Powering up
It was only five months ago that the first signs of life in the
Malaysian project finance market post Asia crisis were detected.
The deal in question was a limited recourse financing for Malaysian
Newsprint Industries' (MNI) pulp plant, successfully closed in May.
Since then the market has continued to recover, one of the most recent transactions involves Syarikat Air Johor, the local water operator looking for limited recourse financing for the development of its new water concession (see news). And More deals are expected soon ? the winning bidder for 40% of the 1,000MW Kappa power station is likely to opt for some project financing within its total funding mix, say sources involved in the transaction.
But a few deals does not a market make. Demand for project finance in Malaysia is still well below 1997 levels. ?The project finance sector certainly hasn't exploded in to life like the general economy has,? says one financier.
However, he does add, ?provided that privatization and deregulation in the utility sectors continue, plenty of business can be expected over the next two years.?
The current lack of demand also hasn't prevented a sense of opportunism being felt amongst the international project finance community. One reason why international players sense that more project finance mandates could come their way in the short term is the current financial position of Malaysia's domestic banking industry. While liquidity is generally good for Malaysian banks, banking consolidation is threatening to constrict the longer term funding market.
Malaysia's commercial and merchant banks and general finance companies (there are a total of 58) are consolidating into six core groups.
The process will inevitably mean that the stronger finance houses have to bear the burden of absorbing the weaker institutions.
Yet, as an official at the Malaysian central bank points out, mergers are not likely to be supported by any new injection of capital from the government. A knock-on effect of consolidation, therefore, is a possible disruption to the supply of local bank debt, particularly the traditionally shallow long term debt market. Murray Ashdown at HSBC in Singapore expects the debt market to be restricted for tenor in excess of seven years.
It is this interruption of supply that has led international banks to hope for a larger slice of Malaysian project finance business, at least until the consolidation process has been concluded. How long will that be? ?The government wants the six financial groups to be fully integrated in six months. Given that it was always going to be tight and if you add the Y2K complications, I think it will take a few months longer,? says one Malaysian banking analyst.
So far it is not readily apparent that the supply of domestic long term debt has been greatly restricted, says Ashdown. There are two main reasons:
Firstly, Malaysian banks have been deprived of one particularly large source of business pre-crisis, namely construction loans. In the wake of the slowdown in Malaysia, large scale commercial development has stalled in Malaysia. Lacking this traditional staple diet local banks have been forced to devote more of their attention to the project finance market.
Since Malaysian Banks had already grown comfortable with local project finance risk prior to the Asian financial crisis, it was an easy step to make. The MNI transaction was oversubscribed on the Ringgit portion, evidence of the shifting attention to project finance loans.
The second factor is the more general lack of demand. ?The Malaysian market has traditionally been project constrained not finance constrained,? says Doug McMurrey at Chase Manhattan in Hong Kong.
Even where there is demand for finance, many deals which have been labelled under the project finance umbrella are not true project financings. Corporate finance has been and will continue to be the main source of greenfield and acquisition finance. The much publicized Janamanjung project, a 2,100MW power station being built for Tenaga Nasional has, to date, been financed through export credit facilities on a corporate basis. The remaining M$2.25 billion is likely to be raised through corporate bank debt. ABN Amro, HSBC and Barclays are amongst the banks sniffing for the mandate.
Malaysian project sponsors are fortunate enough to be able to pick on a broad array of financing options. The country is clearly favoured by the export credit agencies above many other markets in Asia, as the number of previous ECA-supported projects in Malaysia demonstrates. ?A good project in Malaysia will get financed. That's not true of everywhere in Asia,? notes McMurrey. There is an obvious downside for project financiers, with ample appetite for Malaysian corporate risk, financing on a project basis will only rarely be the finance method selected.
Ringgit loans and US capital markets
?The Malaysian project finance market is dominated by local currency funding to an extent that many other Asian markets are not,? observers one Malaysian banker. Ringgit financing is favoured because of pricing ? typically Malaysian banks have been willing to lend in Ringgit at single digit interest rates ? and suitability. The income stream generated by most Malaysian projects is usually purely Ringgit, the exceptions being the petrochemical and natural gas businesses where a portion of the receivables have often been denominated in foreign currency.
Projects in the utilities sector in which the tariff is linked to a currency index (easing the way for non-Ringgit loans) have been very rare in Malaysia, indeed in the power sector such indexation is unprecedented, says one banking source. The same source, closely involved in the Kapar deal, confirms that, here again, the tariff will not be linked to the currency index.
