President Joko Widodo when reviewing toll roads - Photo by President Office

Singapore — Moody’s Investors Service says that funding for infrastructure projects in Asia will demonstrate increasing diversity. The rating agency reported growing funding diversity to bridge infrastructure funding gap recent precedent-setting capital markets transactions illustrate the evolution of infrastructure investment in Asia.

These transactions were very well received by the market and indicate that institutional investors are attracted to Asian infrastructure issuances.

“The large infrastructure investment needs in Asia will drive innovation
in financing structures and lead to the increased use of different forms
of credit enhancement. In fact, funding diversity is key to delivering infrastructure investment in Asia,” says Terry Fanous, a Moody’s Managing Director.

Moody’s expect funding diversity to grow, as infrastructure investment needs drive innovation in funding structures and the increased use of different forms of credit enhancement. They said, Asia’s infrastructure needs are large compared to historical volumes of debt raised by state-owned and privately-owned infrastructure companies.

Recent precedent transactions that closed during second half 2017 and 2018 YTD include a project bond issued by an operating project in Indonesia (Baa3 positive) to refinance existing debt, a global Indonesian Rupiah bond to fund road expansion in Indonesia, and a credit enhanced green bond to fund the development of a portfolio of renewable energy projects in Asia.

Moody’s reported, the Asian infrastructure sector is attracting institutional investors. This indicates that institutional investors are attracted to Asian infrastructure and project bond issuances, even those with long term amortizing debt features.

The sector has attributes that are suited to institutional investors’ strategic objectives, such as long tenors that facilitate asset/liability matching, portfolio diversification and credit characteristics that are likely to be attractive to long-term investors. They expect funding diversity to grow.

Favorable investor appetite and constraints on bank lending are likely to lead to more corporate and project bond issuance. Increased deal flow will enhance institutional investor familiarity with the infrastructure sector in Asia, and diversity by sector, geography and credit quality will make the market more robust.

“We expect infrastructure investment needs will drive innovation in funding structures and the increased use of different forms of credit enhancement,” Moody’s said.

The involvement of multilateral development banks (MDBs), including provision of credit enhancements, can mitigate credit challenges such as political risks that constrain investor appetite.

According to estimates from the Asian Development Bank (ADB), Asia needs to invest US$1.7 trillion per year in infrastructure from 2016 to 2030, or 5.9% of projected gross domestic product.

In comparison, annual infrastructure debt raising by SOEs and private companies in the key countries in Asia has averaged only around $200 billion per annum in the past 10 years.

Although government expenditure and equity would account for a size-able proportion of the difference, this still indicates a substantial ramp up will be required to fund much-needed infrastructure investment. For example, the ADB estimates that the gap could be around $459 billion per year.

Meeting those investment needs will require the mobilisation of diverse sources of private sector capital to supplement public sector expenditure. In terms of debt funding, a multi-pronged approach that synergistically combines short tenor bank debt typically raised for construction, with institutional long tenor debt will help boost private sector debt capacity.

With banks becoming constrained in their ability to lend long-term debt, this approach will provide opportunities for institutional investors to increase their exposure to the infrastructure sector. The role of governments and the MDBs is key to catalyzing institutional investment in the sector, by addressing factors that have historically deterred such investors.

Infrastructure Debt For the purposes of this report, we define infrastructure debt finance as comprising four components:

1. Corporate Infrastructure Bonds – Bonds issued by infrastructure corporates, such as SOEs. Infrastructure corporates typically have a strong market position and are often dominant or monopoly providers of utility services. They also typically generate predictable long- term cash flow, and have a low correlation with other asset classes, particularly where demand risk is absent or substantially mitigated.

Examples of infrastructure corporates include State Grid Corporation of China (A1 stable, a utility), PT Pelabuhan Indonesia II (Baa3 positive, an Indonesian port SOE) and NTPC (Baa2 stable, an Indian power generation SOE)

2. Corporate Infrastructure Loans – Loans provided by banks to infrastructure corporates 3. Project Finance Bonds – Project finance bonds are issued typically by a special purpose vehicle (SPV) created solely to complete an infrastructure project.

Project finance debt is typically limited recourse long-term debt. Principal and interest payments are funded entirely from cash flow generated by the SPV, while the scope and duration of the project is defined in the SPV’s contractual arrangements.

