Fallout From The Terrorist Attacks - The terrorist attacks on the United States are expected to affect the project finance market in a number of ways
Here are the main points that came out of a survey of chief financial officers and general counsels at project developers, top bankers and investment bankers, and others involved in the market.
Travel bans are slowing down work on deals.
Many companies still had travel bans in place in late September as the NewsWire was going to press, forcing cancellation of meetings. The delays are affecting projects not just in the obvious places. Scheduling a meeting on a debt restructuring for a project in Latin America became difficult after several of the international banks in the syndicate reported that flying to and from the United States as well as most of the countries in North Africa and the Middle East was not allowed for bank employees until further notice. The head of an Africa investment fund said the fund canceled travel to Amsterdam for meetings because of concern about “US fighter planes in the air.” However, a project developer with a US power company in London said there were “some nervous travelers” at her company but no cancelled trips. “I don’t think financings will be delayed more than a couple of weeks, but we’ll see.”
Insurance has become significantly more expensive and could have an effect on coverage ratios for debt service because it drives up operating costs.
Insurance companies served notice on international air carriers that they would cancel coverage for war liabilities as of midnight on September 24. Air carriers were given options to renew but at higher premiums and for drastically reduced per-occurrence policy limits. The cancellations appear not to have spread to power plants, but one US power company with projects in Moslem countries reported, “We are seeing terrific price hikes on insurance rates, particularly terrorist insurance.”
The US government is expecting to have to fill in gaps — not just in insurance coverage but also in cases where jittery banks back away from financing commitments. Any US government role would be through the Overseas Private Investment Corporation or The Export-Import Bank. One lawyer familiar with the thinking at both agencies — Ken Hansen in the Chadbourne Washington office — said,“OPIC and Ex-Im are already being called on to backfill for financial institutions who are becoming skittish and either want a government partner or want to quit the field and need OPIC or Ex-Im to take over their positions.”
OPIC expects be asked to provide credit guarantees for banks or insurance companies that are under market scrutiny.
The US Export-Import Bank expects to be called on to buttress trade arrangements that, absent Ex-Im involvement, could unravel for reasons unrelated to buyers and sellers of goods but rather because of failing confidence in relationships among banks, Hansen said. An example is where the Export-Import Bank guarantees letters of credit issued by emerging market banks that could have been confirmed two weeks ago by US banks but now are in question. “Ex-Im did a great deal of this following the onset of the Asian economic crisis supporting, for instance, letters of credit by Japanese banks that had not required such support for decades and today no longer do,” Hansen said. “Absent Ex-Im support for a period, innumerable trade transactions might at least have been delayed and possibly unwound.”
There should be a resurgence of interest in political risk insurance. However, it may be difficult to buy such insurance for existing projects. According to Noam Ayali in the Chadbourne Washington office, “MIGA [the insurance arm of the World Bank] will not provide political risk coverage in ‘secondary’ situations. The same is true for OPIC. They will provide coverage in connection with additional, follow-on investments in existing projects, but not for existing projects where the investor is not putting in any new money.” Ayali suggests that “private insurance carriers — Sovereign Risk, Zurich Re, AIG to name a few — do not have the same ‘developmental’ constraints,” but he suspects that even they would be “loath to provide cover for someone who approaches them now for political risk insurance or else accept the underwriting at extremely high premiums.” (See related article on “Spotlight on Political Risk Insurance” starting on page 7.”)
At least two projects — one in the US and one abroad — received force majeure notices from contractors in the two weeks after the attack on the World Trade Center.
Chadbourne lawyers report fielding calls from clients about not only force majeure provisions but also whether the terrorist attacks, collapse in stock prices and the US declaration of war against terrorism are a “material adverse change” that would allow cancellation of acquisition or merger agreements or loan commitments.
The typical force majeure provision in a construction or operating and maintenance contract allows the contractor to suspend performance — or extend deadlines — after “any act or event that adversely affects performance by the contractor of its obligations” but only if “such act or event is beyond the control of, and occurred without the fault or negligence of the contractor.” War and terrorism are usually given as examples of force majeure events. However, some contracts specifically exclude as an excuse for force majeure late delivery of equipment by subcontractors or vendors. If force majeure continues for more than a certain number of days — for example, more than 270 consecutive days or more than 365 cumulative days — then either party usually has a right to cancel the contract.
“Material adverse change” is not usually well defined in contracts. However, it is a common condition to continuing draws on construction loans and to closings in corporate acquisitions, loan agreements or other transactions that there have been no “material adverse change” in the financial condition of one of the parties.
