New EU-backed infrastructure era ahead

Fri Jul 12, 2013 11:27am EDT

* First bond under EU Project Bonds initiative

* EIB funds to lower infrastructure debt costs

* Spanish offshore gas storage first to benefit

By Owen Sanderson

LONDON, July 12 (IFR) - The first bond to be issued under the EU's Europe 2020 Project Bond Initiative was announced on Thursday, which could open a new era of capital markets access for essential European infrastructure.

European authorities have been working on ways to persuade bond investors to back infrastructure projects since 2010, when EC president Jose Manuel Barroso proposed the initiative.

But legal documents were only put in place last year, after they stumbled on how to structure their support, conflicting regulation, and the European sovereign debt crisis.

Pre-crisis, bond insurers called monolines would guarantee project finance bonds, but these institutions fell away during the crisis, leaving only struggling bank balance sheets and unwilling bond investors to fund infrastructure. The EU therefore decided to step in and risk public funds to try to reconnect the capital markets to infrastructure finance.

The new bond deal, dubbed Watercraft Capital, announced on Thursday, will raise EUR1.434bn to fund an underwater gas storage facility in Spain, replacing the bank loans that funded the construction of the project over the past two years.

Lead managers BNP Paribas, Credit Agricole CIB, Bankia, CaixaBank, Natixis, Santander GBM and Societe Generale refer to the whole project as Project Castor.

The project will pump gas into a disused oil field developed by Shell in the 1970s, some 20km from the coast of Valencia, and will allow Valencia to store the equivalent of three months gas supply.

European support comes in the form of a EUR200m liquidity line from the European Investment Bank. This will boost the rating of the bonds by two notches - essential to make them into investment grade with S&P, thus expanding the universe of possible investors way beyond high yield or infrastructure specialists. The deal is expected to be BBB+ with Fitch and BBB with S&P.

The liquidity line will not be drawn at first, but can be used to support cost overruns in the initial project phase, and latterly debt service shortfalls. If there is a debt service shortfall, the EIB's liquidity line (called a Project Bond Credit Enhancement, or PBCE) will prepay some of the bond outstanding, deleveraging the structure.

This will be triggered if the Debt Service Cover ratio is below 1.05 times. At this point, spare cash after paying senior interest will be swept to pay back the EIB, with the equity locked out.

BEATING INVESTOR CHALLENGE

Despite EIB backing, the deal is still likely to remain challenging. It is an amortising bond maturing in 2034, with an average life of 11.5 years. This is to match the expected cashflows from the project, and to reduce the debt burden, but long-dated amortising bonds are rare in euro markets.

Sterling investments are frequently in long-dated amortising format, but most euro issuance is between 5 and 10 years and in bullet format, according to IFR data.

The Kingdom of Spain sold a 15 year bond on Tuesday - its longest in over two years - placing the EUR3.5bn bond at 280bp over mid-swaps. This was a signal that the market is open for long-dated Spanish risk. The leads have been ready to launch this deal for over a year, but have been put off by poor conditions for Spanish sovereign risk, according to one.

This deal will certainly have to pay a liquidity premium to the Spanish sovereign, but ought to comfortably beat the loan margin, which started at 350bp when first extended in 2010, but increased to 450bp, with an annually increasing cash sweep.

Bringing in the EIB brings qualitative comfort as well as a better credit rating - because the EIB is taking a riskier, subordinated position in the company's capital structure, this gives investors in the senior debt comfort that the project has had proper due diligence conducted.

EIB is also taking a separate EUR300m slice of senior debt.

Leads are roadshowing next week in Madrid, London, Paris, Germany and the Netherlands. The equity sponsors are ACS, a Spanish construction and engineering company, and Castor UGS, a partnership of Canadian oil and gas company Dundee Energy and private investors.

This deal should be the first of many to benefit from EIB credit enhancement. The remainder of 2013 is a "test phase" where only EUR230m was available, but the scheme should reach full capacity between 2014 and 2020. By the end of June, the EIB board of directors had approved 9 projects which would be eligible for credit enhancement. Alongside Porject Castor, there is offshore gas in Italy, motorways in Slovakia, Germany, Belgium and the UK, and grid connections in Germany and the UK.

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