Hi Carlo, today we will discuss an interesting topic related to the financing of big infrastructure projects and in particular on the fact that, very recently, as we have seen during the course, the project finance market has evolved. From the traditional syndication of loans to the project bond category that is sold to infrastructure investors. And the case that we will discuss today is the case of the construction; I would say better, The expansion of an existing port facility in the Paita region in Peru. In this case, we're talking about the Port de Paita. And Port de Paita was at the expansion of existing Paita port. It is one of the most important commercial ports in Peru, that is mainly dedicated to import and export. Flows of goods and commodities flowing from Peru to abroad and vice versa. Serving as an input kind of a facility for goods coming from abroad. This product is interesting because on one side. It gives us some hints about how the market for project bonds is evolving and how the application of this instrument has taken place recently. Vis-a-vis the traditional way project bonds were used. And second because it gives us the possibility to comment on some specific features. That typically bond holders require in order to be a little bit more safeguarded in terms of the cash origination of the project and the ability to put their hands on the cash that is generated by the project. before starting our discussion, let me briefly say that in the past, I would say before the financial turmoil, the use of project finance with backup of project sponsor was only a tiny fraction of the overall amount of project finance facilities. And when used, projects were financed with the use of so-called wrapped bonds. Wrapped in English means that it is included in something that it is larger than the thing that you are wrapping. And in this case wrapping was represented by an insurance contract whereby the SPV in exchange for an insurance premium received from a so called monoline insurer. A monoline is essentially an insurer that guarantees you against credit risk, full repayment in case some unexpected events could emerge. So you can understand that if the monoline insurer was a AAA, for example, AIG in the US. You received AAA vis-a-vis the payment of an insurance premium. And so bondholders bought these kind of securities not because they were looking with an extensive due diligence to the characteristics of the project, but simply because they were wrapped. They were guaranteed. They were backed up. By the provision of a guarantee, provided by an insurance company that was specializing exactly in this specific field. Unfortunately for us, after 2008 most of these monoliners got bankrupt or lost their AAA rating status. And so from this point of view, you have now, in front of you, a situation where bond holders are demanding investment in this field. But unfortunately they cannot count any longer on this kind protection. And so the Port de Paita was an interesting application because it didn't use monoline insurance. And it was exactly applied to an expansion and refurbishment of an existing port facility. So, I would, I believe that we will have a lot of things to discuss together. The first thing that comes to my mind by looking at the financing the project for an amount of $110 million, is that the project bond comes with a fixed rate. While this is quite uncommon for loans for example. And the maturity is very long because it's a 25 years maturity. Very good. Yes it is indeed when the project was started. The project goes back to the beginning of 2012. When the SPV was named Terminales Portuarios Euroandinos received from the Ministry of Transportation of the Peru government a 30 year concession. That was a design, financed, built, and operate kind of concession. Whereby the SPV was entitled to run the project and build up the additional facilities for 30 years. The situation you pointed out correctly is pretty characteristic. One, you have a fixed rate. second, you have a very long maturity. Which is absolutely uncommon nowadays for typical project loans. Maturity was very long. It was 25 years with a final maturity of 2037. Which is absolutely unreachable, due to current market conditions on the bond market. Do you remember during the course, Basil tree enactment, the net stable funding ratio, debt averaging of banks? Second, it is a fixed rate. When when instead typically loans. Are given to SPVs based on a floating rate. So typically Euribor or Libor plus a margin. And a fixed rate is particularly sought after by institutional investors like pensions. Or for example, insurance companies that typically want to match. The asset and liability side with a stable and fixed stream of interest. So two particular and very interesting features that are very hard to be found nowadays in the traditional banking market. Let me also add one additional thing, which was interesting from this point of view. For five years, in the first period of the life of the concession, the bond paid only interest. And not principle. So you had a grace period, you know, to not to stress too much the cash flows of the initiative whereby, you only provide the payment of the 8.125. Interest rate fixed upon to the investor. So, pretty interesting from the deal structuring point of it. You described, just a few minutes ago, the role of monoline insurers. And the fact that the enhancement of the credit quality of the project they bring. In this case they were not used. In fact, the rating of the project was a high yield rating, because it was BB and BB-. how would you explain this choice? Couple of things for you. The first one. When you want to place bonds at an international level. And this was a bond placed internationally because it was sold under one specific rule called 144A. And the Regulation S, these are two regulations that according to the SEC, the Securities and Exchange Commission, in the United States, you can sell, in the American market, but not to retain investors. So this kind of bond issue was typically dedicated to big and large institutional investors. And in fact, this kind of bond issue was regulated according to these kinds of rules that are set for the specific American market. The second thing is if you really want to tap the market for institutional investors, you must provide a rating for the issue. And in fact, in the case, the bond was rated by two of the big three rating agencies receive the BB minus from Finch, and a double B flat from Standard and Poor that was slightly below the rating that the country of origin, and the country of the incorporation of the SPV Peru. And at the time, Peru had the triple B. Kind of rating. And that, this basically indicates to you that there was first, no protection on the monoline side. Second, that as it typically happens in an old rule of thumb. Typically a corporation has a rating ceiling that is represented by the rating of the country where that corporate is incorporated. The recent turmoil has changed a little bit the rules of the game. But in the case of Peru you have a maximum ceiling of triple B, and the level of rating was couple of notches below, hm? I will return on it later on, in order to understand exactly why this happened. So another difference that comes to mind with respect to project loans is that all the amount of money that is borrowed comes at the beginning of