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Monday, October 23, 2017 | MANILA, PHILIPPINES
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   banking report
Date posted: Monday, November 28, 2016 | Manila, Philippines

3rd Quarter Banking Report (2016)

Project financing gets boost from Bangko Sentral’s higher headroom

LAST JUNE, the Bangko Sentral ng Pilipinas (BSP) issued Circular 914, encouraging banks to lend higher amounts to related parties undertaking any of government’s priority infrastructure projects.

The move was timely, as the then president-elect Rodrigo R. Duterte was looking to jack up infrastructure spending during his six-year term.

Under Circular 914, banks also could be exempted from capping any unsecured loan, credit accommodation or guarantee made to a related party for project financing.

Related parties refer to a bank’s directors, officers, stockholders and their related interests (DOSRI).

The exemption would hold during the project’s gestation period, or during its pre-operational phase. This means that the borrower can borrow as much as necessary to jump-start its project or venture.

This also means the lender would have to observe the ceiling once the project begins to generate cash flows.

Before the circular was issued, unsecured loans made to related parties for project finance were subject to a ceiling of 30% of the net worth of the lender.

The new circular also relaxed the definition of DOSRI. A lender who has on its board someone who at the same time serves as either an independent director of the borrower or holds only a nominal share in the same would not be considered a related party.

As such, the loan would be considered as a transaction between counterparties, and so not subject to the usual DOSRI limits.

This means a company that wants to tap project finance for infrastructure projects could borrow as much as necessary from a bank if the former appoints as independent director someone who also sits on the board of the lender.

The new circular also relieves the borrower from having to raise additional funds since such loan transactions would no longer impair the former’s capital. In lieu of impairing the borrower’s qualifying capital, the new policy would allow for risk weighting of the loan exposure.

In providing lenders greater headroom, the BSP expects banks to help "spur investment in infrastructure development," Deputy Governor Nestor A. Espenilla, Jr. said.

Under its medium-term plan, the government aims to increase the share of infrastructure spending to 5% of gross domestic product, helping the economy shift from a consumer-led growth to one that is investment-led.

"Project financing is essentially funding or supporting supposedly self-liquidating projects," Asian Institute of Management (AIM) professor Emmanuel A. Leyco said, adding that the projects "should be able to generate enough revenues to pay for the debt and still make money for the investors."

"Depending on the scale of the project and the amount of resources required, these will determine whether or not use project financing or the usual equity financing of the companies," Mr. Leyco said.

This points to an advantage of project financing, which is that it allows project proponents to raise bigger amounts than what they could borrow through corporate finance.

"Equity financing is limited to the equity of a conglomerate and no conglomerate will be able to finance the kind of infrastructure that this new government is saying that they would like to undertake. Not even the Philippine government by itself can be able to finance all these contemplated infrastructure projects," Mr. Leyco said.

This leads to another advantage of project finance for either the lender or the borrower: it enables them to go around the BSP’s single borrower’s limit (SBL). As it is, the BSP is averse to relaxing its SBL rules.

Project finance addresses this restriction, particularly in a market comprising of a limited number of companies able to embark on big-ticket infrastructure projects.

The government’s Public-Private Partnership (PPP) Program already has a pipeline of 54 projects, but interest in these ventures have emanated from only about a dozen or so conglomerates.

Since project finance is structured on a limited or non-recourse basis, servicing the debt would depend on the cash flows of the project, and not the assets of the sponsoring company. As such, the loan would be off the sponsoring company’s books, thus not having to jack up its leverage ratio.

Doesn’t project finance mask the risk of the project?

According to China Banking Capital Corp. managing director Ryan Martin L. Tapia, project finance can be structured in a way that the risk is distributed among a syndicate of lenders, each of which takes on risk that they are comfortable with.

For example, a syndicate of three banks can each take on a third of the exposure, or distribute it in a way that commensurates with each of their risk appetites. For example, bank A could take on 40% of the risk if it has more than enough buffers to absorb any loss, leaving banks B and C with 30% each or some other configuration that is proportional to their capital.

Furthermore, part of the risk in project finance can be passed on to international credit agencies that are in the business of reinsuring risks.

Of course, sharing the risk among many parties could unnecessarily increase project costs, and if the partnership turns sour, delay the project altogether.

