Lenders in the South Korean market are used to financing toll roads and rail links, but privately financed subway transactions only emerged this year. Seoul Subway Line No 9 was signed in May and financing, for the New Bundang Line, will come to market shortly, with the arranger targeting financial close in November. Both deals are $1 billion-plus financings, but are expected to feature important differences in structure.

The sponsor of Seoul Subway Line No 9 – the development of a 25.5km line and 25 stations under a 30-year concession – is Hyundai Engineering & Construction, Daewoo Construction & Engineering and Ultra Construction & Engineering. The project is being developed as a Private Participation in Infrastructure (PPI) scheme.

Although the project introduces a different asset class to Korean lenders, the financing template is standard for Korean public infrastructure projects and includes long-term senior debt with fixed and floating interest rates (interest fluctuations are fully hedged for the construction period), a short-term standby facility, a long-term, subordinated shareholder loan, pure investor equity and sponsor equity.

In total there is KRW436 billion ($420 million) of senior debt in the project, KRW67 billion of mezzanine debt, a KRW492 billion government subsidy, KRW167 billion of equity, a KRW50 billion standby facility and a KRW50 billion credit facility. The senior debt is divided equally between the fixed rate and floating rate tranches, both of which have a 22-year term. Shinhan Bank arranged the funding.

Revolution Number 9?

Similar templates were used to fund two other mass transit build-transfer-operate (BTO) schemes developed under Korea's PPI scheme – the Yongin LRT and Incheon Airport Rail Link.

As with other Korean projects, the deal benefits from a minimum revenue guarantee (MRG) from the government, but one difference is that this is lower than previous MRGs for major infrastructure projects. The guarantee is set at 90% of the revenue levels agreed in the concession agreement for the first five years, 80% for the following five years and 70% for the five years thereafter. "The financing is unusual in the sense that the structure places some revenue risks on the lenders. The MRG is not always sufficient to service senior debt interest," notes John Walker, CEO at Shinhan Macquarie Financial Advisory (adviser to the consortium behind the development).

The financing is non-recourse, except for capped construction period cost overrun funding commitments. Given the greenfield nature of the project, the lower revenue guarantee structure and the non-recourse arrangement, the financing is also unusual for its low margins and costs. The floating rate senior loan is priced at 170bp over the AA- corporate bond rate during construction, falling to 165bp after construction. The fixed rate senior loan carries a coupon of 7.2%.

This is the first Korean project where banks have invested senior debt, subordinated debt and equity. The banks providing senior debt are Industrial Bank of Korea (IBK), Chohung Bank and Daegu bank. Both IBK and Shinhan Bank provided mezzanine debt. They are joined by life insurance companies, LG Insurance, Korea Life & Insurance, Shinhan Life Insurance, Kyobo Life Insurance, Samsung Life Insurance, Samsung Fire & Marine Insurance and Dongbu Insurance. Shinhan Life, LG Insurance and Korean Road Infrastructure Fund (which is managed by Macquarie Bank) also participated in the mezzanine tranche.

New Bundang snares the KDB

Like No 9, New Bundang is a BTO PPI scheme and entails the construction of a 19.3km line in Seoul, with six stations. The sponsors include Daelim Construction and Engineering, Daewoo Construction & Engineering, Doosan Development and Posco. Construction of the subway is due to commence this year and is scheduled for completion in 2010. The sponsors hold an operating concession of 35 years.

Korea Development Bank (KDB), financial adviser to the New Bundang sponsors and sole arranger of the project financing, is currently in the midst of due diligence. Leo Kim, project manager in KDB's project finance department, says the financing is likely to be launched at the end of October and to close in November – the total project cost is KRW1,574.1 billion.

The financing comprises a KRW722.6 billion government subsidy, debt of KRW642.7 billion and equity of KRW208.8 billion. The debt is split between a KRW247.3 billion fixed rate, 20-year loan (including a 6-year grace period) and a floating rate loan of up to KRW 395.4 billion. Tenor on the floating rate tranche is 19 years including a 5-year grace period. The fixed rate loan pays a 7.9% interest rate. The floating rate loan is (initially) priced at 167bp over the one year, AA- rated corporate bond rate. The margin on the floating-rate debt will decrease as the debt service coverage ratio increases once the project is operational.

The financing scheme also includes a six-year KRW100 billion standby facility provided by KDB. The facility will plug a gap in cashflow during the early period of operation and allow the sponsors to meet the loan repayment schedule and operating cost commitments in the project's early years.

Kim describes the financing structure as straightforward. But in contrast to Subway Line No 9, other banking sources say the New Bundang rail link financing will be at least partly recourse to the sponsors during the operating period (Walker confirms that Subway Line No 9 is completely non-recourse during the operation period). "The New Bundang financing will also have additional lender protection mechanisms," says another financier, "which means the financing structure won't be quite as efficient for the investors." Details are sketchy but the financing includes capped sponsor support up to KRW80 billion.

