Project finance insurance leads to more deals

Project finance lenders are increasingly turning to nonpayment insurance ( NPI), also known as structured credit insurance, to facilitate lending deals.

Project finance is the longterm financing of infrastructure and industrial projects based upon the projected cash flows of the project rather than the balance sheets of its sponsors.

Infrastructure spending especially in Asia is forecast to explode up to 2025.

China alone will represent 60- percent of infrastructure spend in the region.

In Indonesia, infrastructure spending is expected to grow to around $165 billion by 2025, with growth in public investment spending expected to grow by around seven percent per year.

In the Philippines, spending in infrastructure is expected to grow at around 10- percent per year in the next decade, reaching a total of $27 billion a year by 2025.

Stephen Kay, US Practice Leader for Political Risk and Structured Credit said NPI covers banks and other financial institutions when borrowers fail to pay back loans, enabling project finance lenders to leverage the bank’s credit limit on the borrower and allow the bank to obtain capital relief to lend more money.

Having evolved significantly over the past several years, these policies offer several benefits, which are increasingly being recognized in the market.

As of 2015, project finance NPI now accounts for 10 percent of the total NPI market in the US, up from four percent in 2013.

Typically, project finance lenders enter into a syndicate with other lenders to provide loans for infrastructure deals.

NPI has given lenders the same lending capacity without involving other banks.

Rather than having active partners, as is the case with a loan syndicate, the insurance policy merely provides a backstop, enabling lenders to act more independently.

The benefits of NPIs for project finance lenders include:

• Risk appetite: NPI enables lenders to take on larger deal tickets and complete deals that would typically exceed the bank’s credit limits. It also enables the lender to manage obligor group, sector, or country risk concentrations;

• Competitive advantage: By not involving other banks, NPI provides a competitive advantage. Clients are not introduced to your competitors. The insurance enables you to lend amounts that maintain relevancy for sponsors and buyers that you may not have acting alone;

• Revenue: Larger tickets equal larger upfront fees, meaning lenders with NPI behind them can increase their revenue; and,

• Regulatory: NPI may help optimize the banks’ use of regulatory capital, with many jurisdictions allowing the policy to count as tier-one regulatory capital under Basel III rules, providing capital relief for banks.

NPI insurance capacity has increased significantly over the past five years, with the largest project finance loan insured around $500 million.

Project finance deals are often measured in billions, making NPI best suited to midsize transactions or facilitating an individual bank’s participation in a larger transaction.

“It is important to remember that NPI is an insurance contract rather than a straight guarantee,” Kay said.

Like any insurance policy, there are conditions such as representations and warranties made by the insured bank and administrative responsibilities that the bank needs to meet to maintain coverage.

Failure to comply with these conditions can impair coverage.

However, these operational risks are manageable and entirely within control of the insured lender.

Aside from using NPI, the most common method for banks to manage default risk is to syndicate the loan to other banks, or employ unfunded ( or funded) risk participation from other institutions.

There are customized credit default derivative instruments for project finance loans, but market and price of these tools make them less attractive to lenders.

“As demand for project finance increases, instigated by the need to fund critical infrastructure projects around the world, we expect lenders to use alternative forms of risk transfer, such as NPI, to stay relevant in the project finance lending arena,” he added.