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RBS to underwrite construction projects

RBS has created its own “construction guarantee” that could help chancellor George Osborne’s ambition of enticing institutional investment into UK infrastructure.

The bank, majority-owned by the government, confirmed to Construction News that it has developed a “construction wrap” to guarantee the building phase of infrastructure and is now looking for its first project.

The Confederation of British Industry welcomed the move this week after it called last year for banks to partner with institutional investors under new investment models.

The National Association of Pension Funds, which represents 1,200 pension funds and around £800bn in assets, also welcomed the wrap while describing guarantees as “attractive” to investors.

However, there were some concerns in the market over pricing and the structure of the deals.

RBS told Construction News that in theory there are “no limitations” to the use of the construction guarantee, which is a bond providing upfront funding, guaranteed with the bank in case of failure to complete a project.

It said the more immediate opportunities are likely to be in hospitals, the Priority School Building Programme and energy-from-waste projects.

Mr Osborne has previously said that British pension funds could provide £20bn of infrastructure funding.

That led to the development of a pension infrastructure platform, which has pledged £1bn so far. But most funds are still reluctant to take on construction risk, which means focusing on existing assets instead.

Meanwhile funding and regulatory issues mean banks’ appetite for long-term lending has been considerably reduced.

Infrastructure UK chief executive Geoffrey Spence said the Treasury is “very supportive” of the RBS product, adding that “banks are responding to the challenge” facing infrastructure.

He said Chinese and Qatari sovereign wealth funds are also being targeted by the Treasury to offset an “irrational aversion” from investors to construction risk, which he said was delaying projects.

“[It will] allow banks to support infrastructure projects despite limitations to long-term lending”

RBS

An RBS spokesman said: “We know other banks are thinking about it but feedback from stakeholders is that RBS is advanced. It is quite new, though some of the features have been done before.

“[It will] allow banks to support infrastructure projects despite limitations to long term lending.

“Additionally, the involvement of highly experienced PF banks provides comfort regarding due diligence and soundness of financial structure.”

NAPF chief executive Joanne Segars said while some pension funds were willing to take construction risk on, others were not.

“There is a recognition that it may be attractive to get into projects at construction phase if ways can be found to wrap the risk. So initiatives which offer a guarantee can be attractive to pension fund investors,” she added.

CBI head of infrastructure policy Nicola Walker said a lot of the £330bn the government has identified in its National Infrastructure Plan must come from the private sector.

She said: “Many institutional investors, like pension funds, do not find infrastructure projects attractive despite them being a good match on paper – especially ‘greenfield’ projects with much riskier construction phases.

“Any products and initiatives designed to address and mitigate this construction risk is a positive step and will help the private sector deliver the new infrastructure we sorely need.”

However, Mr Spence said there had also been some resistance from investors to the construction guarantee.

It is understood that a number of investors have said they are not interested in exchanging high construction risk with bank counterparty risk, as this technically gives them a financial services exposure.

Although RBS said the pricing will be “as competitive as possible”, critics said it was unlikely to be cheap.

There have also been questions over whether investors would opt for the RBS product if the government is offering a guarantee instead.

The Treasury has announced two projects under its UK Guarantees initiative, which can be used to underwrite the debt on schemes and help them reach financial close.

RBS construction guarantee

RBS said commercial banks were experienced and equipped to evaluate project risks and put together appropriate financial structures, adding they were willing to take construction risk for greenfield projects.

But funding and regulatory issues mean bank appetite for long-term lending is considerably reduced.

The decline of the monoline market – guarantees that enhanced credit ratings on schemes – after the financial crisis also left a long-term debt void, although the FT reported last year that a monoline revival could be in the pipeline.

The construction wrap is a bond providing upfront funding guaranteed with a bank in case of failure to complete a project.

If the guarantee is called, it would give rights to the guarantor to seek termination compensation and/or restructure the deal.

RBS said pricing “is the result of inputs from a number of parties and should be as competitive as possible”.

Structure

Bond Investor(s) provide a long term senior debt loan to the project at financial close

Bank(s) provide a guarantee during the construction phase of the project, in the form of a letter of credit (LC) facility to the borrower and callable by the investor(s)

In the case of failure of the project to complete construction by a long stop date (LSTD) the guarantee would be called and Investors paid out. The LSTD will be linked to the project construction period plus contingency

On project completion, the guarantee is released and the guarantor exits the transaction. Bondholders’ exposure is then to a completed project

If the guarantee is called, this would trigger an EoD (end of day notice stating when something must be completed) and would give rights to the guarantor to seek termination compensation and/or restructure the deal (as under a more typical PF structure)

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