"There will be more disclosure made and governance of the project will be subject to an oversight scrutiny of investors’ representatives or governing bodies of the investors," AIM’s Mr. Leyco said.

"There will be more scrutiny, oversight, disclosure but at the same time it can also paralyze operations or progress of projects if they are over scrutinized," he said.

Mr. Leyco said the Philippine experience in project finance in the late 1990s underscores the care with which such a financing scheme should be resorted to.

"I hope that the current enthusiasm for project financing of our infrastructure projects will not suffer the same miscalls that many investors made in the late 1990s," he said, referring to the 1997-1998 Asian financial crisis.

"What were those miscalls that we had made? The overprojected demand. We projected the cost based on overvalued pesos. We projected based on strong Philippine economic growth. We projected with very little regard of possible risks. We were not hedged. So when the peso collapsed, it pushed many companies and investors to bankruptcies," he said.

In this regard, project finance is premised on an extensive feasibility study and sound economic forecast.

"For a feasibility study to be an excellent feasibility study it should provide scenarios," Mr. Leyco said.

"For example, what do they think would be the best-case scenario for project; what would be the worst-case scenario for a project; and what would be the most realistic," he said.

Reliable information, therefore, is necessary.

"So for example, when they do demand forecast for a particular project, they need to have reliable information on the market, from the demographics of the market to be able to project demand," Mr. Leyco said.

"If there is a good market demand analysis they should be able to project not only in terms of volume but also in its affordability for the market," he said.

"That’s why it’s important -- looking at that experience in the 1990s, when we embarked on a major energy project to respond to the energy shortage that we were experiencing before -- it is important that we scrutinize the feasibility studies that aren’t being offered to support the project," he said.

"You cannot just say that the Philippines require so many airports here and there; you can’t say that the Philippines now require trans-Pacific highways; if you have to establish the economic demand for those infrastructure," he said.

"You have to make sure that you cover all the bases. But of course, you cannot be 100% sure, but you have to cover the risks that you are confronting," he added.

China Bank’s Mr. Tapia agreed: "[W]hile our local financial institutions have the expertise to do project finance, crucial to the further development of this as a ’financial product’ is the pipeline of good and viable projects, the support of the regulators, and keeping abreast of project financing transactions in the international markets."

Mr. Tapia said parties to the transaction should also ensure the concession agreement is well thought out, and that a clear and credible dispute resolution scheme is in place to resolve issues in a fair and quick manner.

The PPP Center admit that project development should go hand-in-hand with project finance.

"Financing parties should be a regular part of stakeholder consultations or market sounding activities to ensure that the projects that come out of the PPP pipeline are not only viable, but bankable as well," the agency said.

"We have also learned that PPP is not simply the answer to government funding constraints," the PPP Center said, adding that, "It is more of a solution framework for particular infrastructure challenges where opportunities exist in the market to deliver superior service levels at rational costs."

While the banking sector can be a primary source for PPP financing in the near term, the PPP Center is looking to longer-term financing structures. This is why the agency, along with the Securities and Exchange Commission (SEC) and the Philippine Stock Exchange, are exploring different ways of tapping the capital markets.

This month, the SEC approved the listing rules for companies engaged in PPP projects. The new rules will allow companies with PPP contracts worth at least P5 billion to debut on the equities market upon commencing commercial operations or completing construction work.

The PPP Center, with funding from the UK government, is also developing a foreign investment framework for PPP that will make available alternative investment schemes so foreigners can participate in operations and maintenance (O&M).

AIM’s Mr. Leyco said the BSP Circular 914 is a step in the right direction, as it can help stimulate investments in areas in need of infrastructure.

"If they say that they have priority projects in Mindanao and it now allows banks under this circular to extend loans to finance infrastructure projects, that will definitely stimulate bank financing in those areas," he said.

"I cannot imagine infrastructure projects relying purely on government spending or private individual company spending, no. It will have to be an instrument that will allow multi-investments by a lot of entities," he said

"For the Philippines to achieve its infrastructure development goals, it will have to tap more than the resources made available by the Philippine individual companies. Through project financing, it can also attract foreign investors," Mr. Leyco said.

The PPP Center expects a large number infrastructure projects to be rolled out in the coming years, with the Duterte administration’s push for expanding growth outside the already built-up areas like Metro Manila, Cebu and Davao. -- with a report from Mark T. Amoguis

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