The infrastructure and natural resources sectors
As an introduction, it is worthwhile providing a brief overview of what characterises each of these sectors and, therefore, the primary drivers of finance. This will provide context for the discussion of access to, and availability of, finance for these sectors.
The infrastructure sector has two broad categories:
- economic infrastructure – assets that underpin economic activity and for which a user charge can be applied (such as ports, airports, toll roads, power stations)
- social infrastructure – assets that focus on delivering essential social services and for which a user charge generally cannot be applied (such as schools, prisons, public hospitals).
The infrastructure sector can be characterised as a defensive sector, given the relatively inelastic demand for these types of assets during times of economic uncertainty.
In contrast, the natural resources sector can be characterised as a growth sector for the Australian economy. The majority of demand is export-driven, rather than internal demand as is the case with infrastructure (although demand for transport infrastructure such as rail and ports is closely related to the needs of the natural resources sector in delivering its output to offshore markets). The success of the natural resources sector is therefore highly dependent upon the ability of companies to extract resources on a financially viable basis, taking into account commodity prices that reflect high levels of demand by off-take buyers (primarily Asian) to underpin their country’s economic growth.
The natural resources sector can essentially be categorised according to the following:
- type of commodity and demand for the commodity
- maturity of the reserves/resources.
The key drivers for financing in the infrastructure and natural resources sectors primarily relate to merger and acquisition and/or project-based transactions, which tend to be large and lumpy in nature.
Drivers and requirements for debt financing
Financing availability in these two sectors can vary according to the threshold issue, that is, whether the issuer wants to utilise its balance sheet or access off-balance-sheet financing. There are distinct differences in the nature of these financing arrangements. Corporate finance requires borrowers to provide fixed and floating security over the (parent) company balance sheet, and a diversity of cash flows across the business, while project finance is non-recourse in nature, with repayment of the debt facilities and return on equity dependent upon the individual project’s economics, rather than other assets of the borrower(s).
The choice between corporate finance and project finance depends upon a range of drivers and meeting specific requirements, which are broadly identified in Table 1.
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Financing trends
Before 2008, corporate and project finance was widely available and often on very attractive terms and conditions, including competitive pricing (with marginal liquidity and risk premiums) and tenors ranging up to 15 years (and even up to 28 years on certain transactions). The effects of the global financial crisis (GFC) caused debt markets to contract and the demise of the monoline insurers, which in effect closed the credit wrapped bond market. A number of European banks closed down their offshore corporate and project finance subsidiaries (in Australia) completely.
Some major European banks with remaining corporate and project debt holdings in Australia are also starting to retreat from the domestic market as a direct result of the ongoing European debt problems. Affected European banks are attempting to reduce their exposure to offshore loans, or exit portfolios completely, as pressure mounts to repatriate funds from offshore holdings to their home countries. Currently, Europe holds 25 per cent of Australian loan market share (down from approximately 40 per cent in 20071) and the percentage is likely to drop further in the short to medium term.
The latest departures of European banks from the Australian domestic market are likely to leave a funding gap in infrastructure and natural resources projects. As debt is restructured and refinanced, significant opportunities will develop for emerging market participants to gain added exposure to the local loan market. Those participants in particular are Japan, China and superannuation funds (both domestic and international).
A surge in demand from Japanese banks for Australian project and corporate debt has resulted in an increase in holdings from approximately eight per cent in 2006 to approximately 11 per cent today¹, with further growth likely.
We foresee a similar push from China, Hong Kong and Taiwan, particularly for natural resources and associated infrastructure debt. Currently, Chinese bank participation is low at only three per cent of the Australian loan market¹, indicating huge potential to bridge the funding gap for domestic projects in the immediate future.
Over the past several years, Australian superannuation funds have provided senior and subordinated debt directly into infrastructure transactions (alongside banks), including the Victorian Desalination Plant and Wiggins Island Coal Terminal (WICET) transactions. Although superannuation fund participation in debt is a relatively new concept in Australia, and as a consequence is largely untested, it represents a viable source of long-term financing for assets with stable returns.
Increasing numbers of companies are also accessing alternative offshore sources of debt (particularly the US, and increasingly unsecured notes), due to larger project financing requirements and debt levels reaching maximum domestic limit exposures.
In relation to natural resources, the Asian off-take buyer’s relationship banks are executing competitive corporate and project finance facilities (regularly with longer tenors of five-plus years) for the borrower, often bypassing the domestic banks altogether.
Pressure is also applied to domestic banks where ECA financing is provided to infrastructure and natural resources projects that require a significant component of their funds to acquire imported equipment. ECA direct loans provide competitive pricing and long-term tenors (eg 18 years) that are considerably more attractive than three- to five-year terms preferred by the banks.
Examples of corporate and project finance deals in the infrastructure and natural resources sectors completed recently are listed in Table 2.
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In conclusion
Access and availability to financing for Australian companies in the natural resources and infrastructure sectors is varied across a range of sources, both domestically and internationally. However, events such as the GFC and recent European debt crisis have created opportunities for companies to seek competitive financing from offshore debt markets, in particular the US and Asia.
Recent deals in the natural resources sector indicate that competition from international (Asian) banks, which have relationships with off-take parties, has increased, resulting in longer tenors, lower competitive prices and more attractive conditions than those experienced as a result of the GFC.
In conjunction with the appetite of Asian banks for the Australian infrastructure sector, there is currently a shift in debt market share (both Corporate and Project Finance) to Asian sources (from the more traditional European sources), which is resulting in increased pressure on domestic banks to compete for business in both these sectors. This competition can only assist in meeting the financing required to drive the rapid expansion of the resources and infrastructure sectors underway in Australia.
Endnotes
1. “Europe banks shrink local loan books”, Australian Financial Review, 22 November 2011.