A construction contractor for a US domestic project gave notice soon after the World Trade Center disaster that it had received a force majeure notice from one of its subcontractors, and it also warned of delays in getting equipment. An equity fund doing deals in Africa said that worldwide flows of cargo have been disrupted. “Anyone who is building a project and counting on shipment of equipment from Europe will have a hard time getting it, even in cases where the equipment is supposed to move by ship.”
Engineers at a project in Pakistan fled the country in the middle of a major turbine overhaul, leaving the turbines partly disassembled, after the US State Department issued a travel warning for Pakistan advising all US “non-vital personnel” to leave. The project company then claimed a “Pakistan political force majeure event” and notified its lenders and the government-owned utility to whom it supplies power. Under the concession agreement between the project company and the government, the government of Pakistan agreed to make capacity payments in place of the utility during a “Pakistan political force majeure event.” The government had not yet responded to the declaration when the NewsWire went to press. Travel warnings have been issued for a number of other countries in the region.
Projects in the New York area are also expected to be affected because contractors have had to shift employees to help with the cleanup in New York City.
An equity investor doing deals in Africa where transactions are sometimes governed by Dutch or French law said he is looking at whether he can postpone closings on grounds of material adverse change, but has been advised by European lawyers that they have an estoppel concept that makes it harder than under US law to walk away from a transaction at the last moment. Estoppel is the notion that one party cannot back out of a deal when the other party has done things like spend a significant sum of money with the reasonable expectation that the first party will follow through on the transaction — even if he is not formally required by contract to proceed.
Recalculating Debt Coverages
More projects will be put on hold — not directly because of the terrorist attacks or US war effort — but because the economy is heading down. Many people surveyed said that this will be merely an acceleration of a trend that was already in evidence.
Developers tend to be optimists who believe in business cycles. Therefore, there is no reason to delay a project that will take three years to build just because the economy appears to be on the downside of a business cycle. However, lenders are more likely to be influenced by the headlines.
One banker — formerly with a European bank — said international banks have tended to abandon the US project market in times of economic downturn and that this trend might be more pronounced this time because a number of banks had their offices in the World Trade Center.
Another head of project finance lending for a European bank said he is in the market now trying to syndicate loans for two US merchant plants and is “at least a little concerned” about whether he will be able to fill out his syndicates. However, he added, “From my institution’s perspective, our opinion of the US from an investment perspective has been quite stable for more than 30 years and these events, albeit incredibly depressing, are not likely to change this opinion.”
Several consulting firms have been predicting for at least the past year that the United States faces an “overbuild” situation in many parts of the country because of the number of project developers rushing into these areas to build merchant power plants. (See “US Heading for Merchant Plant Overdevelopment” in the NewsWire for September 2000.) One head of project finance lending at a US bank said, “I have read the conflicting articles regarding overcapacity-undercapacity in the wholesale electricity markets. A drop in demand [brought about by a weakening economy] will most assuredly push the balance towards a surplus.”
However, the chief financial officer at a large US power developer said he thought recent events would push in the other direction — the overbuild situation would correct itself. “Power plant developers have to have a much longer range view of the markets than one season that may be hot or cold, or the beginning of an economic downturn. Therefore, I doubt you will see many public announcements of project cancellations. However, lenders and equity markets are driven more by short-term phenomena, and ‘headline risk’ for them is often something they make decisions on, rightly or wrongly. So the reality might be fewer projects getting financed and, therefore, more projects deferred. Companies who had planned to raise equity to keep their balance sheets in balance may be unable to do so in the near term and, therefore, may defer capital expenditures. The resultant slowdown in ‘new builds’ could self correct the ‘overbuild’ scenarios that people are predicting.”
If financing costs increase at the same time that higher insurance premiums and falling electricity prices reduce project cash flow, some projects will not get financed simply because they can no longer pay debt service.
One can almost hear the whirr of computer models recalculating debt coverage ratios for projects that are currently under development.
The head of project finance advisory work at an international investment bank said, “I am getting somewhat concerned that the IPP stock prices will make it increasingly difficult to finance the plants to which IPPs have committed. Moreover, even if financed and built, will these new plants’ returns exceed a rapidly increasing cost of capital? To get a sense of the size problem some companies face, think of how many turbines companies have ordered at $35 million each. Next, multiply this number by five as the turbine is about 20% of the cost of a combined-cycle gas plant. The numbers are quite large.”
The higher cost of capital will inevitably push more projects into the unfinanceable column.
Several other trends are foreseeable.
