the market being an established standard for intercreditor provisions,” Higgins argues. He adds that other Dutch, Spanish and German banks have already begun offering PEBBLE financing, and in turn overcoming deal, client and regional/national specificities.
But as clever and customisable as PEBBLE is, it faces the same big obstacle as Hadrian’s Wall and the PBI: it has yet to deliver proof of concept in a space where debt funds engaging in bilateral private placements are beginning to thrive.
When you put PEBBLE’s complexity in the context of a European PPP market that has just hit rock bottom, you sense the path to success will not be easy.