Generalisations are easy in times of panic, but as the dust settles more subtle effects can be observed. The 'credit crunch' has had a selective impact on project finance deals: the effects are not global and have impacted liquidity most substantially in banks either side of the Atlantic. "It's a liquidity issue rather than a credit issue," is a common refrain from project finance bankers. Also 'crunch' seems too strong a word, as many banks are untouched by the turbulence – Japanese, Middle East and German banks (IKB Bank the exception) still enjoy substantial liquidity.

Some project finance deals have also escaped the effects of the 'credit crunch' altogether, whether by geography, such as the South American and Asian markets (the Mexican toll road deals are a good example of large syndicated deals), by sector or by size.

"The liquidity squeeze has not had much effect on the medium-lower ticket end," says Gershon Cohen, Head of Infrastructure at Bank of Scotland. "With good quality assets such as PFI and where a club deal or no syndication is required, there is still plenty of competition, and though there is some upward pressure it is not having as marked effect as at the higher end."

As well as the liquidity issue, markets are also being shaped by other factors. "Hybrid corporate transactions with PF features to improve their credit rating, such as those in the utility sector, have dried up," says Bart Oosterveld, Chairman Project Finance Credit Committee at Moody's. "UK PFI has slowed down for reasons other than the credit crunch, and the highly leveraged acquisition market goes up and down through its own cycles."

North Sea oil and gas sector is an example of a sector unlikely to be affected by the credit crunch because it is benefiting from the stability brought about by the price of oil tipping $80 a barrel. Small- and medium-sized projects, and vanilla project financings such as most European PFIs are also likely to remain unaffected, because of most banks continued willingness to underwrite quality assets without much syndication risk.

The US power market has witnessed the retreat of the B-loan lenders, only for their vacancy to be filled by banks using the same covenants and with only a modest uptick in pricing. The $1 billion bank financing from Credit Suisse and RBS for the Sandy Creek project is the most notable example of banks filling institutional lenders' shoes (search 'New rules, new assets' for more).

"It is apparent to me that the impact on the project market has not been as severe as other markets such as the leverage market," says Tom Hardy Global Head of Project Finance at Royal Bank of Scotland. "This is due to the nature of project finance structures and the layering of protective elements therein. It is also due to the underlying alignment of interests between sponsors and lenders which is perhaps not as evident in other markets."

It is the hybrid deals that overlap between project finance and leveraged acquisitions that are likely to be kicked hardest by the crunch. The nadir of acquisition debt pricing was five month's ago, when buyers were enjoying seemingly limitless bank liquidity for highly leveraged assets. Asset buyers were migrating from leveraged deals toward non-recourse debt despite more onerous covenants because of cheaper debt pricing – but it is unlikely that the asset buyers will enjoy the same conditions again in the foreseeable future.

Some banks are in the unenviable situation of straddling the effects of the credit crunch having underwritten a hybrid deal before the turmoil, but trying to distribute the debt into a patchy market. Just how these hybrid deals sell into the market will give a good indication of current bank appetite for highly leveraged acquisitions.

Syndication wobbles

The National Grid Wireless/Arqiva deal, which was bought on a 21x Ebitda multiple, is struggling in general syndication. Sub-underwriters on the debt backing Macquarie's acquisition of National Grid Wireless were offered £130 million for a 25bp underwriting fee with a participation fee of 75bp, yet in general syndication the fees are higher. On tickets of £50 million, £35 million and £20 million fees are being offered of 130bp, 115bp and 100bp respectively.

HSBC is sole underwriting £1.5 billion in seven-year senior debt and a £350 million capex facility backing Macquarie's $1.9 billion Airwave emergency services telecoms acquisition from O2. Both Macquarie deals were banked outside HSBC's project and export practice. HSBC's concerted push into underwriting large telecoms deals, starting with the hiring of two senior telecom financiers from Morgan Stanley in 2006, has suffered exceptionally bad timing.

