The value of counter-cyclical lending

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Despite the crisis, the EBRD committed more money to the water sector in 2009 than ever before. It also broadened its sphere of influence in anticipation of future investment needs in Turkey and Belarus’.

The European Bank for Reconstruction and Development committed a record €282.6 million of funding to the water sector in 2009, as its historical portfolio broke through the €1 billion barrier for the first time.

More than half the money pledged last year was in the form of equity, although the bank continued to extend loans to public and private sector clients across Central and Eastern Europe, despite feeling the effects of the credit crisis.

Two key trends informed the EBRD’s investment strategy over the course of 2009, according to Jean-Patrick Marquet, the bank’s director of municipal and environmental infrastructure. “Last year, we signed four projects purely for wastewater, and that was clearly a first,” he told GWI. “For many years, there was a strong drive to invest in water supply, but this is now receding a bit, meaning we see more and more cities getting concerned about wastewater.”

The challenge is twofold – as cities across the region have grown, wastewater collection networks have failed to grow in parallel. The logical consequence of this is that, as more wastewater is collected, the need for increased treatment capacity becomes more pressing.

“Wastewater is coming up the agenda, and I see this trend amplifying this year. Last year we signed four projects. This year we have seven in our pipeline, so I think it’s a very positive trend, and something that we are trying to support as much as possible,” said Marquet.

“The other element that I see is an acceleration of private sector participation in the water and wastewater sector. The crisis has put municipal, federal and government budgets under pressure, and clearly that is driving everyone to look at other options, with private sector participation being a pretty obvious one.”

Nurturing Mother Russia
Given its status as a committed long-term lender to the water sector, the EBRD has a unique viewpoint of the trends that are unfolding across its area of coverage. “There are a number of opportunities: new private sector operations, former municipal companies being privatised, assets being leased, and the acquisition of existing operators,” Marquet points out. Unsurprisingly, he singles out Russia as having the intentions – if not yet the framework – to support a much greater level of private sector participation in water.

“We have multiple cities that are currently working on tenders, including Yaroslavl’, Samara and Lipetsk,” he enthuses. Part of the attraction of private sector participation for Russian mayors is that this mobilises federal funding, although the sector still has to overcome some obstacles. “It remains a challenging environment for various reasons,” observes Marquet. “There is a real lack of experience among Russian public authorities of working with the private sector. The legal environment is improving, but remains deficient in several respects, and tariff regulation is also far from perfect.”

With an estimated RUB15 trillion ($459 billion) of investment needed over the next ten years to bring Russia’s water and wastewater infrastructure up to scratch, it is no surprise that international private water operators have been showing increased levels of interest in the sector. “Most companies were extremely cautious about Russia, and reluctant to engage, and this changed in the course of last year. We’ve seen many more enquiries than before across the board from the big water operators, and also from private equity,” Marquet told us.

Some of the more significant requests for capital honoured by the EBRD last year came in the form of substantial equity commitments to two of the largest international private water operators. Having invested €90 million in 2007 for a 10% stake in Veolia Voda – the Eastern European operating arm of Veolia Water – the EBRD injected another €70 million of equity at the end of last year. The returns have evidently been sufficient so as to convince Marquet’s team that the investment was worth adding to, and the wider prospects in the region should allow for substantial further growth. “Clearly the ambitions of Veolia have grown over these two or three years, and they now have a very ambitious expansion strategy across the region,” Marquet observes.

Veolia’s Moscow-based business development team, headed by Remi Paul, is, Marquet believes, in a strong position to take advantage of market opportunities in the water sector, although it missed the chance to snap up one of the existing Russian private water operators at a knock-down price when their crisis-hit owners were touting around for buyers last summer.

The EBRD’s second equity investment last year was a deal to inject €80 million for a 49% stake in a newly created Eastern European subsidiary of Spanish private water operator aqualia. Although a small fraction of the funds have already been released in order to cover running costs, the idea is to “drip-feed” the money into the SPV as and when investment needs dictate.

Diversifying its loan book as investment priorities pick up across the region was also an important hallmark of the EBRD’s lending strategy last year.

Far from crimping the bank’s lending activities, however, the crisis merely served to underline the importance of the bank’s role as a source of long-term capital last year. “At the peak of the crisis we were alone on the market, because there was no benchmark from lenders,” Marquet remembers. “We have very deliberately taken a long-term view, and we have continued to be responsive and support clients,” he emphasised.

Where the EBRD also noticed a difference last year was the extent to which commercial banks were willing to step in to cofinance deals. Marquet describes his success at attracting commercial co-financing in 2009 as “almost nil”, adding that “we’ve had several projects where commercial banks actually pulled out. It has changed our modus operandi to the extent that we are now in most of these [deals] alone.”

It’s not that commercial banks have stopped lending. The crisis has merely made them cautious to the extent that they are not yet willing to return to lending at tenors which match those required by the EBRD’s infrastructure clients.

New shores
In August last year, the bank announced its first investment in the Turkish water sector, signalling its intention to take a stake of up to 20% in TASK – a private sector joint venture active in water concessions and BOTs. While the equity commitment is small, at around €5 million, the accompanying debt package is more substantial. The first project to be funded is an industrial wastewater operation in Dilovasi, although the JV has also negotiated concessions in Kars and Çorlu, which are expected to require significant capital expenditure in future.

The EBRD only began operations in Turkey in December 2008, and while the legal environment is still under-developed, the bank is already looking at ways to improve the landscape for private sector operators in the Turkish market.

“As always, we try to leverage our business operations with policy dialogue. We are in discussions with the [Turkish] government to provide advice on upgrading the PPP law and concession law, but at this point it remains at the exploratory stage,” Marquet emphasises.

The other country where the bank is preparing to ramp up its activities is Belarus’, and the approval of a new EBRD strategy for the country in December 2009 gives the bank a new mandate to invest in the country’s public sector. “We are looking at five or six cities, including Vitebsk,” notes Marquet. “Belarus’ is coming out of the cold.”

In terms of the overall constraints on the EBRD’s water sector lending going forward, “I think the real bottleneck is to find the right investment, the right partners, and the right concessions or privatisations,” observes Marquet. “There is clearly a growing interest for private sector involvement.”