It has been a good few months for the Philippines’ Aquino administration. In May senatorial elections, Team PNoy, the umbrella coalition supporting the President Benigno Aquino’s incumbent administration, won three-quarters of the available seats. The country has been one of the few in the region to withstand the slowdown in output and its currency has remained relatively stable, partly due to the sophistication of central bank monetary policy and its forward guidance.

The government’s PPP programme has not had such an auspicious couple of months, however. The government launched the programme to much enthusiasm in November 2010 but so far only three of the 50 PPP candidates that Aquino identified have been awarded. And nearly all, including the three to be awarded, have suffered from delays during their tendering phase, and during the period following the appointment of a preferred bidder.

In July Aquino used his state of the nation address to affirm the government’s commitment to its PPP programme, but a recent series of setbacks has prompted market observers to call for a rethink. In August the Philippine Department of Transportation and Communication (DOTC) rejected the only bid for the roughly Ps60 billion ($1.3 billion) Light Rail Transit Line 1 Cavite extension (LRT-1) project from the Metro Pacific Investment Corp consortium, comprising Metro Pacific, Ayala and Macquarie.

The DOTC is expected to ask for fresh proposals, after the four prequalified bidders questioned the concession’s risk sharing mechanisms and the way local municipalities would levy property taxes. The DOTC has also pushed back the deadline for proposals for the roughly Ps17.5 billion Mactan-Cebu airport expansion project, reportedly because the seven prequalified bidders expressed similar concerns about that draft concession agreement.

“I think that it has been a case of too much too soon in the Philippines” said one adviser active in the market. “The government is slowly realising that not everything taken out to market will be gobbled up, and that certain issues, such as rights of way, payment of concession fees, and tax immunity need to be carefully thought through before a project comes out to tender. The government would benefit from focusing on a few key infrastructure projects rather than trying to rush everything out to market.”

A new deal

The Philippines does not suffer from a lack of a visible pipeline, unlike some of its neighbours. According to the government’s PPP Centre, the bidding for seven projects is currently live. They are the Orthopedic Centre project, the second schools bundle, LRT-1, Mactan-Cebu, the Cavite-Laguna expressway, an automatic fare collection system project, and the rehabilitation of the Angat hydroelectric power plant.

This list is not exhaustive and excludes several projects that are not officially PPPs but are still expected to access private capital, as well as projects in the preparation phase that are expected to come out to tender shortly, such as the New Centennial Water treatment project and the NLEX-SLEX Connector road project. This has meant that the Philippines has outshone rival PPP markets, particularly Indonesia, as a target for investors.

The Aquino administration has made its PPP programme one of the cornerstones of its economic policy. Although the Philippines has a history of harnessing private capital, the government upon its election in 2010 removed some of the obstacles to investing in infrastructure, through executive order 8. The order also ditched the old BOT centre, which was the government body responsible for overseeing infrastructure projects, and replaced it with the PPP Centre.

The government has followed this up with other policy changes. These include a pledge to co-finance up to 50% of the value of any PPPs – either through direct loans or multilateral investments, policies to protect investors from regulatory risk, whether in the form of make-up payments or adjustments to contractual terms, a relaxation of existing single borrower limits regulations (although this relaxation has since lapsed) and proposed changes to rules regarding local taxation and land expropriation.

Foreign lenders struggle to get a foothold in the market, primarily because of the strength of local banks, which are liquid in both dollars and pesos, but the PPP programme has attracted interest from overseas sponsors – at least during the prequalification stage. The stipulation that winning consortiums provide an upfront concession fee 30 days after the appointment of the preferred bidder is a local norm but a deviation from international best practice. This has caused some difficulties but interest is still strong.

Bank billing

The interest from several overseas sponsors such as Macquarie, Leighton Contractors and Samsung in recent concessions has provided some opportunities for international lenders, which are looking to build up their profile in the Philippines through advisory mandates. But as the country reduces its dependence on bilateral sovereign redevelopment assistance loans towards financings with meaningful risk transfer to the private sector, local lenders are expected to dominate.

Local banks, once considered wary of construction and revenue risk, have already financed toll roads and power plants and are likely to finance most upcoming concessions. Local lenders have already eliminated the small foothold that the US high-yield market had established in the Philippines when BDO and the Rizal Commercial Banking Corporation closed the refinancing of the Manila-Cavite toll road in 2012.

Two of the three PPPs to be awarded to date have closed – the Ps1.96 billion Daang Hari-SLEx project and the Ps16.42 billion first schools bundle – and both did so without using a project financing. The relatively modest capital requirement for Daang Hari lent itself to a balance sheet financing, while the schools projects proved unsuitable for a non-recourse commercial bank financing.

But market rumour suggests that for LRT-1 several lenders expressed a willingness to shortlisted bidders to underwrite all of the project’s Ps25 billion debt financing without syndicating the debt. Deals from before the launch of the PPP programme suggest that local lenders have the resources to make good on these offers.