The combined effects of currency fluctuation, lack of indexation, cost of hedging and the limited number of licenses for foreign banks, restrict the market share that international institutions can have in the Malaysian project finance business. Of those foreign banks that have the necessary license to book Ringgit business, there are only two with large enough balance sheets to lend on a regular basis; Hong Kong Bank Malaysia and Standard Chartered Bank Malaysia, thanks to their country-wide branch networks. Before the financial crisis, Hong Kong Bank was a regular player in the local syndication market, taking chunks of M$200 billion, says Ashdown ? well beyond the capacity of most other international banks.
Its not for nothing therefore that foreign banks are hoping to see an increasing role for the US capital markets in Malaysia from the year 2000. ?In our experience projects with an export related element will be particularly well thought of,? says John Mulcahy at Bank of America in Hong Kong. The market has already been stimulated by large dollar bond issues by the Malaysian government. And even at the tail end of the regional financial crisis (January 1999) Tenaga made history when it succeeded in issuing the first ever 100-year bond by a non-US company, indicative of the relatively favourable view investors have of Malaysian risk. The deal was a $150 million century bond at a coupon interest rate of 7.5% per annum.
Previous to Tenaga's century bond, there have been only eight other 100-year bonds issued in the history of the international debts markets.
Industry opportunities
As to be expected, the greatest demand for project finance over the next three years will come from the utility sectors, as a result of deregulation and privatization. The chief target for the banking industry is the power market.
A potential source of concern for investors in Malaysia's power industry lies in the amount of electricity oversupply. One banking source in Singapore quotes a reserve margin (a measure of excess capacity) for peninsular Malaysia of 60%. If the source is correct overcapacity is extraordinarily high. ?Overcapacity of 30% is a reasonable standard in developing countries,? explains one industry analyst. ?15% to 20% is the norm in developed economies.?
Even taking in to account rapid GDP expansion in Malaysia, and the fact that electricity demand grows at a multiple of about 1.5 times GDP, oversupply of that magnitude would significantly dampen investor interest in both power sector acquisitions and greenfield projects. The same banking source says the Janamanjung financing has been delayed because of overcapacity and is still fraught with difficulties. ?The financing is continuing,? says the source, ?because the project has accumulated too much momentum to be stopped?.
Comments about overcapacity are not uncontroversial. Some analysts have even said Malaysia runs the risk of running short of power by 2003 if the 2,100MW coal fired Janamanjung power station, is not built.
Andrew Ancone at Macquarie Bank's representative office in Kuala Lumpur gives a present peak load figure of 8,500 megawatts and total capacity of 12,500MW, implying that the overcapacity above peak load is 47% not 60%. ?But there's also a problem of definition,? says Ancone. The so-called reserve margin does measure the amount of extra capacity but capacity can't be directly equated with supply. That's because there are a number of reasons why in practice capacity cannot be fully utilized. For instance, 2,000MW of the total capacity comes from hydroelectric power, but the actual availability of power from hydro sources is determined by constantly changing water levels held in Malaysia's dams. In addition, at any one time a portion of the electricity grid and the power production facilities are under maintenance. Transmission losses and forced outages limit supply even further.
In fact, overcapacity concerns have not discernibly dampened investor interest, illustrated by several recent developments. In the middle of last month, CLP Power, the Hong Kong utility, bought 5% stake in Malaysia's YTL Power for M$388 million. Meanwhile bidding for the 40% stake in Kapar is reported to be fierce. 26 proposals were originally submitted for the stake estimated to fetch between $1 billion and $1.2 billion. Bidders include National Power with Malakoff, Powergen, Sithe, YTL and Marubeni. TNB will make its recommendation of preferred tenderer to the government this September.
An official at ABN Amro in Singapore says the main stumbling block for project financing is not demand and supply as much as uncertainties over the future regulatory framework and the protracted tariff formula review. ?The way in which the energy companies buy, sell and distribute will directly impact on the creditworthiness of the individual companies and projects,? he says.
TNB Distribution (TNBD) is already organized into four franchise areas ? Northern, Metro, Southern, and Eastern regions, solely for enhanced operational efficiency. Datuk Sidek Bin Ahmad, managing director at TNBD, says that there are no firm plans for the TNB's distribution business to be further split up into separate regional businesses. In slight contrast, some industry analysts now have a working assumption of five regional distributors, with Tenaga owning a collective 40% stake in the distribution companies.
