Korean life insurance companies, equity investors, and the debt capital markets are making serious inroads into the business of financing Korean Private Participation in Infrastructure (PPI) projects, a market traditionally dominated by domestic banks. But recent changes to the Minimum Revenue Guarantee (MRG) scheme through which the government supports PPI projects, may halt this trend, shifting the balance of power in a competitive finance market back in favour of the banks.

Pick any deal in the PPI market at the moment and it is highly likely that insurance companies and equity funds will be major participants. According to Munhyon Hwang, Senior Manager, in Korea Development Bank (KDB)'s project finance department, the increasing involvement of these institutions is driven largely by the desire to tap new long term investment opportunities to match their liabilities, "Long-term financial instruments are in short supply in our financial markets and this supply rarely satisfies the demand of insurers or pension funds," he says.

Insurers, including Kyobo Life Insurance, Korea Life and Samsung Life, are active both as debt and equity investors, typically participating, on the debt side, as senior lender syndicate members. "Insurance companies, like Samsung Life, are even starting to take a more aggressive stance on infrastructure projects than the banks," notes John Walker, CEO of Shinhan Macquarie Financial Advisory. "They are doing so to establish their position in the developing project financing industry," he says.

Non specialist funds and other local financial equity investors have invested or signed commitments to invest in roads projects ranging from Machang Bridge, to Daegu-Busan Expressway and Seoul-Chunchon Expressway. And while there is only one dedicated Korean infrastructure equity fund active in the country, the Korean Road Infrastructure Fund (KRIF) managed by Macquarie, Walker reveals that other local institutions are now investigating the possibility of establishing specialised infrastructure funds. The other dedicated fund which has been established to date, KDB's Korea Infrastructure Fund, has yet to make a PPI investment.

Insurance companies and equity funds have further increased their involvement in PPI through recent refinancings. Two of the five national PPI projects now operating, the Incheon International Airport Highway and Gwangju Second Ring Road have been refinanced. According to Junglim Hahm, a senior analyst at the Private Infrastructure Investment Center of Korea (PICKO), "the sponsors of two more national schemes, the Mt. Woomyeon Tunnel and Chunan-Nonsan Expressway are also looking to refinance." Refinancing is usually accompanied by a change in ownership, with pure financial equity sometimes replacing the original sponsors. In the case of the Incheon International Airport Highway, all of the equity owned by the original sponsors (mainly construction companies) was sold to investors including the Korea Teachers Mutual Fund.

Similarly, increasing reliance on the debt capital markets has eroded the banking industry's share of the PPI market. With the exception of KDB, Korean banks are not able to capitalise on the rise in debt capital markets finance as they are barred by law from underwriting bond issues.

Edward Kim, senior project manager at Hana Bank, says that approximately half of the debt financing for the W1.105 trillion ($967 million) Busan-Geoje Link project was provided by a bond underwritten by KDB. The financing, which closed on 18 December, also included equity from financial investors, and fixed and floating rate long-term loans.

"Although the exact details of the financing have yet to be worked out, a bond is also likely to be issued to part finance the upcoming Incheon international airport railroad project," says Hwang. The banker says the transaction will be the largest project finance deal in Korea to date, and is expected to close in the next six months. Equity from financial investors will not be used in the rail scheme's fundraising, says Hwang, because the concession agreement was signed in 2001, before investor equity was considered as a suitable mechanism for funding PPI projects.

Hungry for more

Since 1995, the table below indicates that Korean banks have lent about $22.5 billion (or an average of $2.5 billion per year) to PPI schemes. With exposure mounting, particularly for the two most active players, Kookmin Bank and KDB, a casual observer might expect bankers to welcome the emergence of alternative forms of finance.

A small portion of the Korean bank market has indeed expressed concerns to Project Finance about high exposure to PPI projects. "The bank market is divided in this respect," comments one financier, "some banks are very aggressive and accept the government's support package for PPI without any apparent anxiety. But other banks have voiced anxiety about the government's long-term commitment to these guarantees, even in deals which have already reached financial close."

But the number of institutions that are worried about levels of PPI lending is still small. KDB, the biggest lender to PPI projects, has shown no indication of wanting to reduce its participation in the market. Hwang says of the Korean bank market in general, "banks are comfortable lending on a limited recourse base because of the government support for these projects. Also typical project debt to equity ratios are reducing and are at comfortable levels for lenders."

Legal analysts believe Korean banks are right to rely on the government MRG scheme. "There have been a few test cases in the courts concerning the government's commitment to certain PPI projects, but in each case the government has honoured the terms of the original support package," says one lawyer.

In fact, with the added element of strong support from sponsors, the PPI market continues to present one of the best opportunities for big ticket lending in Korea. "Another arena where banks traditionally lend considerable sums is the consumer finance market, but the recent performance of this market has been very poor and banks are much more cautious about consumer finance lending," says one source.

Therefore, rather than retrenchment in the PPI market, most banks are increasing credit limits for PPI ventures, says Kim at Hana Bank. "Our bank, for instance, was not a major lender in PPI projects in 2003," he says, "but because of our relatively low exposure to PPI, we have appetite for more exposure this year."

