Infrastructure in Nigeria: Unlocking Pension fund investment (3)
The Infracredit business model was simple, in concept. There were many potential infrastructure projects, companies, or funds that needed to borrow long-term capital, but whose stand-alone credit was unattractive to most investors (including the expected large pool of investable pension fund capital). Prospects were bleak for raising either debt or equity for those projects. To address this problem, Infracredit and its allies would perform their own underwriting of the risk and uncertainties. If satisfied, Infracredit would enter into a contractual obligation with the project borrower to provide credit enhancement: a callable facility to which lenders could turn if the principal borrower got into trouble.
The presence of Infracredit would make some projects “bankable” which would not otherwise have been able to attract investors; and the presence of Infracredit would enhance some rated securities several grades, making them both investable by more conservative institutions and also lowering the interest rate demanded by investors. This was a valuable commitment.
For this service, Infracredit would receive a fee from the issuers (the borrowers). These fees would be the major source of revenues for the Company. Operating costs included the costs of investigations, due diligence, and underwriting; sales and marketing to attract projects (and investors); and overhead and salaries. According to its promotional material, Infracredit expected to adopt a “zero loss underwriting policy” and only underwrite a portfolio of investments that contained very low potential default frequency and low loss severity characteristics.
Observers noted that if there were guarantee payment losses, those of course would also be operating losses for the Company. Traditional insurance companies and banks would expense and carry a loan loss reserve (in this instance a guarantee loss reserve). As yet it was unclear to observers how Infracredit would book this consideration. In part, the accounting treatment would depend on the terms and conditions under which Infracredit could reach back to the contingent capital.
Infracredit – The First Deal: Viathan SPV Infracredit’s first credit enhancement transaction closed in January 2018 with an entity called Viathan Funding. The press release said, in part:43
With Infracredit’s guarantee, Viathan Group through Viathan Funding Plc, a special purpose vehicle established to raise debt capital, successfully accessed the debt capital markets for the first time by issuing a NGN 10.0bn 16.0% Series 1 Senior Guaranteed Fixed Rate Bond Due 2027 (the “Viathan Bonds”) backed by the irrevocable and unconditional guarantee of Infracredit and accorded ‘AAA’ long term national scale rating by Global Credit Ratings CO.(GCR) and Agusto & Co.c
The Viathan bond issue was subscribed by sixteen institutional investors including about a dozen PFAS and two insurance companies. The largest investors were two PFAS, ARM and Stanbic. See Exhibit 12 for a list of all Viathan bond investors and the amounts of their investments. The Viathan bonds priced at an 82bps premium to the 10-year sovereign benchmark bond (NIGB 16.288 03/17/2027 Govt), according to the press release. It was expected that the bonds would be listed on the FMDQ OTC Securities Exchange. Observers noted that it was beneficial for institutional investors to have access to a liquid market in the event they did not want to hold the bonds to maturity.
Viathan expected to use the bonds to expand its generation capacity by 7.5 MW, to construct a 104,800 scm/dayd Compressed Natural Gas (CNG) plant, and to refinance short-term bank debts, according to the release.
This was the final step in a long process for Viathan. In July of 2015, the private equity firm Synergy Capital invested in the existing Nigerian operating business Viathan Engineering LTD. The intent was to build and own power projects.44
Subsequently, Synergy Capital and Viathan Engineering formed Viathan Funding as a special purpose vehicle (SPV) to pool cash flow generated by certain Viathan assets for the purpose of raising debt capital.
Viathan Funding as a potential bond issuer was given an implicit BBB credit rating by Global Credit Rating Co. (GCR), a rating agency, in June of 2017.45
With the involvement of Infracredit, in October of 2017 the Viathan Bonds were rated AAA by GCR. The offering was oversubscribed, and the bonds were sold, including to the 16 institutional investors mentioned above.46 Observers commented that this infrastructure offering was denominated all in local currency (the cash flows, the investors, and the returns) and was AAA rated without a sovereign guarantee.
