Latin American mining finance has witnessed a significant drop-off in commercial bank interest. Shorter tenors, higher pricing and the re-imposition of high debt service coverage ratios dominate the market. Export credit agencies are back in vogue and can anchor deals, but only those that are strategically important.

In this tight market, bankers like to point to the closing of large deals, though they are few and far between. The Minera Esperanza deal shows that with the right agency backing, large-scale project finance deals in the region are still viable, and can still bring in at least some commercial banks.

Esperanza: Old schooled

The financing closed almost exactly ten years after the Antamina copper-gold project in Peru, which had a similarly large cast of agency development finance providers. Ten years on, the cast of lenders on Esperanza is depressingly familiar, although their presence is more the result of liquidity constraints than political risk perceptions.

The $1.05 billion Esperanza copper-gold project is a joint venture between Chile's Antofagasta, with 70%, and Marubeni, which owns the balance of the equity. The project, in Chile's Antofagasta Region, a little south of the El Tesoro mine, has a 16-year life that could be extended using an adjacent property.

The deal brought in the Japan Bank for International Corporation (JBIC) for a $400 million piece, Export Development Canada with $200 million and KfW IPEX-Bank with $50 million. The three agencies were enough to coax in five mandated lead arrangers and bookrunners, in the form of Bank of Tokyo Mitsubishi-UFJ, Calyon, ING Capital, Mizuho Corporate Bank and SMBC, and two arrangers, Santander and Natixis, which together supplied $400 million. The sponsors provided completion guarantees in proportion to their interests and the balance of the $2.3 billion total estimated capital costs.

Given the timing, the market was surprised by the number of banks in the initial solicitation, says Hugo Dryland, managing director and global head of mining at Rothschild in Washington DC, who advised on the deal. Dryland says that as market conditions improved, a range of new banks expressed interest in joining the club and the two most ready to move were signed up.

In the prevailing tight market, the borrower's usual leverage in negotiations was reduced, Dryland admits. "We were worried at the end of 2008 about securing participation of banks as many sought their own recapitalisation," he notes. Today, banks' funding costs are below September's levels, he notes.

To obtain participation, the sponsors provided more aggressive cash-sharing arrangements and tighter covenants, particularly on environmental issues, because of the participation of agencies, Dryland notes. Although the participation of agencies usually implies longer completion times, the process took a total of nine months against a more typical 12-month period, he says.

Which Asian offtaker?

Bankers see Japan as the prime mover in the current market, whether through its trading companies, banks, or through JBIC. But it is not alone. Other leading Asian consumers of commodities are entering the breach. South Korea is reproducing the Japanese model of joint ventures and an offtake agreement. Export credit agency Kexim and the Korea Development Bank help to coordinate and raise government-backed financing.

India is at a less developed stage, but has also started to show signs of interest in Latin mining properties, notes Richard Brach, partner in the global project finance department at Milbank, Tweed in New York. Bolivia's huge iron ore deposits at El Mutun have enticed Jindal Steel and Power, which committed $2.1 billion in the spring to develop the site, with full production slated for 2012, he notes.

The most significant and least understood player Asian player is China. The country's mining and metals producers have been highly visible in bidding for assets but have rarely been transparent. Chinese players have been buying junior copper assets, particularly in Peru, but these assets often had higher production costs than their peers. They have also dropped out of projects, such as Baosteel's joint venture with Vale, without clarifying why, bankers say.

Chinese offtakers would be natural partners for ambitious mine developers, but are still relatively unfamiliar with international project finance norms. With clients pressuring advisers for a fast turnaround, the long-time frame needed to secure Chinese participation limits the country's presence in Latin mining markets, Dryland believes.

They are also seen as overly aggressive. Baker & McKenzie turned down a $1 billion Chinese M&A mandate because of the tough conditions demanded, claims Santiago-based Antonio Ortuzar, partner and head of mining, chemicals and energy for Latin America.

As China is short in some key materials, Latin America is a good fit, especially in iron ore and copper concentrate, says Steve Smith, managing director and global head of metals and mining at WestLB in London. While he also notes the slow pace of deal-making, he expects China to become more prominent in supplying foreign direct investment, providing financing as equipment providers and offtakers, and buying into senior and subordinated debt tranches.

China has committed to some large investments, for example in Peru's Toromocho, a poly-metallic deposit in the Andes with estimated copper reserves of over 7 million tonnes. Aluminum Corp of China (Chinalco) acquired 100% in Peru Copper for $860 million and is planning an open-pit mine to produce 250,000 tonnes annually, with estimated capital expenditure of $2.15 billion. Essentially the deal is that China provides the capital and negotiates the offtake or sells a stake, says Smith.

In addition to agencies, multilaterals have made a comeback, particularly in markets with high political risk, such as Argentina, Bolivia, Ecuador, and Venezuela, says Smith. Still bankers remain wary of doing business in these countries, as the uncertainty regarding the mining legal framework, including changes to base regimes and royalties, might change completely a project's economics and thus debt repayment capacity. In Venezuela, work was carried out on Gold Reserve's Las Brisas project to ensure it was bankable for two years, covering mining and environmental issues, and the deal never appeared, notes Smith.

Commercial banks

"Despite the relative stability of mining over the long-term and long lead times for projects, commercial bank interest has plunged", notes Brach. The number of commercial banks in the project finance space in Latin America has fallen since last September to roughly a half dozen, adds Smith.

There has been a particularly striking drop in international bank participation. Commercial banks need a strong reason to participate in new deals outside home markets to get an approval from credit committees. Reasons for these forays might include involvement from a home market agency, thereby reinforcing the need for agencies, or long-standing relations with the sponsor.