With greater reluctance, Korean banks are also starting to participate in projects as equity investors, to provide enhanced yields for PPI sponsors. "Sponsors have recently started to request banks' participation both as equity arrangers and investors," says Hwang. In the Busan-Geoje project, (KDB was overall arranger) the banker adds that his bank arranged a general syndication to raise a W65 million equity tranche. Kihyoung Choi, general manager, in Samsung Corporation's finance and accounting team, says four banks were involved in providing the equity. KDB itself, providing W20 billion, Shinhan Bank (W7 billion), Busan Bank (W6 billion), and Daegu Bank (W5 billion). In addition, three non-bank institutions provided funds, including Kyobo Life (W17 billion) and LG Insurance (W5 billion).

Changes to the MRG

"Last year opened a new era for Korean PPI," says PICKO's Hahm, "as the government begun to move away from heavy reliance on the guarantee system to stimulate private participation." Hahm says the government has reduced both the period and scale of the minimum revenue guarantee, a scheme designed to support project cashflows up to a certain percentage of original patronage projections. "The modification to the guarantee made this year reduces level of the MRG by 10% for every 5 years of operation over a maximum period of 15 years," explains Hahm. Previously the guarantee was provided at 90% over the life of the concession, for solicited projects, and at 80% for unsolicited projects.

The Minimum Revenue Guarantee

? old and new

Previous MRG Current MRG

Level Period Level Period

Unsolicited projects 80% 20 to 50 yrs 80/70/60% 15 yrs

Solicited projects 90% 20 to 50 yrs 90/80/70% 15yrs

Source: PICKO

The length of the guarantee has also been reduced from the previous range of 20-50 years, the range of duration for PPI ventures to the 15-year maximum. "A self-responsibility limit of 50% has also been introduced," says Hahm. The analyst explains that, where a project's revenue falls below 50% of projected revenue, the project loses any guarantee support. This change is designed, says Hahm, to promote active and reactive project management by sponsors.

These measures are not likely to be the end of the revisions to the MRG. Walker says: "It is actually expected that the revenue guarantee system will be removed within 5 years. But on a project by project basis, a concessionaire may still be able to negotiate revenue support methods." The general trend in government support will be of progressively transferring more and more project risks to the private sector and, where support is needed, to structure that support to specifically reflect a project's particular risks.

These changes are already being applied to new PPI projects, says Donghyo Yoo in Kookmin Bank's financial advisory department. "For example, financial advisers are working on two port projects which will be financed under the new MRG scheme, Masan Port (Phase 1) and Ulsan New Port (Phase 1)," says Yoo. Masan Port is a W220 billion container port project with a target completion date of 2007. Ulsan New Port, also a container port, is projected to cost W191 billion and has a target completion date of 2006. Concession agreements on both projects have just been signed.

The shifting MRG landscape should play into the hands of local banks, which have far greater experience in conducting PPI project feasibility studies than insurers, or typical pension funds and equity investors. Walker suggests "They aren't really able to fully analyse the risks of a project. To date that sort of analysis has been done by the banks," says the banker.

The changes will, of course, also bring significant changes to the way banks themselves analyse PPI projects. "The government's move is intended to pass on a larger part of the patronage risk to the private sector. Financial institutions have to improve feasibility studies as accurate patronage forecasting will be crucial," says Hwang. Yoo says his bank is trying to do precisely this in its role as financial adviser to the Ulsan Port project. "We are doing more detailed modelling of cash flows and upside and downside scenarios to improve the bankability of the project," says the source.

A large volume of PPI projects are likely to reach the bank market this year, despite the changes to the MRG scheme. Hahm says the government's PPI Committee passed a resolution approving several large projects on 16 March, including the W1.663 trillion Seoul-Chuncheon Expressway backed by Hyundai Industrial Development Company and the W904.6 billion Yongin LRT, sponsored by Bombardier and Daelim. According to PICKO, a total of 18 solicited PPI projects are currently being negotiated.

There are even more unsolicited PPI projects in the works. Hahm says: "last year saw an explosive increase in the number of unsolicited proposals submitted. Before 2003, about 20 unsolicited projects were initiated by the private sector each year, but in 2003 the number almost doubled to 39."

But if banks, insurance companies and equity investors are more circumspect about PPI projects, it is increasingly probable that the less economic projects will struggle to get funding.

This is precisely what the government intends. Last year, according to Hahm, one incident occurred signalling to the government that the unsolicited project system was receiving an unhealthy stimulus from the guarantee. She says: "Nine separate highway projects around the Seoul area were proposed, with similar timetables and significant route overlap. The government therefore hopes to limit possible distortions in the PPI market by reducing the length and scope of its guarantees."

Even for those projects that do still get a financial approval, adjustments to the funding mix will be made in response to the new MRG. Yoo says: "banks will be looking for greater equity capital in the overall funding arrangement, as a buffer against worse than expected patronage performance."

The new landscape is also likely to mean greater pricing differentiation. As Choi points out, one of the peculiarities of the present PPI market is that pricing does not differ greatly according to project type or economic feasibility, a reflection of the strong reliance financiers put on the old MRG system. "So far, pricing on senior loans has not varied that much," says Choi, "typically hovering at 1.6% to 1.8% above AA-rated corporate bonds."