As the first fully guaranteed private infrastructure bond issued to finance a privately-owned Nigerian power company, the Viathan bond was viewed by a number of pension funds as an attractive investment opportunity. According to Eric Fajemisin, Stanbic’s CEO, The bond was of interest to us because it was a ‘first of its kind’ type transaction, infrastructure bond issued by a private entity to finance a privately-owned power company. We view this as an area with huge potential if accessed correctly as it presents huge benefits for institutional investors like pension fund administrators and managers. It also was materially enhanced via the security structure provided by NSIA and Guarantco.47
Fajemisin viewed the Viathan bond as being clearly aligned with Stanbic’s longterm sustainable return focus and meeting the PFA’S most critical investment considerations: improved diversification, attractive yields/returns, and significant de-risking (100% guarantee and issuance backed by solid credit rating). Further, he recognized the important role infrastructure investing could play in addressing the large infrastructure gap in Nigeria, noting that “with efficient deployment of capital, we expect infrastructure investing to be a major catalyst for the next growth phase. Stanbic is keen to take advantage of opportunities in this regard so long as risks can be identified, agreed and effectively mitigated.”48 In line with regulatory limits, Fajemisin expected infrastructure bonds and funds to make up close to 15% and 10% of the Stanbic portfolio, respectively.
In January of 2018, Nigerian government bonds denominated in Naira (FGN Bonds) and maturing in 2027 were trading at yields of about 14.40%.49 For comparative purposes, in many emerging pension countries 10-year BBB corporate bonds traded at about 400 bps above a treasury offering of similar tenor.50
Infracredit Growth Trajectory Infracredit had ambitious growth goals. Analysts projected guarantees in place to approximately triple each year for the first several years of operations (see Exhibit 9).51 Infracredit would presumably face sales and underwriting challenges in identifying, qualifying, and closing deals at that pace. Infracredit’s credit enhancement business model might not require as much capital as a direct investing model, but the balance sheet would likely still need to grow (see Exhibit 9). The Viathan portfolio contained several assets, one of which was a 7.5 MW expansion of a power plant. If Infracredit could successfully unlock funding for smaller power plants, not needing complex guarantees, this would be very positive for the nation.
Azura-edo: An atypical megaproject or a model to emulate?
A benchmark large power project was the Azura-edo facility. Azura-edo IPP was a Special Purpose Vehicle (SPV) established to design, finance construct and operate, on a build-own-operate (BOO) basis a 459 MW gas-fueled open cycle gas turbine (OCGT). According to a World Bank Project Appraisal,52 the SPV’S sustainability would depend on the SPV’S ability to design, finance, procure, construct, test, commission, operate and maintain the power plant. The SPV would have one main source of revenue derived from the sale of electricity under a power purchase agreement (PPA) entered into with NET (the Nigerian electrical transmission utility). The project cost was estimated in 2014 to be about $US 813 million and completion was planned for 2018. The direct EPC (Engineer, Procure, Construct) cost of the plant was about US$387 million, or about US$843 per kw which was in line with international experience.
The Azura-edo financial configuration was complex and involved many levels of guarantees that were slow and difficult to secure. As summarized in the World Bank project appraisal document:
Based on the Lender’s Financial Model…the SPV is financed with 27.5 percent equity and 72.5 percent senior and mezzanine debt. The senior debt will be provided by a mix of international banks led by Standard Chartered Bank, with a total aggregate amount of US$200 million; they will be beneficiaries of IBRD’S and MIGA’SE guarantees, each covering 50% of the exposure in this tranche. The local commercial tranche is expected to amount up to US$150 million, to be provided by First City Monument Bank PLC (Nigeria)(“fcmb”) who, in turn, is expected to receive (and pass on to the Project) concessional financing from Nigeria’s Bank of Industry (“BOI”) through the Power Aviation and Infrastructure Fund (PAIF). The DFI tranche is expected to represent close to US$240 million of the senior debt financing, of which IFC expects to commit US$50