"There was an interesting situation in the loan markets," says Hardy. "Banks were pricing liquidity rather than risk. I said at least over a year ago that this was a dangerous situation and that a correction was likely."

The agents of syndication desks trying to sell down acquisition hybrids structured before the turmoil will be having an uncomfortable time at present. As well as the Macquarie telecoms deals in the market other acquisition deals that may experience a rough ride include the Scandlines and Tank & Rast deals.

The Eu1 billion financing of the Allianz and 3i purchase of Scandlines has been reconfigured by lead arrangers ING, Mizuho, SG and Royal Bank of Scotland in the face of limp demand. Unconfirmed reports have the seven year loan split into an amortizing tranche, a pure bullet tranche and a capex and working capital tranche. The tranches are priced at 15bp, 200bp and 150bp respectively, and compare with 140bp on a single seven year bullet for the previous arrangement. Fees are 100bp for Eu100 million, 80bp for Eu50 million and 60bp for Eu30 million.

Barclays Capital, RBS, SG and UBS are arranging a Eu2.27 billion transaction backing RREEF's 50% purchase of Tank & Rast from private equity firm Terra Firma. A recent S&P report on leveraged infrastructure deals said that although the deal is marketed as an infrastructure play this is only the case in a benign market environment and "motorway service operators' revenues tend to rely upon retail and catering revenues to a great extent, which arguably cannot provide such operational and revenue flow stability as mature infrastructure assets – such as toll roads." Nevertheless, bankers claim that the leverage of 11x Ebitda is consistent with the stability underlying the credit.

Hybrid acquisition deals will probably continue to be the hardest to get away; with higher leveraging and a more aggressive amortisation profile (an entire drawdown is usually immediate with a six or seven year bullet). One consequence of the higher price of debt is falling, or at least moderating asset pricing, and perhaps a shift in the balance of buyers away from infra funds which rely more on the cost of capital and portfolio efficiencies to strategic investors which more often utilise on-balance sheet funding and can rely more on synergies and efficiencies of scale.

Another possible consequence is a moratorium on asset sales by sellers unwilling to accept lower prices, who may wait for improved market conditions or seek alternative routes to divestment such as a listing.

The deals in syndication that will provide the next test for the markets include the Trinergy and Budapest Airport acquisition deals in Europe and the Trans-Bay Cable deal in the US.

Middle East less liquid

Before the tumult, the Middle East was the most liquid project bank market, but there has now been a clear uptick in debt pricing. However, speculation of increases of up to 30bp seem to have been exaggerated. "There has been some nervousness over underwriting with banks unwilling to underwrite significant amounts without protection," says Stephen Crane, Head of Structured Finance at Bank of Tokyo-Mitsubishi UFJ's London office. "Price changes have been slight and hard to discern. The acid test will be when a big or unconventional financing comes to market."

It is clear that in the present climate large sole underwritings of the sort ABN Amro engineered for Yansab and Citi provided for Sohar Aluminium are unlikely to be repeated. Hardy adds: "On larger deals such as those in the Middle East, it is likely that we will see a greater clubbing of underwritings as we see signs of discernable changes in the quantum of final holds."

That next test out of the Middle East will be the National Chevron Phillips Saudi deal which is currently undergoing a funding competition at present, with the deadline for bank submissions due within a week Project Finance Magazine goes to press.

Two deals in the Middle East have been flagged as examples of casualties of the current market conditions: Qafco 5 and Qasco, both hybrid corporate transactions. The financing for Qatar Fertiliser Company's (Qafco) $1.2 billion Qafco 5 has dropped a bond component amid uncertainness over the pricing. Qafco had aimed to have the debt in the market by October, but it will be fortunate to get the deal to market by the end of the year.

The Qasco financing has been postponed by Qatar Petroleum (QP), but it unclear whether this is a result of the market conditions, or the way the deal was engineered, or QP's reluctance to accept price flex, or, a combination of all three. A $1.34 billion debt package was due to be secured by September, but is now not expected to be completed until 2008.

