Mining has been hit hard by the liquidity crunch – both in terms of debt and equity supply. The plummet in commodities pricing has left some of the majors struggling with debt repayments and many juniors are either having to mothball projects or go out of business simply because they cannot raise cash.

With so few projects in the pipeline there is a risk of too little commodities supply when demand returns. Project Finance held a roundtable in London with well-known mining financiers still active in the market to discuss the hurdles to mining projects, funding availability and the potential for new funding sources.

PF: The overall theme is in what ways has the credit crunch impacted on mining and more specifically junior miners?

Lindsay: Given I'm a junior miner I'd better kick off. Everything comes back to the same place – not only the collapse of the debt market but also the collapse of the consumption of commodities. What's different about this downturn is the rapidity with which the carpet was pulled.
In our industry we know that 20% of the forecast supply of nickel this year has been cancelled or mothballed – considering we live in a world where 2-6% compound growth is what you're looking for, to lose 20% in a year is terrible – and even then people are talking about there being oversupply this year.

Balsdon: Its not just about higher cost of the debt – it's the non-availability of debt. You can go with the best project in the world to any number of banks and they just say "we haven't got the money."

PF: What's the perspective of a lending bank still open for mining business?

Tyler: It's true, junior mining companies do have limited access to debt and equity in these turbulent markets. In addition, banks are no longer lending using LIBOR as a base rate but have shifted to a "cost of funds" regime plus margin.
But projects that have good assets, robust cash flow projections and strong economic fundamentals will weather the storm. Nedbank is still open for business and always on the look out for quality projects. Key aspects for us are the strength of the management team and their track record in developing projects and raising equity, a quality asset that is low to mid tier on the global cost curve and an asset that has a decent reserve tail that exists in excess of our funding term. Given liquidity constraints, we consider the pool of deals and decide where best to apply the bank's capital.
And I don't think we are experiencing a mining recession – merely a market correction. We have always maintained that commodity prices were over-inflated and the recent decline in the price of base metals and to some extent precious metals is a function of markets re-aligning themselves. Commodity prices have given up their post-2002 bubble levels and have found support around their long-term trend lines.

Maxwell: I agree that the credit crunch has resulted in many junior mining companies not being able to raise debt, let alone cope with the high cost of debt. And many have had to re-evaluate the economics of their projects, and some have chosen to either abandon projects altogether or place development in abeyance (until at least the markets recover). The credit crunch has also had a ripple effect into equity markets where juniors have not been able to raise equity due to poor liquidity.
But good quality projects with strong management credentials and sound reputable contractors will always attract capital through conventional capital raisings as evidenced recently by juniors such as Great Basin Gold (who raised up to $130 million) in very tough markets.

PF: European Nickel went to China to fund the Caldag project – what are the benefits and does the financing come with any strings?

Lindsay: China is the only place we're aware of where you can get competitive finance at the moment, because China works in a different way. The country announced $600 billion of investment last year, part of that is for investing abroad, and securing strategic resources is still on their agenda. They have an advantage in that they are the world's largest consumer of copper and nickel, so they have greater forecasting confidence.
As for caveats – well the deal's not done yet so I can't be specific. We do spend a lot of time trying to understand a different way of doing business. We were going to do our project geared at 60% – we're now doing 80%. That's not a conventional response to weakening markets, but the project can carry the debt and the Chinese are prepared to lend.
What you've got to do is to make your project Chinese – we've got a Chinese EPC contractor and half the offtake goes to China. The loan facility is ECA-backed and there is a formula for determining what percentage of finance they'll provide cover for. Sinosure will insure the commercial debt risk, not just PRI, and Chinese banks slot in underneath. For example, we're talking about a $350 million facility for Caldag and we're told it may come from only one bank.

Balsdon: Yes – the Chinese have a very different view on how you syndicate down. We did a $6 billion deal and they syndicated it by allocating it between their branches.
They also look at the transaction as a whole. I did a similar deal involving a Japanese trading house – financing cost was low but if you looked at the whole, they were lending money to a Russian borrower, selling the borrower equipment and then getting coal back for Japanese offtakers.

Lindsay: Chinese lenders worry about different things. For example, Sinosure is interested in the balance of payments between China and Turkey – if we're exporting a couple of hundred million dollars of material to China then that's a good thing as far as Sinosure is concerned – no western bank would care less about that.
The Chinese also do lots of due diligence.

Balsdon: As a lawyer, the interesting thing for me about the Chinese project banks is that they've traditionally been document light, as opposed to the document heavy trend in the west. Are they catching up on that and becoming more covenant heavy?

Lindsay: We haven't got to the loan documentation stage yet – heads of agreement have been signed. But we're told we're near the front of the very long queue of western mining companies in the Sinosure approval process.