Falling stock prices mean that equity is now more expensive to raise. This will place a limit on the ability of companies to borrow and push project developers to look harder at synthetic and leveraged leasing and other off-balance sheet methods of finance.
It may also lead some companies to use the opportunity to buy back shares.
Some US utilities could become bigger takeover targets if prices for utility stocks were to decline significantly.
The reason falling stock prices make it more expensive to raise equity is a company must give away a larger ownership share to raise the same dollars as before. The trend in recent years had been to move away from project finance and use balance sheet corporate debt facilities. The general counsels at two large US power companies said they now foresee a move in the opposite direction back toward project and structured finance. As one of them explained, “To the extent the disruption prompts further interest rate cuts, debt financing becomes attractive. But regardless of how low interest rates go, public companies with the need to maintain investment grade ratings can only take on so much leverage on the balance sheet. The equity market was already unappealing to offerings. The events in September only make it more so.”
The US Securities and Exchange Commission made it easier in the week after the attack on the World Trade Center for public companies to buy back their own shares. Public companies are limited in practice by “safe harbors” on both the volume and timing of share buybacks. The safe harbors are designed to protect the companies from charges of market manipulation.
The SEC announced on September 14 that the usual limits would not apply for the first five days of public trading beginning with the reopening of the markets. Instead, the timing restrictions were suspended and the volume limit was increased to an amount, excluding “block purchases,” not to exceed 100% of the average daily trading volume over the four weeks preceding September 10. The normal trading volume restriction was 25% of the average daily trading volume over the prior four weeks. The hope was this would help prop up share prices when the US stock exchanges reopened for business on the Monday after the disaster. On September 28, the SEC extended the exemptions until September 28.
There are no securities law limits on the number of shares that a private company can repurchase. However, all companies must make sure they comply with other limits in their organizing documents or financing agreements and in their local corporation law statutes.
Prospects for action by the US Congress on energy legislation appear to be dimming quickly.
The Bush administration declared in late May that the US is in the midst of an energy crisis, and it called on Congress to act this year. However, its plan began losing momentum almost immediately after it was announced. Jonathan Weisgall, a lobbyist for Mid-American Energy Holdings, attributed this to the fact that Congress only acts when there is consensus or a crisis. There was never any consensus this year on what to do, and the sense of crisis passed in the summer as gasoline and electricity prices returned to more normal levels.
Congress is reportedly under pressure from the Bush administration to conclude its session for the year at the earliest possible time. “The administration wants to limit the possibility of partisan outbreaks, intelligence leaks and debates that dilute the attention of the president and his senior staff,” Weisgall said. “Congressional leaders want to stay in town to show their constituents that they are playing a role in the response, but they will most likely try to comply with the wishes of the administration. They are also facing major problems scheduling business because of travel difficulties.” Many congressmen try to go home to their districts on weekends. The House tends to schedule votes only from Tuesday to Thursday to allow travel back and forth.
Congress has a must-do list of only a few remaining items before it adjourns. These include completing appropriations for the year so that the federal government can continue operating, a short-term economic stimulus package, any legislation necessary to implement anti-terrorism programs, and an education reform bill that was largely done before the terrorist attacks on September 11. “Anything that is controversial has been pushed off the list to keep up the appearance of bipartisanship,” Weisgall said.
Many power company lobbyists are still hoping that at least some action can be taken this year on energy issues, perhaps under the rubric of energy security and economic stimulus. The House already passed a bill this summer. The focus is on the Senate. However, with Congress expected to adjourn around November 1, there is almost no time.
Report from the Gulf
Jack Greenwald, a US lawyer who has practiced law for many year in Dubai, reported in late September that many US companies were deferring plans and projects, and some have pulled their US employees and families out of the Persian Gulf region to Europe until the US takes military action and they can better assess the situation. He had met with Benazir Bhutto in Dubai a few days earlier. He worried about a “real threat” of the violence spreading to Pakistan where “the US has lost the support of the middle class and the moderates.” He said work on the big infrastructure projects in the Gulf was continuing, at least as long as the international banks remain willing to extend finance, but that some large tourism projects are likely to be cancelled.
“If I want to be optimistic,” Greenwald said, “I would say that the World Trade Center bombing will result, first, in Israel and the Palestinians finally reaching a reasonable settlement, with heavy behind-the-scenes pressure from the US on Israel, and, second, in an opening between the US and Iran. Both steps will dramatically reduce the quiet but crucial support of the moderates for the extremists, and although terrorism will remain a threat, it will be marginalized.”
by Keith Martin, in Washington