With the financing still to hit the market, the list of debt participants has yet to be finalized, however, market sources indicate that life insurance companies, including Kyobo Life Insurance and Daehan Life Insurance, and banks including Kookmin, will join the fundraising.

Bonds yet to blow

It is interesting to note that Shinhan Macquarie Financial Advisory and the sponsors of Subway Line No 9 did consider trying to finance the development partly with bonds instead of bank debt from day one. However, Walker comments: "the bond market is not yet as aggressive as banks for greenfield projects in Korea. Additionally there are other problems including the negative carry and the lack of drawdown flexibility."

He adds that it may be possible for the bank debt to be replaced by bonds, either directly at the special purpose company level or through another entity, at the end of the construction period, once project cashflows can be more accurately forecast and construction risks are removed. But no specific refinancing packages are being considered at this stage.

In contrast, Kim says it is unlikely that the New Bundang financing will be refinanced through the debt capital markets. Jong-Hyuck Park, senior manager in Kookmin Bank's Investment Banking team (Kookmin is participating in several mass transit project financings) says it will be difficult to refinance any major infrastructure project in the local bond market. "A market in Korea does not exist for longer duration bonds," he says.

Apart from the New Bundang, Kim says at least one other subway project, the Shin Ansan Subway is likely to be financed in the next 18 months. Kim expects a financing for the scheme to be drawn up at the end of 2006. Hanhwa Engineering & Construction is the lead sponsor of the subway and proposed the unsolicited project early this year. Korea's Public & Private Investment Management Center is currently reviewing the proposal.

Two other subway lines, the Kyungjun Line and Chunla Line probably be developed as solicited projects and built on a build-transfer-lease basis. But most mass transit projects likely to be financed over the next few years are light rail projects, which include Eujeongbu LRT, Incheon LRT, Gwangmyeong LRT and Gwangju LRT. Eujeongbu LRT will be one of the first to be developed. The project involves a 10.3km rail track with 12 stations at a cost of about $310 million, with the Ministry of Construction & Transportation and Eujeongbu City Government expected to provide 40% of that project cost.

MRG minimising

The government continues to reduce the level of guarantee support in infrastructure financings, but financiers expect the upcoming light rail deals and potential subway financings to enjoy some form of MRG. That said, it is highly unlikely that the terms of the MRG will be as generous as those provided by the government in the Subway Line No 9. project. Walker says MRG is only likely to be provided for the first 5 to10 years in new deals and "this level of MRG is only sufficient to repay senior debt".

There are several toll road projects in the market that do not have any minimum revenue guarantee support whatsoever, including the World Cup Bridge project. How precisely the financings for these new mass transit and road projects will be structured under the reduced MRG regime has yet to be seen. The World Cup Bridge fundraising has not reached financial close and is still being negotiated.

Walker expects greater reliance on patronage forecasts and more detailed financing documents and structures. "But," he adds, "with reductions in project rates of return, it is likely that lower costs of financing will be sought. It is possible that strategic investors will be asked to bear more risks in order to find lower-cost funds."

Even if MRG support is scrapped entirely, bankers say termination payment protection will still be provided by the state and senior debt providers will continue to enjoy protection – even in the worst case scenarios. Nevertheless, the move to the MRG-free PPI environment presents difficulties for many local debt providers, which are as yet unable to properly assess project risks.

Jong-Hyuck Park at Kookmin Bank says some banks are already prepared to fund transit schemes without MRG. "We are willing to consider projects that have no MRG program on a commercial basis, provided that the termination payment can cover the priority debt, and provided we are satisfied with the due diligence results," he says. Despite his concerns in the short run, Walker is also confident that the Korean market will adapt quickly to the changing PPI environment.

New stories, new structures

As market sophistication increases, and along with it the availability of more efficient financing mechanisms, Walker also suggests that projects could be closed with financing methods unseen in Korea before, including infrastructure bonds and single-asset infrastructure funds. "The main difficulty will be in finding equity investors, which will need to bear full project operations risks," he says.

Kim does suggest that Korean institutions are becoming more active as pure equity investors, leading rather than simply funding project developments.

This was the case in the recently closed Incheon Bridge project. The principal investor in the development is Macquarie Bank. Through its investment vehicle, Incheon Bridge Investment Company, Macquarie is purchasing a 41% stake in Incheon Bridge for a total price of W67.5 billion. Macquarie joins the initial shareholders in Koda, which are Kookmin Bank (15%), Industrial Bank of Korea (15%), AMEC (23%) and Incheon Metropolitan City (6%).

Non-specialist funds and other local financial equity investors have been particularly active in the roads sector and have invested in roads projects ranging from the Machang Bridge to Daegu-Busan Expressway and Seoul-Chunchon Expressway.