PF: The original Caldag deal was SG, Standard Bank and Standard Chartered – they're all still lending so why did they pull out? And how significant are the pricing benefits of the new Caldag facility?

Lindsay: It looks like the margin will be light – although there's an up front premium which is far from light. The deal with western banks fell through because of permitting problems – but the NPV we got for that and what we have now are about the same. But that's good given how the market has changed over the period.
Also, the western banks could not go to 80% gearing. We've had to go to 80% because we can't go to the equity markets – our share price has collapsed, and to try and do the 40% equity we were going to do originally would dilute the value for existing shareholders to the point of insult.
That's why we got the Chinese in at the project equity level – because the project is less devalued than the listed entity. Rio Tinto is partially doing the same thing with Chinalco, selling off stakes in particular assets.

PF: Will there be more M&A with majors taking out minors, or are the majors strapped for cash?

Tyler: Probably not. The majors have also had to cope with the high cost of debt and some have reduced their capital expenditure programmes by as much as 40%. Some have embarked on "cash preservation strategies" and others have abandoned acquisition targets. Nevertheless, majors have strong balance sheets and have been able to readjust their short-term strategies with minimal effort, in line with changes in market fundamentals.

Goss: Some of the majors are up to the hilt in debt – their room for movement is quite small. But then the Chinese are buying into them – OZ Minerals for example.
Some of the mid-size miners have also run into problems – Glencore, Xstrata etc. But of the majors sitting on cash mountains, very few are interested in taking over juniors – they'll just take a seed stake and wait for them to grow. They don't want the trouble of a full acquisition.

Lindsay: They might come in for an OZ Minerals sized deal. But majors are not very good at investing in a downturn – they get nervous. They've got project pipelines and have to take a view – do I have the zero holding costs of a project which I can do one day when the market is right or do I stick my neck out and spend real money on a deal? In the end they tend to caution.

Street: The deals that have been done so far have largely been as a result of miners being in financial difficulty. If the majors such as BHP Billiton were offered the same projects two years ago and didn't like them then – they're certainly not going to like them now.

PF: Given juniors just can't get the equity in these markets – other than some of the gold company raisings – and are either going out of business or putting projects on hold, what is the impact of the crisis on the future project pipeline and how severe will it be?

Lindsay: We raised £4 million of equity very recently (April) – but to put it into context, we raised £84 million two years ago: The deal is a bridging finance until the Chinese take a 22% interest in the project for $20 million at discount to the NPV.
To answer the question, the project pipeline oscillates and has shrivelled to nothing at the moment. For example, in the 90s no-one was exploring for copper – then the copper price hit $1.5 and that sucked every copper project into production. Then it dropped off again.

Backes: We have been looking at the reversal in exploration effort from majors to juniors in recent years – the question now is how many of these junior dollars are no longer there? No-one knows yet.

Lindsay: Because the credit crunch happened so quickly, every junior has switched everything off they can. We haven't seen a lot of consolidation because everyone is so cash oriented. Sponsors look at a consolidation and say what does it do for my cash – not what does it do for my project portfolio. If it doesn't come with cash you don't bother. But I'm still surprised there hasn't been more.

Backes: The other thing that's happening is consolidation in the junior sector among juniors – some are trying to consolidate on assets and cash resources and maximise value. We have seen juniors looking for other less cash-rich juniors, which may lead to some consolidation. But not much has happened yet – although there is a lot of talking.

PF: How effective do you think the Canadian flow through shares scheme and the new South African 100% tax break on amounts invested by venture capital funds will be on volume of equity flowing to juniors? Should other governments follow suit?

Tyler: The Canadian Flow-Through Share Scheme is a successful incentive to investors looking for tax breaks. It has also resulted in thousands of juniors raising exploration capital they would otherwise not have access to. So, this is a win-win situation.
The new SA Tax incentive is not as bullish as the Canadian scheme but is seen as a milestone in promoting the capital raising for junior mining companies in South Africa.

PF: Why don't banks apply the reserves-based lending techniques in the oil and gas sector to mining?

Balsdon: I've never really understood why reserve based lending can't be applied to mining – I can't really see the difference. But it never has been and now no-one has the cash for new products.

Street: Oil and gas people argue cashflows are more predictable than in mining because you don't have variances in mine plans, grade, strip ratios etc. But those issues are not insurmountable – I just don't think anyone has got their head around it.
A few years ago there were some North American mining deals where companies had one or two assets that they borrowed against – almost like a borrowing base with a discounted NPV of future cash flows and a reserve tail. That was as close as it got.
Plus, in a better bank market you'd often see a standard corporate deal for a producing company in any case.

Tyler: Ore reserves are measured according to worldwide standards such as JORC, SAMREC, 43-101, etc. But compliance with these standards only give investors and banks a certain level of confidence in the ore-body itself.