A number of European banks have strategically cut back exposure, including Royal Bank of Scotland and ABN Amro, although there are a couple of newcomers, including Standard Chartered and HSBC, says Dryland. Japanese banks as well as Calyon, WestLB and ING have remained active, says Clarence Tong, senior vice-president, project finance Americas at Mizuho Corporate Bank in New York.

In 2007, the pattern in Latin America was for short-term bridge loans, as private and public equity was readily available and the use of over-allotment options was prevalent, says Ortuzar. Since September, equity financing has not been available. Banks are no longer willing to write large tickets, with $100 million seen as the very upper limit, while they have cut the length of tenors to less than 10 years make project financing viable, as well as insisting on tighter covenants, ratios and more extensive hedging.

In 2007, 12-year tenors were common, but today banks balk at providing financing beyond 10 years with anything beyond seven years seen as the sweet spot, says Tong. In their search to mitigate risks, banks have imposed structures that have become highly complex and difficult to manage, says Ortuzar. This is manifested in tighter reporting requirements, or the insertion of waivers and consents that have to be given with the full support of all lenders. Sweep arrangements are back in vogue too. In the financing for Quadra Mining's acquisition of Centenario Copper Corporation, a 60-70% cash flow sweep was imposed, he says.

Coverage ratio covenants have inched up, too. In the early part of this decade, the market standard was for a debt service coverage ratio of 1.5x and as more banks entered the space, this came down to 1.2-1.3x while three-month debt servicing accounts were replaced by one-month provisions, or simply axed. The earlier tougher terms have now been re-imposed, says Smith.

Historically low Libor rates have helped mine operators, but overall lending rates have increased. Partly that's because commercial banks are not funding themselves at Libor and are making up for this by charging a premium, partly risk mitigation and partly a function of wider credit trends.
Equity-debt ratios have been fundamentally re-thought. In the years up to 2007, sponsors sought splits of 20% equity to 80%, says Smith. These days, banks are demanding equity of more than 50%, says Tong. Banks have been insisting on tighter waterfalls and avoiding debt subordination, he adds.

The absence of a deep secondary market has also fundamentally changed financing techniques, says Smith. In 2007-08, banks started to participate in the market, driven in part by the expectation that there would be more commitments and a deep market to sell into. That market disappeared overnight, he notes. Those syndicated loans that had been mandated were continued, forcing banks to take a paper loss as loans were retained on balance sheet. That caused a shut down in the underwriting market, he notes.

There has also been a return to club deals, common 10-15 years ago, but more recently replaced by syndicated deals. Tighter-knit club deals allow the sponsor to hand pick banks and provides parity, notes Tong. Overall there has probably been a 50% drop in project financing in the sector between the first half of 2007 and the first half of this year, he estimates.

The amount and type of hedging required by banks has also expanded substantially, despite sponsors' attempts to combat the trend. Large companies that once shunned project finance are using it, as well as agreeing to hedging and thus giving away price upside, notes Smith.

The most contentious area is product hedging, says Brach. Sponsors dislike hedging, partly because their own shareholders usually disdain the practice, and partly because of the difficulties that many producers have encountered with hedging products. As Dryland notes, banks might insist on hedging for credit reasons, but often this hedging helps boost banks' returns.

Sponsors were previously able to use hedging for only a very small portion of output, perhaps 10%, compared to 30-40% in today's market, says Ortuzar. Banks have been surprised that, even as sponsors consent to tighter debt terms, they resist hedging requirements with such passion. Sponsors retort that a depressed market is worst time to lock in output prices.

Junior miners

The absence of financing will not have a great impact on well-financed miners. Local companies mainly stayed clear of leverage and include Brazil's Vale and Votorantim; Chile's Corporacion Nacional del Cobre; and Buenaventura of Venezuela, where cash flows are generally higher than capex needs, notes Smith. Indeed, these companies are avoiding project financing, except for very specific deals such as Vale's Moatize coal project in Mozambique.

At the other end of the spectrum, junior miners will suffer disproportionately. The number of such miners increased hugely in the boom years, generating hundreds of potential financings. Only a handful are likely to come to market any time soon. If two years ago, 20-25% of projects were achievable, in today's market only 10% look doable, says Smith. Equity will be extremely difficult to raise for these companies, thanks to dilution of what are already often penny shares.

There are exceptions to the funding drought in this space, Smith notes. Australian miner Mirabela's financing for Brazilian mine Santa Rita started as an underwritten deal with Credit Suisse and Barclays, which were looking to syndicate to a large number of banks. The deal was launched the day of the Lehman Brothers collapse. WestLB worked with Credit Suisse and Barclays on a new structure and did close the deal, although pricing was higher, he says.

Lack of access to financing opens up the possibility of widespread consolidation in the industry, particularly mid-tier miners. The likely targets are those firms that can rapidly start generating cash flow. Big miners, however, may not be a large part of that process, as they knuckle down to cost cutting, having got flabby in the boom years.

Junior miners face an absence of agency and bank funding and unattractive deals from offtakers. Multilaterals are focusing on projects deemed strategically important, following intensive talks with government officials. And while commodity traders are re-emerging as financiers, they are said to be offering unattractive terms, often including debt in return for a large portion, some 10%, of the top line. That can make deals unviable for junior miners. "It's a lighter structure but you lose all potential upside," says Smith. That leaves junior miners with the unpalatable choice of abandoning most of the upside from their project, either by selling out or accepting punitive terms, or waiting for a significant improvement in financing terms from banks.

Bankers get squeamish when asked how long the current drought may last. When it ends, new Asian agencies will have more clout, there will be fewer banks operating in the space and there will be fewer accommodating junior miners.

Santa Rita: A timely rescue