The Malaysian market, like many of its neighbours, is suffering from an embarrassment of liquidity. A combination of bonds, bank loans, and Islamic products eliminated the need for dollar debt for non-oil and gas projects long ago. Malaysian banks have built up a strong track record in domestic toll road and power projects, and have even begun to follow local sponsors abroad.

But the market is currently experiencing a hiatus. Infrastructure debt makes up roughly 30-40% of the country's private debt securities issuance, but new projects have been few and far between. The three sources of new business, and of some nervousness at Malaysian lenders, are upcoming financings for water assets, state-owned power company Tenaga's attempts to renegotiate power tariffs, and the Ninth Malaysia Plan (9MP) for 2006-2010.

The most recent financing in the market was the RM1.46 billion ($404.7 million) Bai Bithaman Ajil (deferred-payment sale contracts) issue for the Senai-Desaru Expressway. The Islamic bond issue, which closed through Maybank subsidiary Aseambankers and Standard Chartered Malaysia in September 2005, financed a 77km toll road at the southern end of the Malay peninsular. It connects Pennawar and the Malaysia Singapore Second Crossing, and its lead sponsor is Ranhill.

The bonds have maturities of between six and 18.5 years, priced with a coupon of 3.5%, and gained an AA3 rating from the Ratings Agency of Malaysia. The road is located outside of the Klang Valley, which incorporates capital Kuala Lumpur and its suburbs and is the site of most current toll projects. It also competes with the free Pasir Gudang Highway, but in many respects the leads consider the deal straightforward. The success of the road in ramping up traffic levels will be key in convincing the Malaysian government to concession out toll facilities elsewhere in the country.

The Ninth life

In this respect, the forthcoming 9MP will be key. The plan is the latest in a long line of dirigiste five-year plans produced by the government of the federation to upgrade the country's infrastructure at a rapid pace. It succeeds the Eighth Malaysia Plan, which set aside RM170 billion in spending, and envisages a RM200 billion spend over the next five years.

The plan is likely to provide a windfall to construction companies and bond underwriters. Compared to the 8MP, which explicitly focused on information technology and social issues, infrastructure projects are likely to be more prominent. Malaysian construction companies have frequently complained that since the 1997 crisis they have not received sufficient opportunities, although Kuala Lumpur's skyline seems none the worse for this.

The RM46.94 billion set aside for infrastructure in the 9MP is comfortably exceeds the RM38.7 billion of its predecessor. Of this total, roads will receive RM17.3 billion, and water RM8.2 billion. The construction sector is broadly satisfied with the allocation, which is likely to spur the development of infrastructure in rural and less developed areas.

What it may not lead to is an increase in the levels of project bond issuance. The amount of federal money earmarked for infrastructure and utilities projects may be used on direct procurement, or it may be provided as subsidies. The periods of increased activity in project bonds in the past – particularly for toll road roads and power assets – have not necessarily coincided with cash from five-year plans.

Moreover, the assets under consideration are located in less-developed areas of Malaysia, especially in Eastern Malaysia, or the northern part of the island of Borneo. These assets are only likely to work as subjects for concession-based finance as some form of public-private partnership or build-operate transfer. Real tolls, for instance, are not likely to support some of the road projects destined for Eastern Malaysia.

Nevertheless, the 9MP does allocate RM20 billion of the infrastructure haul towards a private finance initiative, which would involve the selection of concessionaires for national priority projects. These concessionaires would then be responsible for financing those projects.

Details of how these concessions will be structured are at present scant, and few of the lenders canvassed by Project Finance hazarded what these would look like. The projects will likely be identified towards the end of the year, and tendered at that point. The Simpang Pulai-Lojing-Kuala Berang road, second Penang Bridge and the Penang Monorail are the most likely early tenders.

Liquid gold

The water industry, on the other hand, may be a candidate for fuller privatisation. Malaysia's water industry, fragmented and inefficient, is a headline government target. In particular, it wants to diminish the proportion of non-revenue water (NRW), or water lost through spillage, wastage and theft. This varied, in 2003, between 20% and well over 60%, depending on the state.

But the implications of raising tariffs to provide for capital expenditure are well understood at the federal government, which assumed overall responsibility for managing the country's water industry in early 2005. It is now trying to decide whether the fully privatised model, represented by SYABAS, or the corporatised but state-owned model, represented by PBA, would go forward.

SYABAS, or Syarikat Bekalan Air Selangor, was placed in private hands on 1 January 2005. It was previously known as Perbadanan Urus Air Selangor Berhad, and provides water services to Kuala Lumpur, Putrajaya, the country's new seat of government, and the state of Selangor.

Its two new owners are water treatment specialist Puncak Niaga Holdings (70%) and Kumpulan Darul Ehsan Berhad (30%), owned by the state of Selangor. SYABAS' 30-year concession includes the requirement that it reduce NRW from 43% to 15% by 2015. It will also have to spend over RM11 billion in capex, and RM2.7 billion on reducing NRW losses.