Project finance debt can be regarded as either “greenfield”, where assets are in the construction phase, or “brownfield” or “operating”, where assets have been commissioned and are operational. Examples include Minejesa Capital BV, the issuer of project bonds (Baa3 stable) related to Paiton Energy, an Indonesian independent power producer

3. Project Finance Loans – Bank loans provided to infrastructure project SPVs Data in this report covers the following Infrastructure sectors: Power and renewables, other utilities such as water and waste, transport infrastructure such as airports, ports, rail and roads, energy infrastructure.

Infrastructure & Project Finance – Asia

Infrastructure corporate debt is a major source of debt funding in the region, accounting for 81% of total infrastructure debt issued in the 18 years from 2000 to 2017. Infrastructure corporate bonds accounted for 60% of total infrastructure debt issued in the same period.

Around 91% of all project finance debt raised was in the form of bank loans in the same period. China is the largest infrastructure debt market, accounting for 53% of all infrastructure debt raised in 2017.

Infrastructure debt raising activity in China started to gain momentum in 2008 when it accounted for 21% of all infrastructure debt raised in Asia in that year. Annual volumes of infrastructure debt raised for the region would have been flat since 2012 if we excluded China.

Its also evident that the proportion of debt originated in the form of bank loans is higher excluding China. This indicates that there are opportunities to enhance funding diversity in the rest of Asia.

Certainly infrastructure debt raising will need to grow substantially to meet Asia’s annual infrastructure requirement of approximately $1.7 trillion over the next 15 years.

As the market matures, Moody’s expect investors to take on greater or different kinds of credit risks. In Asia, infrastructure corporate bonds dominate the overall debt mix, while loans are more prevalent than bonds for project finance.

“Over time, we envisage that Asia’s infrastructure needs will drive innovation in long-term funding from the capital markets, as more investors become familiar with the infrastructure sector,” it said.

Institutional investors’ increased focus on the infrastructure sector is already apparent, with strong demand for corporate bond issuance by state-owned infrastructure companies. With a recent project bond issuance, we also see strong demand for bonds to refinance operating projects’ bank loans.

Recent capital markets transactions set viable precedents that highlight the continued evolution of infrastructure investment in Asia Precedent bond transactions that closed during second half 2017 and 2018 YTD demonstrate the continued evolution of the market.

These transactions include a project bond issued by an operating power project to refinance existing debt, a Komodo bond to fund expansion of road infrastructure, and a credit enhanced green bond to fund the development of renewable energy projects.

The Paiton Energy bond (Baa3 stable) was issued by its finance entity affiliate Minejesa Capital BV in August 2017 to refinance Paiton Energy’s earlier bank loans. Paiton Energy is an independent power producer in Indonesia operating 2,045 MW of coal-fired generating capacity.

This is the first offshore project bond in Asia in more than a decade. The return of offshore project bonds issued by the private sector is a significant step toward broadening funding diversity in Asia, a region whose sources of infrastructure financing have been dominated so far by infrastructure corporate debt, raised mainly by SOEs.

The Paiton Energy bonds were long-term amortizing bonds with two tranches: 13-year and 20-year, totaling $2 billion and issued in August 2017. Investor demand for the longer-dated bond was encouraging and Paiton Energy concluded an additional tap issuance in December 2017.

The bonds benefit from key credit strengths including (1) long-term power purchase agreements which allow for cost pass-through, resulting in stable cash flow that is resilient to downside scenarios; (2) a set of strong committed sponsors, and; (3) an investment grade offtaker.

Jasa Marga’s (Baa3 positive) bond issuance in December 2017 to fund investment across its toll road concession network in Indonesia. This global Indonesian Rupiah denominated bond, the first ever for an entity based in Indonesia, raises the prospect for other Indonesian infrastructure corporates to access global debt markets, notwithstanding that their revenue is denominated in local currency.

Currency risk has been a key constraining factor for broadening funding sources for Indonesian corporates. Jasa Marga issued IDR4 trillion of bonds in December 2017 with a three-year tenor. The short tenor relative to the asset life of Jasa Marga’s assets is a trade-off, as investors are bearing currency risk.

Sindicatum Renewable Energy Company issued green bonds (A1 stable) guaranteed by GuarantCo (A1 stable) in January 2018 to finance the development of a portfolio of renewable energy projects in Asia. This is a maiden issuance of rated guaranteed green bonds by an Asian issuer.

