Project finance - underwritings in the credit crunch

Publication | October 2008


We recently passed the one year anniversary of the credit crunch and, despite recent attempts by the governments of the US, EU countries and Japan to present a unified response to the crisis, the debt markets are still choppy and difficult to navigate. Commercial banks are seeking greater protections in their underwriting commitment letters as they have little to no visibility on what pricing and structures the market will accept in 2009. Borrowers are struggling to cope with the requirements that banks are placing on underwriting commitments.

Bank underwriting commitment letters – impact of

The general consensus in the project finance community seems to be that deals are taking longer to complete in the credit crunch world.

Additional delays are the result of a number of factors, such as negotiating higher margins and stricter terms. Generally, commercial banks are taking significantly less risk and not agreeing to underwrite the same amounts they were a year earlier.

In some markets and sectors, banks are not willing to provide any form of underwriting commitment. The days of having a sole underwriter for a project are behind us and club deals are increasingly a requirement with commercial banks seeking to syndicate underwritings quickly.

We are also seeing the credit committee approval process take longer.

Financing structures that have been accepted in the past may no longer be considered good “precedent” and the result is that negotiating power has shifted away from borrowers and even the front office origination teams at commercial banks. The syndication desks and credit committees now seem to call most of the shots. This underlines the importance to borrowers of ensuring that banks have consulted their syndication teams and have credit committee approvals prior to entering into underwriting commitment letters. Otherwise, there is a risk that financings may need to be restructured to take account of syndication and credit committee concerns.

In underwriting commitment letters, MAC clauses and market flex provisions are taking much longer to negotiate. Indeed, these clauses may have been absent in the underwriting commitment letters of the best borrowers prior to the credit crunch!

Not any more.

Unfortunately for borrowers, this coincides with rising construction and commodity expenses that have pushed up the costs of building a project. As a result, firms are required to increase the amount they are borrowing. In an effort to minimise financing costs – and reduce risks associated with commercial bank syndication – developers are increasingly seeking additional sources of liquidity from other credit providers such as export credit agencies and Islamic funding institutions.

MAC clauses

Banks and borrowers alike are paying particular attention to the Material Adverse Change (MAC) provisions in underwriting commitment letters. In particular, discussions focus on whether the test should be objective (a question of fact) or subjective (determined in the discretion of the banks).

Commercial banks are currently requiring a subjective and more discretionary test so that they do not have to negotiate with borrowers whether or not a MAC has occurred.

The MAC clause allows the banks to terminate their underwriting if any event occurs or any circumstances continue to occur which adversely affect or could adversely affect certain markets or jurisdictions where the banks may seek to syndicate their underwritings.

Commercial banks are requiring the definition of these markets to be very wide – encompassing, at a minimum, the international or any relevant domestic syndicated loan, debt or bank markets.

The LMA standard MAC provision requires that syndication must be “prejudiced”. Borrowers are understandably nervous about the scope of this clause, as determining when syndication may be prejudiced is likely to be more art than science.

There is nothing to suggest that a hair-trigger event would not prejudice syndication. If a MAC occurs, the banks will have the right to terminate their underwritings. The scope of this language could be viewed as undermining the benefit of an underwriting and borrowers may wish to resist referring to syndication being prejudiced rather than prevented.

In certain cases, borrowers may benefit from a qualification in the MAC clause whereby the MAC must prevent syndication below a threshold target hold. These sorts of thresholds are less likely to be found in today’s market.

Market flex clauses

The market flex clause tends to complement the MAC clause in that a more borrower-friendly MAC clause can lead banks to take a more aggressive approach on the flex clause.

Whereas prior to the credit crunch, flex clauses could be found in emerging market deals (and even the terms of the flex were restricted), now we are seeing flex clauses on virtually every transaction irrespective of market.

In more credit-worthy markets, with strong borrowers, flex clauses can be limited to pricing (such as margin or arrangement fees) and the pricing may be capped. In emerging markets, flex clauses are wide open and would allow for no caps and structural flex.

Market flex provisions are also being tied to the duration of the underwriting commitments. Commercial banks are more reluctant to underwrite for long periods of time and those that do will demand more flex to cushion against the risk of deteriorating debt markets prior to syndication.

Even the best borrowers are not able to control the timing of the market flex rights, which ultimately exposes their shareholders to the risk of uncertain equity exposure. This is particularly troublesome for borrowers seeking an underwriting for a concession-based project as the risk of flex may lie entirely with the international developers bidding on the project – with sovereign sponsors/project participants seeking to avoid any exposure to the risk of market flex.

As the market deteriorates, lenders are increasingly exercising their rights to flex. What was earlier an unusual occurrence reserved for the most exceptional circumstances, exercising the flex clause has become a reality on a number of transactions.

Local banks and local currencies

Local and regional banks may find that the credit crunch has opened a door of opportunity.

Given the increasingly tight credit conditions that are being imposed by the large international banks, borrowers may find that local banks are able to bring liquidity to the table.

This has been the case on recent project financings in Western Europe and some Middle Eastern countries such as the Kingdom of Saudi Arabia. However, these banks are significantly smaller than the large international banks, and borrowers will need to carefully assess their credit position to ensure that local banks will be able to meet their funding obligations for the duration of the construction period.

Another impact of the credit crunch has been that borrowers are increasingly seeking local currency facilities as a means of mitigating the lack of liquidity for US dollars in the syndicated loan markets. Where a portion of the project costs are denominated in local currency there may be commercial sense in this. However, local currency borrowings throw up additional obstacles in that they may not be funded at a LIBOR based interest rate and interest rate hedging for the local currency funding rate may not be available for the same tenor as LIBOR interest rate hedging.

Foreign exchange risk will be another concern that commercial banks will wish to see addressed – particularly on projects in the GCC, where there are press reports that certain countries may wish to re-peg their fixed US dollar exchange rate.

Margins and other fees

Margins have also risen across the energy and infrastructure sectors.

Fees payable to banks for structuring a transaction, negotiating a term sheet etc, are also increasing.

In the Middle East, where the project finance market has been particularly active over the last few years, structuring fees have generally not been payable. Compare this to projects in other jurisdictions, notably sub-Saharan Africa, where these fees are often payable.

There have been recent press reports suggesting that banks may begin charging structuring fees for Middle Eastern deals in an effort to ensure they hit their budgets given that it is taking longer for deals to close and for them to collect their arranging fees.


Reading the financial press, one would think that project financings have come to a halt along with all other transactions which require commercial bank debt.

This is however far from the truth. Yes, deals are more difficult. Yes, deals are taking longer to structure and complete. However, good deals are still getting done and successfully syndicating.

We are finding that more time spent at the outset of a project – ensuring that it is well structured – will help in ensuring a smooth negotiation, closing and syndication process.

This article was originally published by Infrastructure Journal in September 2008.



Madhavi Gosavi

Madhavi Gosavi

London India Nordic region