It issued RM1.030 billion in medium-term notes, led by Commerce International Merchant Bankers, Bumiputra-Commerce, BIMB, and HSBC Malaysia, in September 2005, the largest in the sector that year. The notes broke down into a 5% eight-year tranche, a 5.2% nine-year tranche, a 5.4% ten-year tranche, and a 5.6% 11-year tranche. The notes were structured as Bai' Bithaman Ajil so as to appeal to Islamic investors.

The government, however, has also been taken by the experience of the Perbadanan Bekalan Air Pulau Pinan (PBA), which is majority-owned by federal and local agencies (25% is a free float). PBA has had a strong history since the 1999 corporatisation, although, like SYABAS, it serves a relatively developed area, in this case Penang.

It is likely that current government thinking tends towards Water Asset Holding Companies (WAHCOs), state-owned entities funded through off-balance sheet debt. This would gratify public opinion, which currently militates against private ownership and the costs of private water treatment concessions. Running bonds for WAHCOs, which would resemble the 100% debt funded UK's water companies common in the UK, would be good business for the banks, although they acknowledge that replicating the structure for the less prosperous regions will be difficult.

Moreover, several distributors say they are struggling with the burden of payments to water treatment concessions, and cannot thus channel resources towards capital expenditure. The assumption of federal responsibility should help in the renegotiation of these contracts, and many may operate their concessions under over much shorter guaranteed periods.

Tenaga tries to tangle

Much the same dynamic is at play in the power sector. Independent power producer debt has made been a sought after asset, and have enjoyed a strong financial performance in the last 13 years, on the back of take-or-pay contracts that limit their exposure to demand risk. Now Tenaga claims that the contracts are costing it RM4 billion a year, and it wants to renegotiate them.

The IPPs have operated under power purchase agreements of varying degrees of generosity. The earliest plants – including those operated by YTL (from 1993), Tanjong and Genting – were 100% availability-based. Second generation plants have a capacity element of 90%, while the third generation plants enjoy capacity elements nearer to 80%.

But the Ministry of Energy, Water and Telecommunications, while ostensibly opposed to coercion, has signalled that it would like to see a restructuring of the contracts. This would likely involve, according to banks familiar with the market, an extension of contracts in return for a lower tariff. Since debt markets are much more generous that they were in the mid-1990s, then refinancings might even boost sponsor returns.

Still, sponsor and lender interest in the market looks strong, even in the confused present circumstances. Ranhill, for instance, is close to signing a power purchase agreement for a 190MW combined-cycle gas turbine project in Sabah. If it manages to reach terms with offtaker Sabah Electricity, an RM800 million financing is likely.

And bidding is underway on the concession for a 300MW coal-fired project also on Sabah. According to one analyst familiar with the situation, the project attracted heavy initial interest from a field of 28 bidders, although the pack has now thinned to roughly eight. At issue is the fact that Tenaga is a participant in the tender, but at the same time has an 80% stake in Sabah Electricity. "It's good that Tenaga is holding more open tenders [many previous concessions were bilateral affairs] but it still needs to bring more clarity to the process," the analyst notes.

But bilateral IPP agreements make for solid financings. An illustration of the terms available can be found in the RM1.6 billion financing package available to Jimah Energy Ventures, a third generation IPP that closed financing in May 2005. Jimah, whose sponsor is the royal family of the Malaysian state of Negeri Sembilan, achieved a 94:6 debt:equity ratio.

Jimah is a 1,400MW coal-fired project located at Port Dickson, Negeri Sembilan, in Western Malaysia. It is due to come online this year, and is part of the third wave of IPPs, which have slightly less generous PPAs. It raised RM930 million in medium-term notes with tenors of between eight and 12.5 years, at pricing of between 6.3% and 7.2% (for more on the financing search "Jimah" at www.projectfinancemagazine.com).

More importantly, Jimah used an intermediate issuer, a special power vehicle, to issue a further RM405 million in subordinated debt. This debt featured tenors of between six and 16.5 years, and represented quasi-equity, had a margin of 60bp to 160bp over the senior debt, and was rated at A1 by Ratings Agency of Malaysia (the senior debt was AA3).

The achievement is an impressive one, although not one likely to be replicated. The high level of gearing reflects the fact that the private owners were not able to raise the conventional 20% equity contribution, and also that, since they are not listed companies they are more concerned with cashflow than how the interest expense from the subordinated debt shows up on the project's balance sheet. Publicly-listed entities, which comprise most of the universe of bidders, may still prefer a straight debt and equity mix.

Funds – Islamic and unlisted

But the deal illustrates the opportunities available to sponsors, as well as the exceptional health of the country's Islamic debt sector. Islamic lenders benefit from tax breaks that include a break on the registration fees applicable to issuing vehicles. Many also make use of the tax breaks available to Labuan-domiciled fund managers.

Malaysia's government has been an assiduous supporter of the growth of the Islamic market, and issuance has grown steadily. As an example of the strength of the market, Jimah's arrangers contemplated a financing package led by JBIC (since the project used Japanese content), but found the terms on offer in the Islamic market competitive.