GuarantCo is a financial guaranty company whose shareholders are the development agencies of five countries: United Kingdom (Aa2 stable), the Netherlands (Aaa stable), Switzerland (Aaa stable) Sweden (Aaa stable) and most recently, Australia (Aaa stable).

The size of the issuance was equivalent to around $40 million and highlights that the debt capital markets is a viable avenue for debt raising, even for smaller transactions. This is especially relevant for renewable energy projects, which tend to be modular and with relatively modest capital requirements when compared to conventional thermal power projects, for example.

The guaranteed green bonds were issued in two tranches (seven-year and five-year) and are denominated in Indian Rupees. The GuarantCo guarantee facilitated the issuance of the longer tranche, which is not common for INR-denominated offshore bonds.

Asian infrastructure sector is attracting institutional investors The Paiton Energy, Jasa Marga and Sindicatum bonds were very well received by the market. This indicates that institutional investors are attracted to Asian infrastructure issuances, even those with long term amortizing debt features or which are denominated in local currency.

High savings rates in Asia suggest that investors here are well placed to fund infrastructure investment in the region. The Paiton Energy project bond attracted an order book of over $4.5 billion for each of the two tranches of debt issued in August 2017. These are significant amounts given total bond issued totaled $2 billion. Asian investors were allocated around 46% of the issuance.

The Jasa Marga bond issuance had an order book of over IDR15 trillion for the issuance size of IDR4 trillion, with 55% of the investors being based in Asia. Institutional investors are ideally suited to providing longer-tenor debt that matches the long life of infrastructure assets. This will enhance funding diversity by supplementing bank loans and government-sourced funds.

Institutional investment is an especially important fresh source of capital, because bank limits on lending to individual countries, sectors or borrowers will restrict their ability to increase funding to the sector over time. Banks also face regulatory constraints under Basel III that make long tenor lending to sectors, such as infrastructure, less attractive.

The opportunities for greater funding diversity are a function of the development of capital markets and institutional investors’ risk appetite. In terms of scope, there are also opportunities for institutional investors to broaden their exposure to the sector and invest in project finance debt, facilitated by MDBs.

This is especially relevant for developing Asia, where greenfield infrastructure needs are expected to be higher than for renewal of infrastructure and tend to be project financed.

Following Paiton Energy, another Indonesian power project, Star Energy Geothermal (Wayang Windu) Limited is proposing to issue USD project bonds rated at provisional (P)Ba3. The bond was announced in late February. If successfully priced, the Star Energy Geothermal project bond will add diversity to the project bond market in terms of credit quality and sub-sector.

Innovative structures, such as project finance collateralized debt obligations (PF CDO), have been used in other parts of the world to allow institutional investors to gain exposure to infrastructure and at the same time, to free up balance sheets of the original debt providers, usually banks.

“For example, we assigned definitive ratings to three classes of notes issued by RIN Ltd, a PF CDO issuer, in October 2017,” it said.

Well-structured PF CDOs enable traditional project finance lenders, such as banks, to continue to originate and fund greenfield infrastructure, while allowing institutional investors to gain exposure to long-dated assets.

Greenfield infrastructure needs are pressing in Asia. MDBs can play a key role to bridge the infrastructure funding gap. Advisory roles by MDBs to strengthen project execution capabilities in certain countries, and credit enhancement by MDBs and export credit agencies can mitigate credit challenges such as non-payment of principal and interest, political risk, misalignment of risk allocation and cost overruns.

Moody’s has rated several precedent transactions that illustrate the use of credit enhancements to facilitate private sector funding of infrastructure investment in emerging markets, including:

» The Sindicatum Renewable Energy Company transaction described above

» The Elaziğ Hospital Public-Private Partnership (PPP) transaction (Baa2 stable) in Turkey (Ba2 stable) that combines political risk insurance cover from the Multilateral Investment Guarantee Agency (MIGA) with subordinated liquidity facilities from the European Bank for Reconstruction and Development (EBRD, Aaa stable)

» The Central Storage Safety Project Trust transaction (Aa2 stable) supported by political risk insurance from the Overseas Private Investment Corporation (OPIC) to finance the development of a spent nuclear fuel storage