According to Sidek, early indications from the independent grid system operator (IGSO) task force (the unit set up by the government to design the new electricity market structure), suggest that the wholesale market mechanism is likely to be a pooling system, ?based on the market models introduced in the UK, Australia and elsewhere.? ?However,? adds Sidek, ?the IGSO taskforce has not yet finalized the market design.?
Sidek also hints that the Malaysian market model will accommodate a single centralized buyer during the initial phases of implementation. Sidek favours a single buyer because it will allow for a smoother transition to the new market model, given that Malaysia, unlike the UK or Australia, has traditionally had only one pre-dominant distribution company (namely TNB's subsidiary). Tenaga, backed by Sidek, is likely to have given its recommendation for the company to continue acting as single centralized buyer for the next three to five years.
Sidek is more guarded on what the outcome will be of the tariff formula review currently being conducted by the Malaysian Director General of Electricity Supply & Gas. It is likely, says the managing director, that electricity tariffs for end customers will be unbundled into separate components to reflect cost of energy purchased from the pool, transmission and distribution and power market operational costs. At the moment prices are set by a more simple rule of thumb ? ?to allow TNB to obtain a sufficient rate of return to satisfy the covenants attached to loans obtained from the World Bank and other financiers,? says Sidek.
Sidek also believes that cross-ownership among different generation, transmission and distribution companies may be a feature in the electricity supply industry for some time, because the unbundling of TNB needs to be implemented in a number of separate stages.
The question of whether foreign ownership limits can be changed in an industry in which the state (the main shareholder of TNB) still holds a major stake, Sidek leaves unanswered.
The senior TNB official concludes that electricity market reform may take between three and five years to implement, referring to the experiences of the US, the UK and Australia: full competition in the UK electricity market was initially planned to take eight years to completion but is still unrealized.
Although the shifting structure of the Malaysian electricity industry will present enormous opportunities for power companies and their financiers. A Malaysian banking source has a final word of warning. ?The whole push to restructure the power sector is aimed at helping Tenaga reverse its debt position. The companies net debts for the year to August 1998 were more than M$22 billion. That is a burden that private companies will be expected to help carry.?
Since then the market has continued to recover, one of the most recent transactions involves Syarikat Air Johor, the local water operator looking for limited recourse financing for the development of its new water concession (see news). And More deals are expected soon ? the winning bidder for 40% of the 1,000MW Kappa power station is likely to opt for some project financing within its total funding mix, say sources involved in the transaction.
But a few deals does not a market make. Demand for project finance in Malaysia is still well below 1997 levels. ?The project finance sector certainly hasn't exploded in to life like the general economy has,? says one financier.
However, he does add, ?provided that privatization and deregulation in the utility sectors continue, plenty of business can be expected over the next two years.?
The current lack of demand also hasn't prevented a sense of opportunism being felt amongst the international project finance community. One reason why international players sense that more project finance mandates could come their way in the short term is the current financial position of Malaysia's domestic banking industry. While liquidity is generally good for Malaysian banks, banking consolidation is threatening to constrict the longer term funding market.
Malaysia's commercial and merchant banks and general finance companies (there are a total of 58) are consolidating into six core groups.
The process will inevitably mean that the stronger finance houses have to bear the burden of absorbing the weaker institutions.
Yet, as an official at the Malaysian central bank points out, mergers are not likely to be supported by any new injection of capital from the government. A knock-on effect of consolidation, therefore, is a possible disruption to the supply of local bank debt, particularly the traditionally shallow long term debt market. Murray Ashdown at HSBC in Singapore expects the debt market to be restricted for tenor in excess of seven years.
It is this interruption of supply that has led international banks to hope for a larger slice of Malaysian project finance business, at least until the consolidation process has been concluded. How long will that be? ?The government wants the six financial groups to be fully integrated in six months. Given that it was always going to be tight and if you add the Y2K complications, I think it will take a few months longer,? says one Malaysian banking analyst.
So far it is not readily apparent that the supply of domestic long term debt has been greatly restricted, says Ashdown. There are two main reasons:
Firstly, Malaysian banks have been deprived of one particularly large source of business pre-crisis, namely construction loans. In the wake of the slowdown in Malaysia, large scale commercial development has stalled in Malaysia. Lacking this traditional staple diet local banks have been forced to devote more of their attention to the project finance market.