Backes: Mineral reserves do tend to be more complex than oil and gas. On the other hand, the stuff is solid and it is there – it is no more difficult than trying to suck gas out of a subterranean well – especially if you've got a junior operator. I don't think the risks are any greater necessarily – I think it is cultural.

PF: When do you think it is likely the banks will come back to the mining market and what are the kind of terms on offer? And can higher debt pricing be offset with project cost savings elsewhere?

Tyler: We haven't left – but more banks will probably return to the market in line with commodities pricing increases. From 2010, the outlook for commodities turns positive with global growth expected to increase to 1.8%, climbing to 3.7% and 4.3% in 2011 and 2012. This recovery is expected to be led by infrastructural spending, with consumer spending being the lagging sector. A large portion of global GDP growth is largely supported by China and the extent of demand for various commodities going forward.
On the cost side, there is a time lag between the readjustment of commodity prices and mining deflation. Whether or not this will be sufficient to offset the cost of higher debt will depend on many factors such as the quantum and type of debt, the terms and conditions. Add-on costs – higher fees etc – are a function of market conditions and rates will always depend on the size of the project and the time taken for certain tasks to be completed.

Balsdon: I've noticed that banks do have more appetite for projects than a few months ago – but they are looking at them more carefully. They are really concerned about rates of return and their credit committees bounce back structures. As a consequence banks want total security which slows transactions down – so not only is pricing of debt going up but you also have higher transaction costs.

Lindsay: They can afford to be fussy. You probably don't want to be the first bank to be seen to coming back into the market in a big way unless you've caught the upturn in the commodities market.

Street: This is the big issue for sponsors. Previously you'd go to banks and they'd underwrite a big amount. Now hold amounts are very small. You have to end up with a club, and you either manage the club yourself or let the banks do it – which is hard for the sponsor because he ends up with the lowest common denominator of every term going just to ensure that he gets his money. And tenors have shortened – except for those from offtake investors such as the Chinese and DFI's.

Lindsay: The short tenors squeeze the cover ratios. It means you need an even better project to satisfy lenders. If you have a fantastic project you've got a chance of getting it financed by western banks – but if you had a fantastic project you'd probably have done it already.
Some projects have been caught mid-motion to getting into production, but there aren't many. The average unit costs of most commodities had been going up pretty fast. Suddenly a brake has gone on and people are saying we've got to bring costs down again. But there aren't many projects that can.
The whole reason commodity pricing was going up was because you couldn't find low cost production – that's the miners' argument.
But banks don't take a view on that. They look at the current price and knock a bit off. So when you're down 75% on the value of an asset on where you were a year ago, for someone to knock it back further is not helpful, particularly given asset values will go up again.

Balsdon: Oil and gas is not dissimilar. I did a deal in 1998 for Lukoil where the oil price went down to $9 dollars a barrel. The banks walked away. I couldn't believe it because the ratios were still fine at $9, but the banks couldn't deal with it.

Street: The positive side is some capital costs are coming down. We are speaking to a couple of firms that did feasibility studies in the middle of last year and they are predicting a 15-25% cost reduction by the middle of this year.

Lindsay: I'm sure that's right. We haven't explicitly re-costed in the last few months because we haven't got to that stage, but you can see it coming. Acid used to cost $100 per ton and now its free – delivered. That's an extreme example, but every engineering firm has less work, employees are cheaper because they've got less choice, fuel costs are down, and local costs come down because of the FX regime. All that helps – but it doesn't over come all the other problems.

Street: I'm working on a copper project at the moment – the copper price, for various fundamental reasons, has recovered quickly. The project is in a similar position to where it was a year ago because capital and operating costs will come down, but debt capacity will likely be reduced.

Goss: Another thing on the cost side is that project cycles should shorten by 10-20% because there are more people available to complete projects. Just six months ago, getting a consultant to finish off a feasibility study on time and on budget was literally impossible. Now it'll probably be on time and well written.
Another point is Libor risk is very big. Spreads are huge, cushioned by very low libor at the moment – but if interest rates go back up to 5% suddenly you're going to be facing double digit financing costs and you got to have a pretty good rate of return to cope with that.

Street: It certainly makes sense for people to do interest rate hedging during construction at least.

Balsdon: But only if the banks are willing to offer it – and even then they'll require a huge up front fee to cover it. The same goes for commodity pricing hedging. And you can forget any long term hedging.

PF: So what shape will mining recovery take and will private equity have a role to play?

Goss: Whereas in the last boom everything went up – the recovery could be very selective. Metals may recover selectively – if the US and Chinese stimulus packages are very steel heavy they may take off, but then demand from the auto manufacturing sector is down. That said, there's not that many mining projects being closed at the moment, so commodity demand could outstrip supply post-recession.

