Project Finance: When Prestige and Savings Come Together

Having a prestigious bank as a lead arranger in syndicated project finance loans does not cost more to project sponsors, indeed it creates economic value by reducing loan spreads and fees, Stefano Gatti (Department of Finance) finds out in a paper forthcoming in Financial Management (Arranger Certification in Project Finance, with Stefanie Kleimeier, Universiteit Maastricht, William Megginson, University of Oklahoma, and Alessandro Steffanoni, Meliorbanca). The presence of a prestigious arranger is perceived as a certification of the quality of the project and the cost is not paid for by the sponsors, but by the other banks participating in the syndicate in the form of lower upfront fees, the authors conclude after screening a sample of 4,122 project finance loans, worth $769 billion, arranged between 1991 and 2005.

Project finance is defined by the creation of a special purpose vehicle (SPV), financed with minor equity contribution from one or more sponsoring firms and mostly with debt provided by a loan syndicate organized by one or more banks acting as lead arrangers (in the sample of the study the average debt-to equity ratio is 3.41, meaning that 77% of the total capital is debt). "The banks that arrange these credits become insiders to the project through working with the project sponsors, and then must arrange the bulk of external financing by attracting other banks to become members of a loan syndicate", the authors explain. The lead arranger and the other banks are paid with upfront fees (67.3 basis points on average in the sample) and with a loan spread.

The authors define an arranger's prestige as the market share in the years prior to the arrangement of the project finance and find that spreads are significantly lower for loans arranged by prestigious banks (each one percentage point increase in lead arranger market share is associated with a reduction in spreads of 6.24 basis points). Prestigious arrangers charge overall upfront fees (including arranger fees and non-arranger fees) lower than those charged by banks with a lower market share and the non-arranger upfront fees are lower (each one percentage point increase in average lead arranger market share is associated with a decline of overall upfront fees of 4.20 basis points and a decline of non-arranger upfront fees of 4.22 basis points). "Prestigious lead arrangers", the authors write, "are able to organize bank syndicates at lower spread than less prestigious arrangers and are also able to keep a higher portion of the total fees paid by imposing their bargaining power on other members of the syndicate".

The sample is large enough to allow Gatti and his colleagues to assess the impact of banking crises on project finance deals. They observe that prestigious lead arrangers can counterbalance the increase in spreads even during crisis periods, but total upfront fees are higher: attracting a prestigious lead arranger is not more costly during a crisis period, but participating banks ask for fees 20 basis points higher.