Since Malaysian Banks had already grown comfortable with local project finance risk prior to the Asian financial crisis, it was an easy step to make. The MNI transaction was oversubscribed on the Ringgit portion, evidence of the shifting attention to project finance loans.
The second factor is the more general lack of demand. ?The Malaysian market has traditionally been project constrained not finance constrained,? says Doug McMurrey at Chase Manhattan in Hong Kong.
Even where there is demand for finance, many deals which have been labelled under the project finance umbrella are not true project financings. Corporate finance has been and will continue to be the main source of greenfield and acquisition finance. The much publicized Janamanjung project, a 2,100MW power station being built for Tenaga Nasional has, to date, been financed through export credit facilities on a corporate basis. The remaining M$2.25 billion is likely to be raised through corporate bank debt. ABN Amro, HSBC and Barclays are amongst the banks sniffing for the mandate.
Malaysian project sponsors are fortunate enough to be able to pick on a broad array of financing options. The country is clearly favoured by the export credit agencies above many other markets in Asia, as the number of previous ECA-supported projects in Malaysia demonstrates. ?A good project in Malaysia will get financed. That's not true of everywhere in Asia,? notes McMurrey. There is an obvious downside for project financiers, with ample appetite for Malaysian corporate risk, financing on a project basis will only rarely be the finance method selected.
Ringgit loans and US capital markets
?The Malaysian project finance market is dominated by local currency funding to an extent that many other Asian markets are not,? observers one Malaysian banker. Ringgit financing is favoured because of pricing ? typically Malaysian banks have been willing to lend in Ringgit at single digit interest rates ? and suitability. The income stream generated by most Malaysian projects is usually purely Ringgit, the exceptions being the petrochemical and natural gas businesses where a portion of the receivables have often been denominated in foreign currency.
Projects in the utilities sector in which the tariff is linked to a currency index (easing the way for non-Ringgit loans) have been very rare in Malaysia, indeed in the power sector such indexation is unprecedented, says one banking source. The same source, closely involved in the Kapar deal, confirms that, here again, the tariff will not be linked to the currency index.
The combined effects of currency fluctuation, lack of indexation, cost of hedging and the limited number of licenses for foreign banks, restrict the market share that international institutions can have in the Malaysian project finance business. Of those foreign banks that have the necessary license to book Ringgit business, there are only two with large enough balance sheets to lend on a regular basis; Hong Kong Bank Malaysia and Standard Chartered Bank Malaysia, thanks to their country-wide branch networks. Before the financial crisis, Hong Kong Bank was a regular player in the local syndication market, taking chunks of M$200 billion, says Ashdown ? well beyond the capacity of most other international banks.
Its not for nothing therefore that foreign banks are hoping to see an increasing role for the US capital markets in Malaysia from the year 2000. ?In our experience projects with an export related element will be particularly well thought of,? says John Mulcahy at Bank of America in Hong Kong. The market has already been stimulated by large dollar bond issues by the Malaysian government. And even at the tail end of the regional financial crisis (January 1999) Tenaga made history when it succeeded in issuing the first ever 100-year bond by a non-US company, indicative of the relatively favourable view investors have of Malaysian risk. The deal was a $150 million century bond at a coupon interest rate of 7.5% per annum.
Previous to Tenaga's century bond, there have been only eight other 100-year bonds issued in the history of the international debts markets.
Industry opportunities
As to be expected, the greatest demand for project finance over the next three years will come from the utility sectors, as a result of deregulation and privatization. The chief target for the banking industry is the power market.
A potential source of concern for investors in Malaysia's power industry lies in the amount of electricity oversupply. One banking source in Singapore quotes a reserve margin (a measure of excess capacity) for peninsular Malaysia of 60%. If the source is correct overcapacity is extraordinarily high. ?Overcapacity of 30% is a reasonable standard in developing countries,? explains one industry analyst. ?15% to 20% is the norm in developed economies.?
Even taking in to account rapid GDP expansion in Malaysia, and the fact that electricity demand grows at a multiple of about 1.5 times GDP, oversupply of that magnitude would significantly dampen investor interest in both power sector acquisitions and greenfield projects. The same banking source says the Janamanjung financing has been delayed because of overcapacity and is still fraught with difficulties. ?The financing is continuing,? says the source, ?because the project has accumulated too much momentum to be stopped?.