Compare this to JBIC's progress in the Middle East, where it has competed successfully with Islamic arrangers, albeit for scant margins.

There may be some respite for conventional arrangers. While the Malaysian government has been solidly behind this effort, the growth in Islamic issuance has been according to shariah principles that are acknowledged to be less strict than those prevalent in the Middle East.

At the same time, Islamic arrangers have begun to structure sukuk issues that are designed to be compliant with the rulings of shariah boards further afield. These typically require a broader series of consultations, adding to the cost of putting together a deal. They may, although the evidence of sovereign and supranational issuance so far is mixed, provide less competitive terms for borrowers.

Even Malaysia's state infrastructure bank, Bank Pembangunan Malaysia, has been raising Islamic funds. It raised RM1 billion in Islamic and conventional medium-term notes in an issue that closed on 17 April. The bank, formed from the merger of banks that financed infrastructure and small and medium sized enterprises, raised RM200 million in five-year conventional notes, RM400 million in 15-year conventional notes, and RM400 million in 10-year Islamic medium-term notes. The leads were HSBC and CIMB.

In the mean time, the first dedicated infrastructure fund has launched, targeting the country's infrastructure market. CIMB, the Employees Provident Fund and Standard Bank recently launched the South East Asian Strategic Assets Fund, or SEASAF. The fund's primary focus is on Malaysia and Indonesia, with a mandate to invest elsewhere in South-east Asia. The logic behind the fund, whose business model follows that laid down by Macquarie, is that while East Asia, India and the Gulf have all attracted solid interest, the stronger economies in SEASAF's footprint has not.

The fund is likely to start off by buying up secondary market assets in Malaysia, and one or two are currently under consideration. It is likely to target upcoming sales of stakes in IPPs and water projects, as well as smaller niche assets, with a maximum equity commitment of $50 million. Mining projects, power projects, renewable energy projects, and even upstream oil and gas assets are potential targets, as well as the standard transport assets.

The CEO of the fund's manager, CIMB Standard Strategic Asset Advisors, is Vijay Sethu, formerly head of project finance for ANZ in Asia. According to Sethu, the fund will look for turnaround assets, as well as those within niches. "Competition for large greenfield assets will be intense," he notes. Where SEASAF might have more leverage is in rounding out the equity commitments of Malaysian corporates overseas.

Outward bound

Malaysian developers and contractors, in particular Gamuda, Genting, YTL and Roundbuilders, have been active in India and the Middle East ever since the Malaysian government turned off the public spending in the wake of the Asian crisis. YTL has become familiar, however, to UK readers from its ownership of Wessex Water (it also owns a stake in Australia's ElectraNet). Genting has a growing leisure business, and has been actively examining casino opportunities, a sensitive subject in majority Muslim Malaysia.

For project finance participants, though, it will be the Malaysian-led Shouaiba IWPP in Saudi Arabia that will be the defining example of Malaysia outbound. Tenaga, Malakoff and Khazanah Nasional were among the Malaysian sponsors of the $2.5 billion, 900MW and 880,000 cubic metres per day water and power project (the remaining sponsors were ACWA Power, Mada, Saudi Electricity Company, and the Saudi Public Investment Fund).

Since the deal was a first for Saudi Arabia, and the sponsors were less well-known to international lenders than western or Japanese names, pricing on the deal was generous, although not generous enough to overcome the disadvantage that Malaysian banks suffer in funding in US dollars. As such, Malaysian banks were thinly represented on the deal, with the exception of RHB and Bumiputra-Commerce, which came in on the $875 million commercial piece of the project's debt. (Search "Shouaiba", and "Shuaibah" at www.projectfinancemagazine.com for more details).

The Malaysian bank's interest in the project was largely the result of Tenaga's presence, since while the country risk is acceptable, there is little appetite for IWPP-size levels of debt. The banks approached by Project Finance in Malaysia are not of one mind in their appetites for cross-border risk – Indonesia, for instance, divides opinion sharply. But Thailand, for one, is likely to see some attention.

Moreover, the acquisition of power assets elsewhere continues unabated. YTL bought 35% of the PT Jawa project in Indonesia, a 1,220MW coal-fired station in East Jawa. It bought the stake from E.On, which had bought PowerGen of the UK, and wanted to divest its non-core interests. It is also among the bidders for the 600MW Cirebon project in Indonesia.

In June 2005, Genting bought out El Paso's stakes in four Chinese power projects (26% of 724MW Meizhou Wan, 80% of 76MW Nanjing, 60% of 109MW Suzhou, and 60% 42MW Wuxi). It is now spending $100 million to buy out InterGen and Lippo's remaining stake in Meizhou Wan, and is buying a 26.3% equity interest in Fujian Electric.

This aggressive push overseas is probably not surprising in light of the thinner returns that will be available in the domestic market in coming months and years. Equally surprising, as most domestic bankers and analysts note, is that it has taken Malaysia so long to come up with some standardised tender procedures. At present, strong levels of bank, bond and Islamic liquidity are likely to mask this.