Sponsors Brace for a Bumpy Ride - South Africa

Traditionally, the roll-out of infrastructure projects has been the responsibility of the public sector funded by tax revenues and borrowings through government budgetary allocations.
There is no shortage of infrastructure projects on the African continent. However, the landscape changed dramatically last year. The turmoil in global commodity and financial markets during recent months has probably changed banking forever.
The general consensus is that the African banking sector has escaped the worst of the global financial crisis as it is relatively insulated from mainstream banking. But bankers will be watching as the crisis unfolds and deepens, knowing many of their clients will be taking strain which could lead to debt service interruptions and a breach of lending covenants. This is not the time to persist with a business-as-usual attitude.
As it is the fundamental function of banks to lend money, they are always looking for a destination for their cash which will give them good revenue flows leading, in turn, to good bonuses and dividends. These revenues are earned from lending margins and fees.
One of the problems recently has been that bonuses, whether in the form of cash or stock options, have driven the beneficiaries to look for lucrative projects, perhaps at the expense of prudent banking.
What can sponsors expect?
First, what was bankable last year may not be bankable now. Market conditions have changed. In the past we have seen commodity prices drop significantly as a result of a dramatic slow-down in global economic activity.
A year ago, what was a worst-case situation may have become a base-case scenario.
Second, the due diligence and credit processes are likely to be more stringent. Banks are either smarting from the pain inflicted on them as a result of compromising good lending practices for short-term revenue gain or are taking cover if they have managed to avoid the pain through good fortune. The timetable to financial closure is going to be longer, meaning a delay in revenues, a further negative impact on returns.
Third, gearing ratios will be less aggressive. This means greater equity contributions and an impairment of returns as a result. The more conservative levels of senior debt will open the doors for larger layers of mezzanine finance than may have been the norm in recent years. However, mezzanine finance is more expensive. The position is likely to be further aggravated by the fact that investors may be short of cash or more risk averse than they were 18 months ago and projects may run the risk of not being able to close the financing gaps.
Fourth, banks will require higher levels of sponsor support in the pre-completion phases of the project. This means more standby equity, completion guarantees and cost overrun facilities, all at the expense of financial returns.
On the positive side, the flight of capital from emerging markets has resulted in a weakening of local currencies which means that goods and commodities which are sold in dollars, euros or sterling have become relatively cheaper for overseas buyers. Although weaker currencies mean imported goods are more expensive, generally bad news for countries which have to import their energy requirements, the global meltdown has had the consequence of lower oil prices and this must have a beneficial effect on those economies and their balance of payments. Inflation is showing signs of abating as the credit crunch bites and the long- term benefits will work their way through to project revenues.
So what needs to happen to make sure that shell-shocked sponsors do not desert the continent while the global financial reform process plays itself out?
The fundamental requirements of financing a project will remain unchanged. They are, among others, strong sponsors, a proven market, well mitigated completion risk, and operator experience. Governments can play their part by ensuring an enabling environment, facilitating private sector involvement with access to a strong and established legal system.
Repatriation of capital and profits should be made easy and the tax packages should be attractive. Import processes and work permits should not be held up through bureaucratic delays which have a negative knock-on effect on project timetables.
Bad times do not last, good projects do. Sponsors and governments who have the vision, courage and flexibility to ride out the storm will be well positioned to take advantage of the upturn when it inevitably comes about.
ABOUT THE AUTHOR: Charles Marais
Charles Marais is a director at Routledge Modise in association with Eversheds. He has extensive project finance experience across the economic spectrum, including power and energy. Charles has conducted numerous seminars on project finance.