The financial adviser, Ernst & Young deviated from the usual QP model of involving a large group of banks at the mandated lead arranger level, leaving the deal more exposed to banks' reluctance to accept syndication risk. Still the deal should have got away with a price flex mechanism, but QP, a renowned taskmaster, is thought to be unwilling to budge on the flex or put up additional security.

One possible knock-on consequence of the turbulent markets and the reduced liquidity of some international banks is a shift toward alternative sources of funding. However, sizeable changes are unlikely. "I don't envisage a large shift in the funding mix, whether to ECA or Islamic facilities in the Middle East," says Crane. "It is possible that Islamic financing will have a greater role in deals as some regional banks appear to have been more insulated from the wider market issues."

Some deals have got away in the Middle East completely unscathed. The $1 billion Dubai Electricity and Water Authority (Dewa) securitisation of future electricity and water bills transaction, on the face of it, looked like a suitable candidate for trouble – it was the largest securitisation from the Middle East, the first of its asset type, and it closed mid-August. Nevertheless, lead arrangers ABN Amro and Calyon got the deal away without a hitch.

Despite the conditions of the capital markets the deal was done without change to pricing or timing. The deal was structured with a Cayman Islands-based SPV purchasing the receivables from the proceeds of a bond issue. The bond has a legal maturity of 24 years, and was rated A+/Aa-/A1.

The bonds were entirely placed with ABN Amro and Calyon's commercial paper conduits, called Tulip and LMA respectively. The conduits offer short term paper, often as short as a week, to commercial paper investors principally in the US and Europe. In the case of LMA it is published that the conduit has zero exposure to US sub-prime, so apart from wider market sentiment the securitisation was fully insulated from the effects of the credit crisis.

Much of the multilateral and ECA debt out of the Middle East is reliant on the conduit model, with much of the debt placed in highly rated conduits and chopped into short-term commercial paper. It is unclear whether these conduits have had any trouble rolling over their short-term funding, a financier from a prominent ECA said that they were having discussions about what this might mean for their funding activities. One consequence of fewer final buyers is a higher cost of ECA/Multilateral funding, but to what degree as compared to the pricing of other sources of funding remains unclear.

"With regards to the market at the moment, the commercial paper market shows signs of life with the CP market coming back although the price is still above where it was," says Cohen.

The PF businesses of the much maligned ratings agencies are unlikely to alter their PF models in light of what has happened with the subprime securitisations, so mutli-notch downgrades or vast changes in methodology can be ruled out.

"Our models are robust to cycles to a large extent and we don't think our models will change as a result of the credit crunch," says Oosterveld of Moody's. "Our approach to CBOs [with regards to a securitisation of project finance debt] where the assets going into the pool are rated and an assessment is made on the assets' correlation is also unlikely to change unless the prevailing conditions alter our expected correlation between assets."

Bond vs. Bank

There is likely to be a slight shift toward bank debt rather than capital markets route in the short term. The $2 billion financing for the UK's Future Strategic Tanker Aircraft (FSTA) is going through an eventful funding competition. An EADS-led private consortium are financing the purchase and adaptation of roughly 20 Rolls-Royce-powered A330-200 jets to provide aerial refuelling and air transport for the Royal Air Force. The deal is a one off, large PFI deal that six month's ago would likely have been placed completely in the capital markets and has suffered from unfortunate timing.

At present it looks as though the financing will be split between a £1.5 billion bond issue and a £500 million bank tranche. One financier active in the bidding says, "Deutsche [the financial adviser] is caught between a rock and a hard place, they're trying to obtain a committed financing within a reasonable timeframe and they're facing uncertainty in the market. Before the summer the deal could have been priced at around 75bp but it's now above 100bp."

