Transcript PEF, Middle East & North Africa Business Review December

Bond
Federation of GCC Chambers Conference on
Frameworks for funding
industrial projects
Pub
lic
EC
Banks
A
Su
ku
k
12 October 2010
Agenda
Lay of the Land
What is Project Finance?
Structuring Considerations
Sources of Liquidity
Financial Process & Scheduling
2
The Economic Backdrop - Global
What has happened is known; what will happen is now the subject of much debate .....
New questions over
Europe
Global - Real GDP growth
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
-2.00%
-4.00%
-6.00%
Developed
Emerging
Source: HSBC Research
3
Key Player – The Middle East
Despite significant regional government liquidity, the Middle East has not been immune to the
effects of external liquidity constraints
Volume (US$m)
No. of loans
45,000
50
40,000
45
35,000
40
35
30,000
30
25,000
25
20,000
20
15,000
15
10,000
10
5,000
5
0
0
Q1
Q2
Q3
2005
Q4
Q1
Q2
Q3
2006
Volume (US$m)
Q4
Q1
Q2
Q3
Q4
Q1
2007
Q2
Q3
2008
No. of loans
Q4
Q1
Q2
2009
Source: Dealogic, 12 May 2009
4
What is Project Finance?
5
What is Project Finance?
A form of asset
based finance
driven by cashflow
analysis
Significant
advantages to
lenders as well as
owners
 Form of lending which can be be applied to a wide range of industries and involves
the financing of a single major capital investment
 For which repayment (either largely or exclusively) of the lenders relies on the cash
flow and assets of the project, with such debt facilities being “limited” or “nonrecourse” to the owners of the asset
 Project finance facilities are typically provided to a SPV (a project company)
established by the project sponsors solely to own and operate the project
Shareholders
Shareholders
Project
Lenders
Low
Commercial and Financial
Completion support
Relative Repayment Risk
= Lender credit risk
Project
Lenders
High
6
Why is Project Finance used?
Depending on the
country / industry,
project finance
may offer
significant
advantages for
Project hosts or
sponsors...
 Allows for high levels of leverage and is therefore investment enhancing
 Enables cash constrained - or risk averse - project sponsors to raise significant
amounts of debt - and share risks - whilst still retaining the benefit of equity
upside
 Enables sponsors to leverage off general banking relationships to (1)
potentially circumvent constraints on corporate debt, and / or (2) access longer
term funding
 Facilitates multiple joint venture partners raising finance to undertake major
projects, especially if the partners have different credit standing
7
Project Finance vs Corporate Lending
Key differences
between
corporate lending
and project
finance
Corporate Lending
Project Finance
 Full recourse
 Limited or non recourse
 Lenders rely on established
balance sheet and cash flow
 Security over project assets
including physical and accounts
 Credit analysis and rating
 Detailed economic and financial
analysis carried out by lenders with
support of independent consultants
 Usually unsecured
 Limited covenants (financial,
cross default and negative
pledge)
 Comprehensive covenant package
(affirmative, negative)
 Short to medium tem tenor
 Usually relatively high fees and
margins, although current trends
favourable to borrowers
 Refinancing risk
 Long term tenor
 Relatively low fees and margins
8
Structuring
Considerations
9
Project Economics and Rational
In structuring the
financing, it is important
to ensure
complementary
contracting and product
marketing solutions
Lenders closely scrutinize the Project’s rationale and its ability to withstand difficult
market conditions. The following aspects in relation to project economics are analyzed:
 Demand / supply analysis and likely competition
 Evidence ability to generate sufficient cash against credible product pricing forecasts
 Project’s competitive advantage, including:
– Feedstock volume and pricing
– Terms and conditions of the offtake arrangement
10
Project Finance – identifying the risks
The risks associated with the repayment of the project debt can be categorised into
three broad areas:
 Completion Risk
 Operational Risk
 Revenue Risk
11
Completion Risk & EPC Contracting Strategy
Completion risk is at
the core of any project
finance structuring
given that this
determines the
availability of future
cash flow

Completion risk for projects is basically a function of construction strategy:
– Which parties are responsible for completion?
