On project finance and the first road concession in Portugal

In broad sense, Project Financing1 as a mean of financing large scale infrastructural projects worldwide has had a steady growth in popularity for the last 20 years. This growth has been relatively unscathed from most economic cycles. However in the wake of the 2007 systemic Financial Crisis, Project Financing was also in trouble. The liquidity freeze and credit crunch that ensued affected all parties involved. Traditional Lenders, of this type of financial instrument, locked-in long-term contractual obligations, were severely hit with scarcity of funding compounded by rapidly increasing cost of funding. All the while, Banks were “rescued” by the concerted actions of Central Banks and other Multi-Lateral Agencies around the world but at the same time “stressed” by upcoming regulatory effort (Basel Committee). This impact resulted in specific changes to this type of long-term financing. Changes such as Commercial Banks’ increased risk aversion; pricing increase and maturities decrease of credit facilities; enforcement of Market Disruption Event clauses; partial responsibility for project risk by Multilateral Agencies; and adoption of utility-like availability payments in other industrial sectors such as transportation and even social infrastructure. To the extent possible, this report is then divided in three parts. First, it begins with a more instructional part, touching academic literature (theory) and giving the Banks perspective (practice), but mostly as an overview of Project Finance for awareness’ sake. The renowned Harvard Business School professor – Benjamin Esty, states2 that Project Finance is a “relatively unexplored territory for both empirical and theoretical research” which means that academic research efforts are lagging the practice of Project Finance. Second, the report presents a practical case regarding the first Road Concession in Portugal in 1998 ending with the lessons learned 10 years after Financial Close. Lastly, the report concludes with the analysis of the current trends and changes to the industry post Financial Crisis of the late 2000’s. To achieve this I’ll reference relevant papers, books on the subject, online articles and my own experience in the Project Finance Department at a major Portuguese Investment Bank. Regarding the latter, with the signing of a confidentiality agreement, I’m duly omitting sensitive and proprietary bank information.

Market risk charge of the trading book: a comparison of the Basel II and Basel III

This paper aims to investigate if the market capital charge of the trading book increased in Basel III compared to Basel II. I showed that the capital charge rises by 232% and 182% under the standardized and internal model, respectively. The varying liquidity horizons, the calibration to a stress period, the introduction of credit spread risk, the restrictions on correlations across risk categories and the incremental default charge boost Basel III requirements. Nevertheless, the impact of Expected shortfall at 97.5% is low and long term shocks decrease the charge. The standardized approach presents advantages and disadvantages relative to internal models.

Is the Basel III Leverage Ratio countercyclical? A study for Portuguese banks

This work analyses how the leverage ratio behaves through the cycle, vis-à-vis other capital ratios. For a sample of the largest Portuguese banks, the Basel III leverage ratio is indeed countercyclical. This result is relevant from a regulatory perspective, since the introduction of a limit on the leverage ratio will function as a restriction in the banks’ balance sheet size, reducing the economic costs associated with the excessive growth of leverage in periods of economic expansion followed by aggressive deleveraging in the downturn. However, one cannot exclude that restrictions on banks’ leverage incentivize its transference to less regulated intermediaries.

Basel III new capital requirements, impacts and bank behavior

For some years, researchers could not find a clear effect of capital adequacy on the risk profile of banks, as shareholders could increase the riskiness of the assets (qualitative effect), crowding-out the effect of reduced leverage (volume effect). Some shareholders might have the will to increase the riskiness of the assets, but they may lack the power to do so. Considering only ”powerful” shareholders, definitive conclusions were drawn but with constant ownership profile. In this paper I investigate whether there is a significant change in the type of shareholders in response to regulatory capital shocks and, if so, will the banking system be in the hands of more “desired” shareholders. I find that ownership profile responds to a regulatory shock, changing the risk appetite of the ruling power at the bank. I find more banks and the government in the ownership of undercapitalised banks and much less institutional shareholders and free float. I claim that these new shareholders may not the desired ones, given the objective of the regulatory change, as they are associated with a preference for more leverage. One possible explanation for this crowding-out effect is that regulators are trying to contain idiosyncratic risk (more linked to the riskiness of the assets) with a rule that contains systematic risk (capital adequacy). This has a distorting effect on ownership. Another insight can be drawn from the tests: supervisors should be aware of significant ownership movements that cause the crowding-out.

Basel III: The impact of new capital requirements on profitability of Portuguese Banks

This empirical study aims to explore the impact of increased capital ratio requirements, on the ROE of the Portuguese banking sector. The paper employs both a quantitative- and qualitative approach, with the qualitative approach as the main method of research. The method adopted to conduct the qualitative research was semi structured elite interviews with banking executives. Higher capital requirements decrease the ROE of banks in Portugal, but huge impairments charges, macroeconomic factors and increased costs of deposits are clearly the dominant reasons for the reduced levels of ROE the past years. Among the measures taken to increase capital ratios, reduction of RWAs and non-core assets have been the main focus, but the issuance of CoCos is regarded as the most expensive measure due to high interest payments. However, the CoCos will not have any effect on the ROE in the long term. It is difficult to draw any conclusions on the impact of more equity in the balance sheet on the ROE of Portuguese banks, as many banks currently don’t generate enough money to pay back on shareholders´ investments.