Balsdon: Business has got very thin. We're looking at some coal mines in Indonesia and bits and pieces in Africa – but there are not many active projects and Russia has closed down.

Goss: We've got one coke and coal in abeyance, one mining project in the far-east edging along and that's about it. Early equity is something we like to do, but as the crisis has developed we've been looking for later stage projects where you don't have the further financing risk.

Lindsay: We're seeing more of private equity and if you're prepared to wait you can make 20 times your money on the right mining project. So I think there will be a pick up via specialist funds that will keep mining projects ticking over.

Balsdon: Private equity is interesting – there are huge sums sitting there that could join up with specialist funds – and if they can see a squeeze on a commodity in three or four years, you can see them going for it.

Lindsay: Downsizing in senior management pushed many very experienced mining financiers into private equity, which gives those funds the confidence and expertise to invest. A couple of funds have come along recently in Hong Kong. World Mining Investment raised $400 million and aims for $1 billion – and unusually its stated aim is to get at least 51% of anything it invests in. So there must be some serious expertise in the background there.

Street: There are a number of funds around currently raising capital. Raising the money is the difficult part. Endeavour has recently raised C$115 million in equity on the Toronto Stock Exchange to make gold investments and we plan to raise more funds from other investors.

PF: There's a concept put forward by some projects bankers of persuading specialist funds to put up both debt and short miniperm-style debt. How feasible is that?

Street: Its something we've thought about but I don't know whether there's enough appetite to do it, particularly over that period of time. One of the big problems a lot of the funds have had is that they are open-ended and as soon as the markets collapsed people withdrew their money. Those funds then had to sell assets to pay redemptions. A 6 to 8 year commitment for a project is a very long time for most funds and pretty unlikely.

Goss: To broaden the funds question – you've got a real shortage of debt, and you've got big Libor risk so that you may have your returns capped by interest costs. In that context are miners looking at full equity finance for project development?

Street: At the moment there isn't sufficient equity available to wholly finance big projects. In the first instance investors financed existing operating companies and large miners that did rights issues. Then you had companies just coming into production.
But there are signs of the equity market improving, and if it does this will filter down to the junior market in the next six months or so. Most people on the mining company side would still say the cost of raising equity is more expensive than debt, even with higher margins on debt. That said, Rio announced a bond issue at 9% for 5 years, Anglo American 9.2% – those are pretty good returns for your average pension fund.

PF: Is it still worth persisting with western banks?

Lindsay: We are still talking to western banks. The problem is that Libor may be low but you just get a bigger fee so the total costs are the same as ever. We did transaction banking in the past where banks made money on the bells and whistles on the project deal. Now banks want relationships based on future business streams and that's very difficult for a junior.

Balsdon: Even for a major it is getting difficult. There's a particular oil and gas asset we are looking to project finance with two sponsors in it with credit ratings of A- or A. The reserves in barrel terms are larger than the entire North Sea, and the project will be up and running for 20 months before financing – so banks are not even taking technical risk.
But the amount of sponsor support being sought for the financing is enormous, and the sponsors are also being asked to provide a steady stream of business entirely outside the project financing. Translate that to mining and it becomes exceedingly difficult.
I've been working on the deal for 5 years and we recently had a beauty parade for 15 banks. All of them said the same thing – it's a 15-year tenor, we want it down to 10 please, and can it be 8 with a full cash sweep!

PF: With so few banks lending you've got to questions what they are doing for money at moment?

Goss: After the sub-prime mess you would have thought there'd be a bank move back to project finance, which is old-fashioned solid banking. But there hasn't been because banks are scared of long tenors. But I don't see why. Macro economic risk is 5 years and everyone thinks the global economy will be back in growth in 10 years, so banks should be indifferent to 8 or 10 year tenors.

Balsdon: Its all about the allocation of capital – banks don't want to tie capital up long term. There are also country and sector concentration limits to consider.

Goss: I can see that argument for 6, 12 and 18 months versus 6 or 8 year debt – but I don't understand it for 5 or 10 year debt. If you can lend to 5 years you may as well go to 10.

Street: Banks typically use tenor in their risk weighted asset modelling. Why tenor? I agree with you – I don't think it makes the proposition more or less risky per se – it's just the way the banks' models function.

Balsdon: And banks are making vast advisory fees from restructuring deals to which they already have exposure – the Rusal $17 billion standstill agreement for example – so why take the risk of a new loan?
But I don't think things are as gloomy as they were three months ago – although it is still very hard for sponsors. If you can get it, I think trade finance is the way a lot of mining companies can live out the next 3 to 5 years. The risk weighting is lower and it is becoming more and more common – for example, many Russian oil companies that were getting vast corporate loans are now having to put trade receivables on the line.