Completion Risk
Engineering
EPC Contractor(s)
Vendor Performance
Process technology
Insurers
If a full guarantee is to
be avoided then
completion risk
mitigation and
allocation become the
critical elements of the
financing
Process Licensor(s)
Insurable Force Majeure
Residual Risks
(non-insurable FM, EPC performance)
Lenders
Sponsors

Lenders’ “default” position will be a full completion guarantee (full repayment)

There are other forms of completion support
12
Revenue Risks
Lenders will usually take
some revenue risks
when they are
comfortable with the
Project
 It is usually necessary that an independent market advisor to lenders indicate
that the Project will be competitive based on
– Relatively low feedstock costs
– Economies of scale
– Detailed marketing and logistics planning
Utility projects are often
financed without such
risks, however
 Lenders will require independent product price forecasts
 Lenders will expect term sheet risk mitigation items for short term variations
– Debt Service Reserve Account
– Dividend lock-up tests
– Variable repayment schedules
– Occasionally contingent equity is required
13
Revenue Risks
Lenders will usually take
some revenue risks
when they are
comfortable with the
Project
 In other sectors the long-term offtake obligations come from one or a small
number customers (for example in the LNG or power and water sectors)
 Due to the nature of the petrochemical business and the large number of
customers, long-term volume offtake commitments from shareholders are often
considered, provided they are “natural” petrochemical players; third parties may
be considered if shareholder group not sufficiently experienced
 Product sale contracts can vary between long-term marketing arrangements
and long-term volume offtake commitments
 Production ramp-ups are usually built into the contracts
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Technical & Operating Risks
Operational reliability
post-construction is a
critical area for
lenders and external
advice will be sought
to analyse the risks
involved
 Technical risks relate to the risk of the plant being capable of operating reliably on the
basis that it has been designed to – one of the two components determining the
plant’s cash flow (the other being refining margins)
– Technical problems can be either process or mechanically based
– Mechanical problems will usually be covered under the terms of the EPC contract
– Although the process technology deployed in refining tends to be viewed as less of
an issue than in typical petrochemical plants, the multiple processes involved can
give rise to concerns over inter-licensor disputes in the event of non-performance
 In addition to concerns over technical operating issues, lenders will also require
comfort that the operator of the plant is sufficiently experienced
 Different models can be used, usually either an external O&M contractor (which could
be sponsor) or operating staff hired directly by the project SPV
 Lenders will require a detailed due diligence report by an engineering firm to review
these risks and it is important that this process is controlled
15
Key Due Diligence Areas
Due Diligence Area
Technical
Key Activities
 Independent review of technology, and key operating assumptions etc
 Independent review of capex budgets, construction timetable etc
 Production of Independent Consultant’s report on behalf of the Lenders
Environment
 Conduct Environmental & Social Impact Assessment
 Categorise Project under EP and evaluate EP compliance
 Develop Environmental and Social Action Plans
Market
 Production of Independent Consultant’s report on behalf of Lenders confirming EP compliance
 Conduct analysis of the target export markets
 Produce and agree price forecasts to be used in the Lenders’ Base Case Financial Model
 Evaluate the competitiveness of the Project compared to competing plants elsewhere in the world
Legal
 Production of Independent Consultant’s report on behalf of the Lenders
 Detailed review by Lenders’ Legal Counsel of all Project contracts
 Detailed review of local law issues that may affect the Project
 Detailed review of Lenders’ security arrangements
 Production of Legal Counsel’s report on behalf of the Lenders
Insurance
Model Audit
 Assist lenders in negotiation and drafting of Finance and Security Documents
 Review of proposed Insurance Programme (incl. levels of cover, principal exclusions, deductibles
etc)
 Production of Independent Consultant’s report on behalf of the Lenders
 Thorough audit of the Financial Model by a recognised Accountancy firm/ Model Auditing specialist
 Production of Model Audit Report on behalf of the Lenders
16
Sources of Debt
17
Saudi Commercial Banks
Aided by a stable
depositor base, strong
capital adequacy ratios
and continued growth in
the local economy, Saudi
banks continue to
represent an important
source of funding for
projects in KSA
 Despite difficult market conditions, the Saudi-based institutions have actively
provided balance sheet capacity for top-tier Saudi projects and relationship clients.
 12 primary domestic Saudi banks, out of which 7 are considered to be active in
project finance transactions in Saudi Arabia
 Inma Bank, Rajhi Bank and to a certain extent National Commercial Bank finance
only Sharia compliant debt facilities. Other active banks in the PF market will have
the capability to fund on Islamic or conventional basis
 Saudi banks have fared better compared to other international and regional
banks. None of the Saudi banks have had to request any government support or
to raise additional equity to shore up balance sheet
 Due to severe shortage of liquidity and risk averseness in the international
market, Saudi banks have significantly reduced their lending in US Dollars
18
Regional and International Banks
Appetite from this
liquidity pool is
mostly dependant
on availability of
ECA cover
 Regional and international banks have been severely impacted by the financial crisis,
with most of the banks having to resort to government funding due to significant
investment writedowns
 It will take these banks some time before they are able to restore their financial
strength and play a major lending role in projects in the region and Saudi Arabia
 Currently, the pool of liquidity available to projects from international and regional
banks is much smaller than that seen during times before the financial crisis. The
international and regional banks have the following characteristics:
 Selective participation in projects within the region with focus on enhancing existing
relationships
 Understand the risks of project finance lending activity in Saudi Arabia but focussed
on reducing their Risk Weighted Assets
 Concern over tenors and pricing are a dominant theme
 Likely to increase involvement in ECA covered facilities
19
Saudi Industrial Development Fund
SIDF remains an
important participant in
project financings in
KSA
 The SIDF usually has a longer approvals process as it involves detailed review of
technical and market issues by SIDF’s own experts.