Comments about overcapacity are not uncontroversial. Some analysts have even said Malaysia runs the risk of running short of power by 2003 if the 2,100MW coal fired Janamanjung power station, is not built.
Andrew Ancone at Macquarie Bank's representative office in Kuala Lumpur gives a present peak load figure of 8,500 megawatts and total capacity of 12,500MW, implying that the overcapacity above peak load is 47% not 60%. ?But there's also a problem of definition,? says Ancone. The so-called reserve margin does measure the amount of extra capacity but capacity can't be directly equated with supply. That's because there are a number of reasons why in practice capacity cannot be fully utilized. For instance, 2,000MW of the total capacity comes from hydroelectric power, but the actual availability of power from hydro sources is determined by constantly changing water levels held in Malaysia's dams. In addition, at any one time a portion of the electricity grid and the power production facilities are under maintenance. Transmission losses and forced outages limit supply even further.
In fact, overcapacity concerns have not discernibly dampened investor interest, illustrated by several recent developments. In the middle of last month, CLP Power, the Hong Kong utility, bought 5% stake in Malaysia's YTL Power for M$388 million. Meanwhile bidding for the 40% stake in Kapar is reported to be fierce. 26 proposals were originally submitted for the stake estimated to fetch between $1 billion and $1.2 billion. Bidders include National Power with Malakoff, Powergen, Sithe, YTL and Marubeni. TNB will make its recommendation of preferred tenderer to the government this September.
An official at ABN Amro in Singapore says the main stumbling block for project financing is not demand and supply as much as uncertainties over the future regulatory framework and the protracted tariff formula review. ?The way in which the energy companies buy, sell and distribute will directly impact on the creditworthiness of the individual companies and projects,? he says.
TNB Distribution (TNBD) is already organized into four franchise areas ? Northern, Metro, Southern, and Eastern regions, solely for enhanced operational efficiency. Datuk Sidek Bin Ahmad, managing director at TNBD, says that there are no firm plans for the TNB's distribution business to be further split up into separate regional businesses. In slight contrast, some industry analysts now have a working assumption of five regional distributors, with Tenaga owning a collective 40% stake in the distribution companies.
According to Sidek, early indications from the independent grid system operator (IGSO) task force (the unit set up by the government to design the new electricity market structure), suggest that the wholesale market mechanism is likely to be a pooling system, ?based on the market models introduced in the UK, Australia and elsewhere.? ?However,? adds Sidek, ?the IGSO taskforce has not yet finalized the market design.?
Sidek also hints that the Malaysian market model will accommodate a single centralized buyer during the initial phases of implementation. Sidek favours a single buyer because it will allow for a smoother transition to the new market model, given that Malaysia, unlike the UK or Australia, has traditionally had only one pre-dominant distribution company (namely TNB's subsidiary). Tenaga, backed by Sidek, is likely to have given its recommendation for the company to continue acting as single centralized buyer for the next three to five years.
Sidek is more guarded on what the outcome will be of the tariff formula review currently being conducted by the Malaysian Director General of Electricity Supply & Gas. It is likely, says the managing director, that electricity tariffs for end customers will be unbundled into separate components to reflect cost of energy purchased from the pool, transmission and distribution and power market operational costs. At the moment prices are set by a more simple rule of thumb ? ?to allow TNB to obtain a sufficient rate of return to satisfy the covenants attached to loans obtained from the World Bank and other financiers,? says Sidek.
Sidek also believes that cross-ownership among different generation, transmission and distribution companies may be a feature in the electricity supply industry for some time, because the unbundling of TNB needs to be implemented in a number of separate stages.
The question of whether foreign ownership limits can be changed in an industry in which the state (the main shareholder of TNB) still holds a major stake, Sidek leaves unanswered.
The senior TNB official concludes that electricity market reform may take between three and five years to implement, referring to the experiences of the US, the UK and Australia: full competition in the UK electricity market was initially planned to take eight years to completion but is still unrealized.
Although the shifting structure of the Malaysian electricity industry will present enormous opportunities for power companies and their financiers. A Malaysian banking source has a final word of warning. ?The whole push to restructure the power sector is aimed at helping Tenaga reverse its debt position. The companies net debts for the year to August 1998 were more than M$22 billion. That is a burden that private companies will be expected to help carry.?
Request a Demo
Interested in IJGlobal? Request a demo to discuss a trial with a member of our team. Talk to the team to explore the value of our asset and transaction databases, our market-leading news, league tables and much more.