The prospect of an active Japanese project finance market has taken a significant step forward with financial close of the country's largest ever non-recourse transaction. The ¥170 billion ($1.32 billion) financing raised by Roppongi Hills Financial Corp just overtakes the previous record of ¥160 billion set by Kobe Steel last year. The financing structures bear similarities, both boasting a Development Bank of Japan loan (DBJ) to complement commercial debt.

Funds back construction and operation of an urban development project in Minato-ku in Tokyo. The complex will comprise office space, apartment buildings, a TV station and other public facilities. These will be leased out on an individual basis by the real estate trust set up by sole sponsor Mori, Mitsubishi Trust Corporation. The beneficiary rights to the trust are held by a bankruptcy remote financing vehicle, Roppongi Hills. Contractors including Obayashi, Kazima and Shimizu have already commenced construction, with completion targeted for spring 2003. Total cost of the project is ¥270 billion, although this rises to ¥470 billion if the cost of the land is factored in. It is the largest redevelopment project in Japan to date.

According to Akio Yamashita, director, project finance department, DBJ, the decision to take a project finance route was taken based on the size of the project in relation to Mori's existing corporate asset base. Compared to Japanese real estate giants Mitsubishi and Mitsui, Mori has a relatively limited portfolio and its balance sheet would have struggled under the weight of a deal of this size and this project would generate strong cash flows.

Having realised the sponsor benefits of going non-recourse, lenders were able to get comfortable with the project based on its commercial strength. Property development in Tokyo can produce impressive returns. Mori does not have an official rating and lenders stress that funds were put up solely against projected cash revenues of the project, not the underlying corporate credit.

Debt breaks down into a 20-year DBJ loan and a seven-year commercial tranche lead arranged by Mizuho Financial Group (formerly Fuji Bank) and Sumitomo-Mitsui Banking Corporation. The latter was syndicated down to a further ten institutions. A full list was not disclosed but is said to include all the major Japanese banks. Pricing and even the exact split between DBJ and commercial amounts are also said to be confidential.

A Mizuho spokesperson does say, however, that commercial debt splits into construction and permanent facilities. The second enjoys a form of credit enhancement in that full drawdown is dependent on a DSCR and other performance tests. Mori has put up a standard construction guarantee. This falls away completely on construction completion. In addition, lenders have assumed full market risk. There is no parent guarantee that leases will be secured at a fixed rate, or even at all.

Since full amortisation of the loan is not going to be realised within seven years, the commercial banks have taken on refinancing risk. They had little choice but to do this, however, given that seven years is said to be the longest tenor they are prepared to put up for a project finance transaction. It was said not to have been a major concern.

DBJ, as a 100% public owned institution, has capabilities to put up much longer-term debt. DBJ's involvement is probably crucial in closing a benchmark deal such as this in Japan. As a proponent of limited recourse finance and a state body, its presence provides comfort for commercial lenders. For the project company a DBJ loan is all important since it provides suitable and flexible financing for the individual project. Yamashita states that DBJ's long term loan helps mitigate refinancing risk and leads to the stability of the project. The difference is believed to be in the region of 40bp.

Market players say that the successful close of this transaction will create impetus towards similar real estate non-recourse finanicngs. There is a considerable amount of under-developed land in and around the Japanese capital, which the government is encouraging the private sector to develop. Given the cost of land and size of projects, potential sponsors are likely to follow suit in keeping the funding off balance sheets.

Such a trend could provide a useful kickstart for the immature Japanese project finance market in general. Major Japanese banks have considerable experience in non-recourse financing offshore but bringing the expertise back home has been fraught with difficulty. Only a trickle of true project deals have closed in the three years since it was introduced. Lending in Japan has historically been based on names and relationships. There is no real culture of risk and return. However, people believe this is changing and the market is starting to see credit risk analysis taking hold. Differentiated pricing is emerging from the historically very thin spreads. As this happens longer tenors will become more acceptable.

Roppongi Hills

Financial Corp.

Status: Signed and syndicated April 2002

Description: Urban redevelopment project in Tokyo

Sponsor: Mori Building Co. Ltd

Cost: ¥270 billion (¥470 billion including land costs)

Leverage: 63%

Lead arrangers: DBJ, Mizuho, SMBC

Debt: ¥170 billion

Legal adviser to project company: Morisogo

Legal adviser to lenders: Anderson Mori and Nishimura & Partners

Financial adviser to project company: Mizuho Securities Co., Ltd.