 SIDF has a normal lending limit per project of US$160m for an LLC. However if there
the Project comprises multiple plants then multiple loans can be granted of up to 50%
of project cost or US$530m whichever is lower
 In order to manage the timing issue, SIDF as soon as possible upon completion of the
feasibility study and completion of application formalities such as application form,
copies of industrial licences, commercial registration of project companies applying
for the loan, copies of commercial agreements, quotes from EPC contractors, etc.
 Given the time required for first drawdown, SIDF loan will however still need to be
bridged by Saudi commercial banks.
20
Public Investment Fund
 PIF is a main source of concessionary financing available in the Kingdom
The PIF is a main source
of concessionary
financing available in the
Kingdom
 One of the main conditions for PIF participation is direct or indirect government
ownership of at least 5% of the project. In any case, PIF's board of directors has the
discretion to set PIF's investment strategy, as well as the parameters that must be
met before PIF makes an investment
 PIF currently has increased its limit to lower of 40% of total project cost or US$1.3
billion (US$ 800 million where the project company is not majority owned by the
government)
 The terms and conditions generally match those of the commercial tranches which
make it an attractive source of concessionary financing
 From our experience, if both SIDF and PIF are considering participation in a project,
PIF approvals will almost always follow SIDF approvals.
 If PIF financing is not available at financial close, additional commitments can
obtained from the local commercial banks to bridge the financing gap on temporary
basis
21
Export Credit Agencies (ECAs) - I
By providing credit
enhancement to lenders
ECAs can facilitate
greater appetite, longer
tenors and cheaper
pricing than purely
commercial sources of
funding
 ECAs are government sponsored agencies which exist to promote the export of
goods and services from within their countries
 They function by providing direct loans, guarantees or insurance policies to
commercial banks
 In most cases the level of ECA support is directly ‘tied’ to procurement of eligible
goods and services although ‘untied’ facilities are also possible
 The financing terms ECA can provide are governed by the OECD Consensus
Guidelines. This covers areas such as:
– Specific ‘content’ requirements
– Minimum contract down payment of 15%
– Support capped at 85% of contract value
– Maximum repayment term of 14 years (with average life of 7.25 years)
22
Export Credit Agencies - II
Increasing proportion of hard currently liquidity …but critical to pair with a considered procurement
strategy.
 Commercial banks provide a loan to the Borrower. This loan benefits from a guarantee or insurance policy
from the ECA
 The proceeds of this loan is used to pay for specific goods and services from the exporting country
 The ECA is paid a premium/guarantee fee
Loan Agreement
Project Company
Lenders
Principal &
Interest
Goods &
Services
Political or
comprehensive
insurance and/ or
direct loan
Commercial
Contract
Application
Documentation
Exporter
ECAs
23
Export Credit Agencies - III
For well-structured
projects in Saudi
Arabia, we
anticipate that
ECAs would be
keen to continue
providing support
with expected
participation
dependant on the
EPC procurement
strategy.
Since 2002, ECAs became an increasingly important source of financing in the region.
Pre-financial crisis the ECA lending to project increased due to:
 Upgrade in OECD country risk classification for Saudi Arabia from category 3 to
category 2 in Nov 2005
 ECA financing became much more competitive compared to cost of borrowing
from commercial banks
 Scale and number of opportunities combined with historically low exposure to
Saudi Arabia resulted in substantial ECA appetite
 Strong track record of ECA support was established for both limited and full
recourse financings in Saudi Arabia, for example SEPC, Hadeed, Yansab, PetroRabigh, and Shuaibah
 Interest of ECAs was not limited to tied facilities linked to specific exports of
goods and services but also started extending to untied facilities where there was
a wider national interest.
24
Export Credit Agencies - IV
For well-structured
projects in Saudi
Arabia, we
anticipate that ECAs
would be keen to
continue providing
support with
expected
participation
dependant on the
EPC procurement
strategy.