If the go-ahead was given on the bond now, the bond would be in the market in December – far from ideal. FSTA is almost certainly a 2008 deal. Another source close to the deal says that depending on the demands of the Ministry of Defence, a sensible solution would be for Deutsche to structure into the deal the possibility of a capital markets refinancing against the same term sheet, so that they can benefit from a reduced cost of funding when the market calms down without the hassle of a full blown refinancing.

"In current market conditions there is heightened uncertainty of strike price in the capital markets at present making sponsors and clients nervous," says Cohen.

Other deals have also been affected by the uncertainty in the capital markets. The Northern Batched Hospital scheme comprising two projects, Salford and Tameside hospitals. The bonds backing the projects had a spread of 80bp and 79bp respectively, compared with around 50bp of comparable hospital PFI bonds, St Bart's and St Helen's. However the all-in comparison was about equal given that the yield on spread had fallen. The £79 million index-linked bonds due 2041 have a coupon of 1.98%, just under 9bp below the coupon on the first batch, the £159 million Salford Hospital bond, which closed a week earlier. Also, at the time the deals experienced positive carry as short-term rates were above long term rates.

Across the Atlantic in July, InterGen priced a combined bond, bank and B loan refinancing of its corporate and some project debt against expectation given the choppy market conditions. InterGen sold roughly $1.26 billion in dollar bonds due 2017 at a discount, with a coupon of 9% but a yield of 9.125%, roughly £200 million ($410 million) in sterling debt due 2017 with a 9.5% coupon, and Eu150 million ($230 million) in Euro debt due 2017 with an 8.5% coupon. All of the debt priced with yields roughly 12.5bp higher than price talk the previous week.

Despite InterGen's corporate financing headache, the funding competition for its Rijnmond 2 IPP financing in the Netherlands is believed to have come in at a low of 50bp. Also, largely unaffected by any liquidity issues, the EdF-Delta Sloe IPP also in the Netherlands achieved a price-flex 60bp with Fortis, HSBC and RBS arranging.

Price flex required

There is a consensus that lenders are requiring protection from their clients in the form of a capped flex pricing agreement. "That flex is required in the current market is generally accepted by the buy side," says Hardy. "It becomes more difficult where sponsors, who are rarely in the market, resist structure and price-flex clauses because of their unfamiliarity with what is happening. It comes down to a relationship question and a trust factor – flex does not necessarily need to be triggered but it is a fall-back option."

Another banker who wished to remain anonymous says that a modest capped price-flex clause was the only concession banks are likely to ask of sponsors, and that he could not envisage any deals being banked with uncapped flex or complete flex with regard to structure.

"The credit crunch is not necessarily a bad thing for the market, which was trending to pricing liquidity rather than risk," says Hardy. "The old adage says that 'competition will inevitably drive lenders to structure weaker deals'. I therefore welcome what has happened in the sense that it is obliging structures to reflect the risks and has brought about a reversal of what was taking place in the market. It is also a reality-check for newer market entrants who may have thought that there were easy pickings undercutting established banks in terms of margins and covenants."

There is a broad consensus that the market will be near to normal by the end of the first quarter of 2008 but perhaps with some deals being put off until next year. "I expect a soft landing within two or three months with perhaps less heat than before," says Crane. "At this point in the year many banks have reached their internal targets, so they may ride out the rest of the year banks' inertia may result in activity taking longer to return to levels reached earlier this year," says Cohen.

There is an outside chance that the subprime malaise is a starting point for a global downward spiral into recession, and this is probably the biggest threat to the global PF market today over and above the current liquidity issues.

"Beyond the deal pipeline we don't envisage the credit crunch having much of an impact on project finance in terms of operating assets, unless the wider economic conditions deteriorate, with lower house prices, a weaker dollar and turbulent credit markets creating a perfect storm which bleeds into project finance," says Oosterveld. "In this situation, deals with merchant or patronage risk will be most vulnerable – but at present this seems remote."