Transcript Project Finance

Cross-Border Infrastructure: A Toolkit
Project Finance
Session on Finance
Sidharth Sinha
Indian Institute of Management, Ahmedabad
The views expressed here are those of the presenter and do not necessarily reflect the views or policies
of the Asian Development Bank (ADB), or its Board of Directors, or the governments they represent.
Cross-Border Infrastructure: A Toolkit
Project Finance
• Objective

Financing a single purpose capital asset usually with a
limited life
• Project vehicle

Legally independent project company
• Financing (debt and equity definition)

Equity from one or more project sponsors
 Non recourse (to sponsors) debt
 Equity at the minimum level to issue debt at reasonable
cost
• Comparison with traditional or corporate finance
Cross-Border Infrastructure: A Toolkit
• Standard & Poor’s defines a project company as a
group of agreements and contracts between lenders,
project sponsors, and other interested parties that
creates a form of business organization 
that will issue a given amount of debt at start;

will operate in a focused line of business;

lenders look only to a specific asset to generate cash
flow as the sole source of principal and interest
payments and collateral.
Cross-Border Infrastructure: A Toolkit
• Project debt is not a permanent part of the capital
structure, but is repaid in most projects according to a
schedule based on the project’s useful life.
• Projects by design do not build up equity, but instead,
use up cash quickly 
First as operating expenses,

then as debt service (often the most significant
expense), and

finally as dividends.
Cross-Border Infrastructure: A Toolkit
• Project finance is suitable for large projects

Takes a longer period of time to structure, negotiate and
document a project financing than a traditional financing

The legal fees and related costs associated with project
financing can be very high

It limits the risk of the sponsor to its equity investment not the total project investment.
Cross-Border Infrastructure: A Toolkit
Main Parties in a Project Financing
Authority
Shareholders
Shareholders
Agreement
Equity
Subscription
Agreement
Supply
Agreement
Suppliers
Construction
Agreement
Contractor
Concession
Agreement
Special Purpose
Vehicle
Lenders
Loan
Agreement
Off-take
Agreement
Purchasers
Operation &
Maintenance
Agreement
Operator
Cross-Border Infrastructure: A Toolkit
Project Financing Participants
• Sponsor/Developer. The sponsor(s) or developer(s) of
a project financing is the party that organizes all of the
other parties and typically controls, and makes an
equity investment in the project company.
• Additional Equity Investors. In addition to the
sponsor(s), there frequently are additional equity
investors in the project company.

These include government, sponsors, contractors,
insurers, suppliers, off-takers, etc, giving them a vested
interest in the success of the project
Cross-Border Infrastructure: A Toolkit
Project Financing Participants (continued)
• Lender. The lender in a project financing is a financial
institution or group of financial institutions that provide
a loan to the project company to develop and construct
the project and that take a security interest in all of the
project assets. Lenders can also include bond investors
in capital markets
Cross-Border Infrastructure: A Toolkit
Risk Analysis
• Since lenders provide bulk of the financing, risk is usually
analyzed from the lenders’ perspective
 Project-level risks - agreements
 Default by counterparties
 Country risk - stability of economic, political, and
regulatory environment
 Business and legal institutions risk - enforceability of
agreements
• Force majeure risk - ‘acts of god/nature’
 Insurance
• Credit enhancements
• The objective is to assess the risk of cash flows available for
debt servicing
 Loan and security agreements
Cross-Border Infrastructure: A Toolkit
Project Level Risks
• Quality of sponsors
 Experience, commitment (equity investment)
 Strategic importance of the project
 Financial strength to meet future obligations such as
contingent equity
• Construction risk
 Construction agreements
 Quality of contractors (could be a sponsor)
 Related investment requirements
• Operations risk
 Quality of operator
 Operations and maintenance contract
Project Level Risks
Cross-Border Infrastructure: A Toolkit
• Supply risk

Availability

Agreements for variability of input prices
• Offtake, demand & market risk

Offtake agreement

May not offer adequate protection against unfavourable
market situation because of problems of enforceability
of contracts