 In light of reduction in appetite from international and regional banks post financial
crisis, there is substantially increased demand from sponsors for ECA support. This
has led to:
 ECAs focussing more on supporting projects involving contractors and equipment
providers from their home countries (ie less focus on untied ECA financings)
 ECA premiums have increased in some cases to reflect changes in perceived risk
while bank pricing for funding ECA assets has risen substantially as a result of
liquidity charges
 ECA supported financing continues to be very competitive for borrowers and
attractive for banks given very low return on weighted assets
 Where ECAs provide direct lending programmes these have also seen increased
demand, given the attractive long-term fixed interest rates and the reduced liquidly
of commercial banks even for covered facilities
25
Multilateral Agencies
 Multilateral Agencies are financial institutions jointly owned by a group of
countries and designed to promote international and regional economic cooperation
 Examples of Multilateral Agencies include:
– International Finance Corporation (IFC)
– European Investment Bank (EIB)
– European Bank for Reconstruction and Development (EBRD)
– Asian Development Bank (ADB)
– Islamic Development Bank
 Have ‘developmental’ agendas and can be useful in certain markets
 Can provide a range of funding including direct lending and equity participation
 Commonly used instruments on project finance transactions are:
– EIB direct loans (with or without bank counter guarantees)
– IFC / EBRD ‘A’ – ‘B’ Loans
26
The Financing Process
27
The Project Finance Process: Summary Timeline
PHASE 1
PHASE 2
1. Prioritise Key
Project
Objectives
2. Finalise JV
Discussions
3. Obtain
Stakeholder
Approval
1. Tender for
Contractors
2. Commercial
Development
3. Term sheet
development
PHASE 3
1. EPC bid review
2. Lender due
diligence
3. Document
drafting
4. Info Memo
PHASE 4
1. EPC
finalisation
2. Launch to
market
3. Preferred bank
selection
PHASE 5
1. Negotiation of
Project and
Finance
Agreements
2. Achieving
Financial Close
Estimated
Timeframe:
Estimated
Timeframe:
Estimated
Timeframe:
Estimated
Timeframe:
2 - 4 months
2 - 4 months
3 months
3 - 6 months
Such may vary materially depending on the progress of commercial and contractual negotiations
28
Managing the Project Finance Process:
Delivering the Financing Plan and Strategy
The Financial Advisors
can support developers
in structuring a bankable
project and securing an
optimal funding package
The Financial Advisor
can act as Lead
Consultant to coordinate
and manage technical,
legal, marketing,
environmental and other
advisors
 Size the project and define the funding requirement;
 Assess the potential debt sources for the financing for the Project, with particular
attention to appetite, tenor, capacity, liquidity and pricing;
 Advise the sponsors on the commercial contractual negotiations to ensure such
contracts are bankable;
 Identify studies typically required to successfully obtain the Financing, including
technical, market and environmental reports.
 Appoint and manage the lenders’ technical and environmental consultant to identify
key lender issues that need to be addressed in the structuring;
 Develop a financial model to analyze the economics of the Project and provide
information to support the Sponsor’s investment decision; and
 Recommend an appropriate financing plan and strategy taking into account current
financial market conditions.
29
Managing the Project Finance Process:
Marketing Phase - Achieving Financial Close
 Develop a bankable financing structure using data from the financial model and
bank market practice and taking into account inputs from the Sponsor’s tax, legal,
and accounting advisors;
 Develop an engagement timetable for the different sources of liquidity, bearing in
mind that certain pools of liquidity will require longer lead times than others;
 Assist in the development of a preliminary term sheet in order to secure Sponsor
approval;
 Prepare a bid package for potential debt providers including an invitation letter, a
confidentiality agreement, a draft arranging and underwriting mandate letter, a
draft term sheet for the Financing and its security package, a preliminary
information memorandum (the “PIM”), a preliminary Bank Financial Model and
summaries of third party reports;
 Review and summarise the financing bids and assist the Sponsor in selecting the
optimal financing group;
 Assist the Sponsors and Legal Counsel in the negotiation and finalization of the
financing documentation until signing of the documents, satisfaction of conditions
precedents and draw-down of the facilities.
30
Conclusions
 Economic outlook remains uncertain, however the GCC is well positioned for robust and sustainable growth
 Select the right financing methodology that suits your requirements and objectives ie corporate vs project
financing
 Financiers are now far more selective with transactions so maximise the sources of funding – tap the Money
Tree
 Focus on developing well structured and viable projects that have a clear competitive advantage, are
aligned with the government’s industrialisation strategy and are supported by credible financial and technical
sponsors
31