Exploring project-specific bonds to finance infrastructure in Nigeria
Project-specific infrastructure bonds have been used in many countries for greenfield and brownfield projects.
The federal government has been making concerted efforts to attract private sector financing with a view to bridging the infrastructure deficit in Nigeria. The Minister of Finance, in an April 8, 2016 article, mentioned that Nigeria's first-ever “project tied” infrastructure bonds are being considered. The Minister opined that these bonds would encourage “private sector financial discipline to the project structuring and delivery process.” (Vanguardngr.com, April 8, 2016). On the back of this soft policy statement, this article provides a brief background on infrastructure bonds in the Nigerian capital market and discusses some of the critical success factors for project-specific infrastructure bonds in Nigeria.
It should be noted that project-specific infrastructure bonds have been used in many countries for greenfield and brownfield projects. Canada is the country that mostly relies on capital markets to finance infrastructure projects. (PricewaterhouseCoopers LLP, “Capital Markets: The Rise of Non-Bank Infrastructure Project Finance” 2013). Such projects have included a 2010 McGill University Health Centre Concession where US$746 million was raised to finance a 300,000m2 500-bed facility under a Design-Build-Finance-Maintain contract, with a 30-year operating period and a 6.63% coupon rate. In South-Africa, a project-specific 15-year 11% coupon bond with a face value of R1 billion was issued in 2013 to finance a 44MW Concentrated Photo Voltaic (CPV) plant, becoming the largest CPV plant in the world. In Abu Dhabi, project-specific bonds worth US$825 million were issued by Ruwais Power Company in 2013 to partially refinance its existing debt facilities in relation to the Build-Own-Operate concession of a 1,500MW power generation facility.
Government bonds in Nigeria
Infrastructure bonds are debt instruments usually issued by the government or public companies to raise funds from the capital market. Federal government and state government bonds in Nigeria are issued on the basis that they would be used to fund capital projects (at least, this is what is stated in the prospectus). For state government bonds, the Securities & Exchange Commission (SEC) monitors the expenditure pattern for the monies raised to ensure they are actually used for the projects stated in the prospectus.
In December 2015, the Debt Management Office (DMO) released data which shows that the federal government has outstanding bonds with a face value of N5.81 trillion. (http://www.dmo.gov.ng). Figures obtained from the FMDQ OTC Securities Exchange (FMDQ) website revealed that at present, state governments have outstanding bond liabilities with a face value of N274 billion.
Project-specific infrastructure bonds
Project-specific infrastructure bonds refer to bonds that are tied to named infrastructure projects with the clear intention that cash flow from those projects should pay out the bondholders. Notably, the government still throws its weight and sovereign guarantee behind the bonds, at any rate.
Benefits of project-specific infrastructure bonds
The following benefits enure to the government and investors, in relation to project-specific infrastructure bonds:
a) Project-specific bonds would more readily attract funding from investors and Pension Fund Administrators (PFAs) who would be attracted to the bankability of the projects. (The Chairman of the Pension Funds Operators Association of Nigeria (PenOp) intimated that PFAs are prepared to invest in infrastructure bonds for bankable projects but their investment is being held back by the dearth of “infrastructure specific bonds”);
b) It is a relatively cheaper, fixed and predictable source of long-term financing for identified infrastructure as opposed to bank lending;
c) Project-specific bonds can fit into multi-tiered financing structures and are usually veritable sources of refinancing bank lending at the time when the project cash flows are mature and more predictable;
d) Project-specific bonds allows the government to borrow on an off balance sheet basis, since a project SPV would typically be the primary obligor.
a) The projects have clear business cases that makes investment decisions relatively easier;
b) Rewards are relatively higher with infrastructure projects because the risk ratings are higher than other types of investments;
c) The bonds may be traded freely on the exchange, i.e. the FMDQ platform and as such, provides an opportunity for the investors to exit the investment prior to maturity, subject to market conditions;
d) For a period of 10 years from the 2nd of January, 2012, bonds issued by federal, state and local governments and their agencies, corporate and supra-nationals and interests earned by the holders of the bonds are exempt from Companies Income Tax; (Companies Income Tax (Exemption of Bonds and Short Term Government Securities) Order 2011); and
e) SEC Regulations provide a level of comfort for bond issuance programmes.
Critical success factors for project-specific infrastructure bonds in Nigeria
For project-specific bonds to be used successfully in Nigeria, the following must be put in place and/or taken cognizance of:
a) Currency risk
Apart from the traditional risk of fluctuation in the exchange rate, which arises where bonds are denominated in foreign currency (e.g. the US$300 million diaspora bond the federal government intends to issue to Nigerians in diaspora, there is now the additional risks of convertibility and transferability arising from the Central Bank of Nigeria's inability to meet the demand for foreign exchange. Potential bondholders will have to consider hedging to mitigate this risk. There is currently an insurance product developed by AXA to take care of this eventuality.
b) Credit enhancements
Credit enhancements in the form of either sovereign guarantees or from eligible financial institutions may be necessary to attract investors with a low risk appetite. These enhancements will typically improve the credit worthiness of projects. Nigeria Sovereign Investment Authority (NSIA) announced plans to establish the Nigeria Credit Enhancement Facility (NCEF) to provide credit enhancements to viable projects. (www.nsia.com.ng). This facility should be operationalised as soon as practicable.
c) Viability Gap Funding
In 2011, The Federal Government emplaced a Viability Gap Funding (VGF). The typical aim of a VGF is to subsidize projects that may not be financially viable at the time but are necessary because of their long-term economic benefits or delayed financial returns. This VGF needs to become operational with clear criteria on how it can be deployed to projects. Using the VGF efficiently to backstop projects and provide other subsidies would make the underlying projects for project-specific bonds more bankable.
d) Future cash-flow securitization
Securitization is a possible mode of raising money for projects that may be used as part of the financing package to give investors greater comfort. Securitization is a tool that secures proven cash flows from a project. It is seldom used for future unproven cash flows and therefore not readily suitable for greenfield projects, except in countries that permit future cash flow securitization. Solving Nigeria's infrastructure deficit will require a lot of greenfield projects. Therefore, to make securitization more useful for financing Nigeria's infrastructure, the SEC Rules on Securitization should be amended to provide possible windows based on set criteria for the securitization of future cash flows.
e) Good project development
To attract investment, the project must be bankable and have the indices of a proper project risk allocation. As such, the government should either establish a department that is tasked with developing bankable projects or, in the alternative, engage private sector specialists to develop such projects.
f) Good project rating
A good project rating is directly linked to good project development and will impact on investors' appetite for any project. It is also the case that the more favourable the project rating, the lower the cost of financing such project through bonds.
Project-specific bonds might be a veritable source of funding to bridge Nigeria's infrastructure deficit. However, such bonds will only be attractive to investors if the underlying projects are viable, properly developed and satisfy the bankability test.
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