the, of the project. And, so there is a need to optimize the management of cash. Exactly. This is another interesting point that you are raising, Carlo. Consider the case of Port de Paita. Port de Paita was based on a 30 year concession agreement but the construction of the new piers that where aimed at receiving in new cargoes and expanding the possibility to manage the 20 feet cargoes. That were coming to the port, was not carried out immediately all of a sudden. But, was staged at different stage of developments. Just to get an idea, the total cost of construction that was envisioned in the business plan was in the region of $210 million. And this amount was split in four different stages. Stage number one that accounted for the largest portion around $130 million was estimated to start at the very beginning. Stage number two for an additional amount of around $19 million. Was estimated to take place once the port reaches a capacity of around 180,020 feet equivalent unit per year. TU is a standard measure in order to understand the capacity of a port. The third stage was a envisioned once the port could reach the capacity of around 300,000. And in addition to this in additional 123 million expense, capital expenditure. Was at the discretion of the concessionaire, in a period that was stretched over 20 years. So the point is, if you launch at 110 million bond issue, at the very end you receive all the money at the very beginning. Differently from what happens with a typical syndicated loans. When we have seen that moneys are drawn from the banks as long as the construction goes on based on milestone payments. You have a problem here. Because you received all the cash. And you are not spending all the cash, all of the sudden. In technical terms this is called a negative carry, story. And, negative carry is a typical problem of project bonds. For which you have to identify ways to optimize it. Put them in a reserve that is remunerated. Finding ways to optimize the return in order to avoid sub-optimization of the use of cash. This is certainly one of the key issues that creates an obvious con for project bonds vis-a-vis the typical syndicated facility. You have described the project as happening in three different stages. So looking from the opposite perspective, how can we make that there is money in the project in order to develop the different stages at the right time? Mm-hm, yes. Yes, it is a good point. Can you- Is there any trapping of cash in some way? Yes there is. Two elements for you, Carlo. Going back to what we have seen for syndicated loans, you have seen that in a syndicated loan there is one key loan that is preformed by the agent bank, that in a sense is a sort of representative for all the banks that are involved in the syndicate. So, typically decisions can be taken quickly because there is one representative that constantly monitors the performance of the project. And typically if you go back to our session on syndication, typically managers, the current accounts of the SPV. In order to disperse money. Giving a certain waterfall and taking all the relevant decisions on behalf of the other banks of the syndicate. When you use project bonds you have two problems. The first one, you have a much larger number of investors then in a typical syndicated loan. When you launch a bond issue in the market you can count 200, 300 investors. And taking decisions to 200, 300 investors becomes a little bit difficult and coordination costs explode. Unless you don't find a solution for this. In the case of the Port de Paita terminales portuarios euroandinos the solution was and this is pretty normal in the bond issue market. To use an indenture trustee. The indenture trustee is the representative for bond holders, it is the equivalent of the agent bank in a syndicate that typically makes decisions, sometimes tough decisions, on behalf of the investors. In this case, the indenture trustee was represented by City and City Peru. And city and city Peru went into an agreement with the independent engineer that, in this case, was R. Rios J. Ingenieros. That typically performed the, technical due diligence. But in addition to this performed also the monitoring activity that was needed by the indenture trustee. In order to communicate how the performance of the project was. Typically test the service cover ratio, loan life cover ratio or taking decisions when decisions are material. You remember, the materiality test. In this case, the independent engineer performed these functions on behalf of the indenture trustee. And then the indenture trustee could communicate this kind of decisions to the bond holders in order to get their approval or denial, in order to this kind of decisions. The second element that you site is the problem of cash trapping, and this is particularly important because. Eh, compared to a traditional syndicated loans where the banks are very active in monitoring the performance of a project. When you have plenty of bondholders scattered around the world where this bond is only a fraction of of their holdings, the incentive not to monitor, so much, is very strong. So, from this point of view, Port of Paita is an interesting application of the typical cash trapping mechanism, in the sense that creditors inserted some, clauses that captured most of the cash. That was necessary to carry out the construction phases as long as the project goes on. Do you remember the schedule that I cited moments ago? We have seen that the port expansion will be carried out in four different stages. The big one was stage number one, around 130 million. Stage number two, around 20 million was started only when the project reaches at least 180,000 TU years. Well the regulations of the bond indicated that. The indenture trustees, so City and City Peru, can start withholding retaining if you want, portions of cash when the project reaches 160,000, TU per annum, so that you can start retaining cash before stage number two starts. And this money is deposited in a so-called stage 2 trust account. That is not usable by the project sponsors. So, sponsors have generated cash but they can not use it because this money is committed for the financing of stage 2 of the project. And the same holds true for stage three. Stage three will start with the expansion of the third stage of the development of the project. When the port reaches 300,000 TU per annum, well, the indenture trustee will start retaining money for this kind of stage three development. When the project, when the port reaches 260,000. And for stage four, the discretionary part, the stage four trust account. Will be created from the very beginning. So you have the comfort of the fact that when the stage of development would start. You are mathematically sure that money will be there. These are all the new features that, due to the fact that unfortunately you no longer have the possibility to resort to monoliner, the capital markets have developed. So, Carlo, we have seen that basically the bond market is evolving. There is a big appetite for these kinds of instruments. And one of the typical features of financial market is to create financial engineering in order to comply and to tackle with the needs of investors. Port de Paita has been certainly one of the largest investors, investments in Latin American. The bond market is alive and well. And with good prospects in the years to come.
