Rising competition for project finance ventures is pushing banks and investment banks into riskier deals and prompting capital market investors to ignore the potential pitfalls, banking sources warn.
"This is a very hot environment, and pricing and conditions have become very aggressive," said Peter Luchetti, senior vice president and global head of project finance at BankAmerica Corp. in San Francisco. "You have to be very careful about how to position assets in this environment."
Commercial bankers and investment bankers blame each other for what they call "aggressive" pricing to fund large infrastructure projects like roads, ports, and power plants.
Bank lending for project finance rose to $42.8 billion last year, a dramatic 84% increase from $23.2 billion in 1995, according to Project Finance International, a weekly publication owned by an affiliate of American Banker.
Bonds issued to fund projects rose to $4.9 billion from $3.8 billion in the same period.
Among U.S. banks, Chase Manhattan Corp. ranked as the biggest arranger of project finance, with $5.8 billion in loans last year. Citicorp was the second biggest arranger, with $2.1 billion, and BankAmerica the third largest, with $1.1 billion.
Project finance experts argue that institutional investor interest in project finance deals is fueling a growth in funding through capital markets.
Borrowers for project finance, they said, also find bond markets more attractive because financing is faster, they can get longer term funding at better pricing, and covenants are weaker.
Concerns about project finance come amid a fast growth in the market and increased efforts by investment banks to grab a portion of the business through bond deals.
Participants in a recent conference in Frankfurt sponsored by the Washington-based Bankers Association for Foreign Trade warned that competition for project finance is encouraging some players to disregard the potential risks, especially in rapidly growing emerging markets.
"Debt structures in emerging markets are more complicated, and sovereign risk is not a thing of the past," warned Malcolm Stephens, secretary general of the Berne Union, an umbrella organization for export credit insurance agencies from 38 countries.
"Many people believe that political risk has evaporated, but some believe risks are rising dramatically and they are being ignored."
More specifically, he noted that many countries are funding projects with foreign exchange and relying on local currency earnings to pay back the debt.
Local currency, he pointed out, is subject to devaluations. Governments, too, may prove to be unwilling to increase local tariffs to offset devaluations.
"Commercial banks have responded to capital markets threat by being very aggressive and seeking to match the capital markets on issues such as tenure, pricing, and capital structures," said Paul Knight, executive director and head of global project finance at SBC Warburg, the London- based investment banking unit of Swiss Bank Corp.
"My concern is that this competitiveness, while good for project sponsors, may be testing the limits of prudence." Given the large volume of deals, he added, "the possibility of a large prominent deal failing is real."
Bankers like Mr. Luchetti sound a similar note. "We're at a stage where everything looks rosy, nothing looks like it's going wrong," Mr. Luchetti remarked. "But some of those capital markets investors will find that the terms and conditions and pricing are not adequate under a more stressed business climate."
