- A construction bond is a sort of surety bond that investors in building projects use to protect themselves.
- The bond guards against delays or financial loss caused by a contractor’s inability to finish a project or meet project standards.
- When a contractor violates any of the contract’s terms, both the surety and the contractor are held accountable.
What does project bonding entail?
According to recent surveys, infrastructure is beginning to be recognized as a distinct asset class, and allocations to this asset class are likely to rise dramatically. However, as a result of the global financial crisis, banks now have to adhere to stricter regulations regarding lending requirements, which means that infrastructure projects can no longer be funded solely through traditional debt, and other more innovative financing options must be considered and implemented.
Project bonds are a new type of debt financing that can be used to finance infrastructure projects. Banks have traditionally financed agreements, but the adoption of Basel III laws necessitates more supervision and disclosures, resulting in increasing costs and capital requirements. These increased expenses will be passed on to project developers, resulting in lower project IRRs (internal rates of return). Companies may be able to lower project funding costs by tapping into the institutional bond market.
South Africa’s R3,4 trillion infrastructure initiative cannot be funded solely by the government and banks. Bonds allow project developers to tap into the R3 trillion in assets managed by institutional investors in South Africa. Furthermore, Sovereign Wealth Funds are beginning to invest directly in infrastructure projects, which could be a future source of finance for capital projects.
Institutional investors can engage in infrastructure projects using project bonds, which are listed, tradable instruments that can provide higher risk-adjusted returns.
Investors with a lesser stomach for risk, which is intrinsically higher in the construction business, may find project bonds to be unappealing as a funding instrument. Prior to the financial crisis, capital markets were thought to be less reliable than debt markets, but this has changed as global liquidity has decreased. While local institutional bond investors are willing to take on performance risk, they are rarely willing to take on construction risk.
Although not all debt portions of these transactions will be able to take advantage of this source of finance, the project developers will undoubtedly benefit from this mechanism in the form of potentially higher returns due to the lower cost of capital.
Project bonds have been used successfully to fund infrastructure projects in Europe and America so far. Despite increased market volatility, corporate bond markets in Europe continue to grow, and it is expected that the use of corporate bonds to fund infrastructure projects in Europe will play an important role in improving the economy.
Kenya and Nigeria are two African countries that have effectively implemented project bonds. Institutional investors are increasing in both countries. Corporate bonds are tax-free in Nigeria, while infrastructure bonds are tax-free in Kenya, encouraging their usage as an alternative funding vehicle.
While the need for infrastructure development is clear, the rest of Africa is still in the early stages of developing project bonds. This will require investors to raise more funds, borrowers to gain greater confidence in the bond market, and governments to create an environment that encourages the issuance of project bonds.
The first listing and investment-grade rated infrastructure project bond, held completely by institutional investors, took place in April of 2013. In June 2013, the bond was listed on the Johannesburg Stock Exchange. The principal transaction advisors were Deloitte & Touche in collaboration with Trident Capital, with Standard Bank acting as lead arranger, book runner, and debt sponsor. CPV Power Plant No.1 Bond SPV (RF) Ltd, a Soitec Solar GmbH affiliate, issued the bond. The money was utilized to build a 44 megawatt-per-watt-hour concentrated photovoltaic plant. The project, which will be located in Touwsrivier, Western Cape, will be the world’s largest CPV plant. Soitec, a Euronext Paris-listed French firm, is a global pioneer in the production of semiconductor materials for electronics and, more recently, energy.
The Touwsrivier Solar Project, which was funded using bond proceeds, is one of 28 round 1 renewable energy projects that were awarded preferred bidder status by the Department of Energy on November 5, 2012. Developers of renewable energy projects will sign 20-year Power Purchase Agreements with Eskom, which will be supported by the Department of Energy.
The factory will be erected in Touwsrivier, a poor town in the Western Cape that is located along the N1 motorway. The community has a high number of alcoholics and has a high unemployment rate of about 65 percent. Despite the fact that Soitec would have benefited from a higher solar resource in the Northern Cape, as part of their commitment to social and economic development, they chose to build their plant in Touwsrivier, which has a high solar resource.
The design of the bond is what makes it appealing. Moody’s Investor Service has awarded the bond a long-term Baa2.za South African national scale rating.
The repayment terms of the bond are its most outstanding characteristic. It has an appealing fixed coupon rate of 11% for a period of 15 years, based on an amortizing profile rather than a bullet structure. This basically gives the bond a 7-year modified term. In contrast to a traditional bond, when investors get the capital return at maturity, this structure allows both the principle and interest to be repaid at the same time. This puts it on par with a seven-year swap instrument. The 11 percent yield is 450 basis points more than a 7-year swap.
The project is contained in a CPV Power Plant 1 special purpose vehicle. Soitec owns 60% of the SPV, empowerment partner Pele Green Energy owns 35%, and the Touwsrivier Community Trust owns 5%.
The ability to supply a bond of this sort successfully demonstrates the sophistication of the South African bond market, especially given that technology has yet to be tried on a utility-scale. The successful issuance of the bond provides an alternate debt funding source for infrastructure-related projects.
How do bonds function?
A bond is just a debt that a firm takes out. Rather than going to a bank, the company obtains funds from investors who purchase its bonds. The corporation pays an interest coupon in exchange for the capital, which is the annual interest rate paid on a bond stated as a percentage of the face value. The interest is paid at preset periods (typically annually or semiannually) and the principal is returned on the maturity date, bringing the loan to a close.
Who is responsible for paying the building bond?
- The Principal is the contractor who needs a bond. The principle assumes responsibility for all valid claims by becoming bonded.
- The Obligee is the person or party who has the right to sue the bond for damages.
- The Surety is the entity that provides the bond and pays claims if the principal fails to do so. Any claims settled by the principal must always be paid back to the surety.
What is the purpose of developer bonds?
Developer bonds, also known as subdivision bonds, are required of developers and are used to ensure the completion of mandatory renovations to public structures or entities that are used on a regular basis by the local community. Developer bonds, like all other bonds, are a form of insurance that safeguards a certain city, county, or state. A developer bond guarantees that the principal of the public construction project will complete mandatory enhancements to public entities for the greater interest of the community. Maintenance of roadways, sidewalks, drainage systems, gutters, sewers, and public buildings are examples of public construction projects that may require this sort of bond.
What are the five different forms of bonds?
- Treasury, savings, agency, municipal, and corporate bonds are the five basic types of bonds.
- Each bond has its unique set of sellers, purposes, buyers, and risk-to-reward ratios.
- You can acquire securities based on bonds, such as bond mutual funds, if you wish to take benefit of bonds. These are compilations of various bond types.
- Individual bonds are less hazardous than bond mutual funds, which is one of the contrasts between bonds and bond funds.
For dummies, how do bonds work?
Long-term financing agreements between a borrower and a lender are known as bonds. When the bond matures (its term ends), the corporation pays the bondholder the face value of the bond. Depending on whose side of the transaction you’re looking at, a bond is either a source of finance or an investment.
Is the bond for construction refundable?
Yes, the insurance policy must include a language stating that the insurance provider may not cancel it without written notice to and agreement from the Owner. The nature, scope, and quantity of such insurance coverage will be determined by the Owner and Contractor. During the performance of the Work, the Contractor shall guarantee that such insurance policy is in effect.