In September 2011 DM Consunji and its other consortium members closed a roughly Ps19 billion financing for the Tarlac-Pangasinan-La Union Toll Expressway project. The deal closed through Ps11.5 billion in 10-year debt from a mixture of state-owned and commercial lenders, comprising BDO, Development Bank of the Philippines and Land Bank of the Philippines.

Lessons from closings so far

But the two deals to have closed so far illustrate the weaknesses of the PPP programme and the limits of local lender appetite. In October 2012 the Philippines Department of Education (DoE) reached commercial close with two sets of sponsors on three 10-year build-lease-transfer concessions for 10,000 new classrooms.

The sponsors of package A, which covers the construction and maintenance of 2,157 classrooms are BF Corporation and Riverbanks Development Corporation, while Megawide Construction and Citicorp Investment won packages B, for 2,885 classrooms, and C, for 4,259 classrooms.

The sponsors are understood to have struggled to close non-recourse financings for the two packages because it would be very difficult, or at least politically sensitive, to enforce a security interest over the school buildings in the event of default and commercial lenders were nervous about the appropriations risk attached to the lease payments. When the government refused to provide a guarantee that congress would appropriate funding for the DoE’s obligations, lenders baulked.

In December 2012 the Citicorp-Megawide consortium raised Ps6.5 billion in 10-year fixed-rate corporate notes, which featured a one-year grace period and carried a coupon of roughly 5.5%, to fund B and C. PNB Capital was lead arranger and sole bookrunner, while the Development Bank of the Philippines and Land Bank of the Philippines were co-lead arrangers. The note-holders mostly comprise local lenders including Bank of Makati, Metropolitan Bank and Trust, and Bank of the Philippine Islands. BF and Riverbanks are rumoured to have used BDO-arranged corporate debt to fund the A package.

Even for projects with fewer security and appropriations issues, corporate debt can be more appealing. In April 2012 Ayala and Getinsa Ingineiera closed the financing for the Daang Hari project  and relied on Ayala’s balance sheet, given the relatively modest costs of the project and Ayala’s success raising equity. Construction on the project has suffered from delays however, primarily due to rights of way issues surrounding the construction of a strip mall.

Future perfection?

Rights of way issues have been the main factor in LRT-1's lacklustre progress. The government was understood to control around 85% of the land it needed, and suggested that the winning consortium would start construction on the areas where the government had already obtained rights of way access before moving on to other areas once they were acquired.

Bidders would have had to be confident that the country’s notoriously cumbersome judicial process would deliver the land on time, and this land issue is understood to be a factor in the decision of three of the consortiums to walk away from the bidding. The government has proposed changing the existing legislation governing rights of way, known as Republican Act 8974, but this would need to be accompanied by additional reforms.

Bidders on both LRT-1 and the Mactan-Cebu project also wanted to be exempt from local taxes. The LRT-1 bidders took comfort from the fact that its concession was build-lease-transfer, but when it became apparent that the government expected the winning bidder to pay real estate and local taxes, their enthusiasm waned.

The LRT-1 deal also struggled because it was too dependent on the completion of additional works outside the control of the project company. Government was to be responsible for the delivery of new light rail vehicles and upgrading existing infrastructure. Bidder skepticism about the ability of government to deliver suggests that government needs to be clearer about the scope of PPP contracts before sending them out to bid.

The larger brownfield transportation projects are particularly vulnerable to problems in allocating roles, risks and responsibilities on PPPs. But even on the first schools bundle only two of the six shortlisted bidders submitted proposals – and both won contracts. Without competitive tension, government will find it hard to persuade voters that PPPs offer value for money.

Salvaging a pipeline

The Philippines’ haste in fostering the nascent PPP market has been a big source of bidders’ confusion. The government has put forward several projects that arguably should have used a different procurement method to PPP.

Still, in many jurisdictions, most obviously Canada, adopting PPP structures from elsewhere led to frustrating and painful episodes, and programmes almost always required fine-tuning in response to local sensitivities. The Philippines’ government has showed encouraging signs in moving away from its previous willingness to procure projects through unsolicited bids with a Swiss challenge.

The pipeline of PPP lending opportunities will thin, but deals still exist and should attract plenty of support. San Miguel, which signed the concession agreement for the NAIA Expressway phase II project in July, aims to close its financing by early next year, and is expected to mandate banks shortly. BDO announced its intention to fund the project earlier this year, and interest from other lenders is believed to be high.

Some of the larger upcoming concessions, especially those which have access to dollar-denominated revenue streams, could offer some opportunities for international banks, though even on those deals sponsors may prefer to access the capital markets or work with a multilateral. As the country’s growth rates start to rival those of China’s international commercial lenders will have little choice but to keep an eye on the Philippines.