In praise of (some) bankers
Energy Blog, 12 March 2021
Moody’s have just published their 11th report on defaults and recovery rates for project finance bank loans, covering a large fraction of all transactions done between 1984 and 2016. The report shows that the sector continues to offer good risk discipline, with a “10-year cumulative default rate of 6.4% and an average recovery rate of 79.3%.” Moody’s further notes that “marginal default rates for project finance bank loans are similar to marginal default rates for high speculative-grade corporate issuers during the first three years following financial close. They fall over time, however, and trend toward rates consistent with the single-A rating category by year seven following financial close.”
Given that lenders on such “non-recourse” loans are only repaid if the project is built and performs at a level close enough to specs, the lenders tend to do serious due diligence of the projects. This includes reviewing project contracts, assessing project management and teams, considering counterparty risk and any price risk, and building financial structures that include buffers and, whenever relevant, comprehensive contingency planning. In other words, bankers who know and understand what their clients do, actually do good work both for them and for their clients.
But there is no secret. To do a complex project well, you need smart people, good planning, a willingness to consider adverse scenarios and then prepare for them, an acceptance that things will go wrong (and what matters is that you have the time and resources to react to the unexpected) – it takes a lot of work. There is no easy investment in project finance – you need large teams, and you need to give them the time to assess the projects. It is not just looking at a rating and pressing a button to buy a piece of paper. But ultimately, it is reasonably profitable and, more importantly, it does not blow up.
Having been in the industry for 25 years now, I have seen the sector being mocked as “has been” as people flocked to the new thing that looked highly profitable and sexy – emerging market bonds, dotcoms, CDOs and CMDSs, bitcoin, market platforms, now SPACs. Without exception they have all suffered severe crises where the losses more than outweighed the earlier gains, and banks end up nursing their wounds by going back to project finance – it might be boring and unglamorous, but at least it’s safe and it gives bankers good name, financing the real economy on terms that make sense for everybody.
Interestingly, the large projects with the best track record on both cost and timing (as per a separate EY report from December 2016 (“Spotlight on power and utility megaprojects — formulas for success”) are offshore wind farms – which is one of the few sectors where banks fully take complex construction risk and finance a large fraction of the projects actually built. Other sectors that have complex projects (like oil&gas fields or LNG terminals) typically have construction guarantees provided by the sponsors, and banks accordingly scrutinize construction risk a bit less. So the sector with the fullest application of project finance discipline is also the sector that does best in terms of building projects on time and on budget…
Green Giraffe officers were involved in the first 4 greenfield offshore wind debt financings and helped set some of the standards still used today to assess construction and other risk. We are pleased to be able to look back, some 15 years later, at the incredibly successful track record of what is still a relatively young industry, and note the crucial role bankers played in that adventure.
Jérôme Guillet co-founded Green Giraffe in 2010 and was a Managing Director until 2021.