Competitive position
 Cost of production relative to competitors
 Availability of substitutes
 Better competitive position implies lower demand risk
Cross-Border Infrastructure: A Toolkit
Construction Contract
• Price. Most project financing construction contracts are fixedprice contracts although some projects may be built on a costplus basis. If the contract is not fixed-price, additional debt or
equity contributions may be necessary to complete the project,
and the project agreements should clearly indicate the party or
parties responsible for such contributions.
• Completion Date. If construction is not finished by the
completion date, the contractor typically is required to pay
liquidated damages to cover debt service for each day until the
project is completed. If construction is completed early, the
contractor frequently is entitled to an early completion bonus.
Cross-Border Infrastructure: A Toolkit
Construction Contract (continued)
• Performance Guarantees. Such guarantees are measured by
performance tests conducted by the contractor at the end of
construction. If the project does not meet the guaranteed levels
of performance, the contractor typically is required to make
liquidated damages payments to the sponsor. If project
performance exceeds the guaranteed minimum levels, the
contractor may be entitled to bonus payments
Cross-Border Infrastructure: A Toolkit
Operations and Maintenance Agreement
• Long-term agreement for the day-to-day operation and
maintenance of the project facilities
• With a company having the technical and financial expertise
to operate the project in accordance with the cost and
production specifications for the project.

The operator may be an independent company, or it
may be one of the sponsors.

The operator typically will be paid a fixed compensation

May be entitled to bonus payments for extraordinary
project performance and,

Be required to pay liquidated damages for project
performance below specified levels.
Cross-Border Infrastructure: A Toolkit
Input Supply Agreements
• Agreements for the supply of raw materials, energy or
other resources over the life of the project.

Frequently, supply agreements are structured on a "putor-pay" basis -

This means that the supplier must either supply the
input or pay the project company the difference in costs
incurred in obtaining the input from another source.

Fixed or spot price
Cross-Border Infrastructure: A Toolkit
Product Offtake Agreements
• The product offtake agreements represent the source of
revenue for the project.

Frequently, offtake agreements are structured on a
"take-or-pay" basis,

The offtaker is obligated to pay for product on a regular
basis whether or not the offtaker actually takes the
product unless the product is unavailable due to a
default by the project company.

Price
 Fixed
 Scheduled changes
 Pass through of fluctuating input prices
Cross-Border Infrastructure: A Toolkit
Country Risk
• Stability and predictability

Economic environment

Political and regulatory environment
 Expropriation or creeping expropriation

Currency risk
 Exchange rate volatility, transfer and convertibility risk
 Currency of revenue, expenses, debt servicing and
shareholder return
Cross-Border Infrastructure: A Toolkit
Loan and Security Agreement
• Security. The project loan typically will be secured by
multiple forms of collateral

Mortgage on the project facilities and real property.

Assignment of operating revenues.

Assignment of any letters of credit or performance or
completion bonds relating to the project under which
borrower is the beneficiary.

Assignment of insurance proceeds.

Assignment of all project agreements
Cross-Border Infrastructure: A Toolkit
Loan and Security Agreement (continued)
• Disbursement Controls. These frequently take the form
of conditions precedent to each drawdown, requiring
the borrower to present invoices, builders' certificates
or other evidence as to the need for and use of the
funds.
• Progress Reports. The lender may require periodic
reports certified by an independent consultant on the
status of construction progress.
Cross-Border Infrastructure: A Toolkit
Loan and Security Agreement (continued)
• Covenants Not to Amend. The borrower will covenant
not to amend or waive any of its rights under the
construction, feedstock, offtake, operations and
maintenance, or other principal agreements without the
consent of the lender.
• Completion Covenants. These require the borrower to
complete the project in accordance with project plans
and specifications and prohibit the borrower from
materially altering the project plans without the consent
of the lender.
Cross-Border Infrastructure: A Toolkit
Loan and Security Agreement (continued)
• Dividend Restrictions. These covenants place restrictions
on the payment of dividends or other distributions by the
borrower until debt service obligations are satisfied.
• Debt and Guarantee Restrictions. The borrower may be
prohibited from incurring additional debt or from
guaranteeing other obligations.
• Financial Covenants. Such covenants require the
maintenance of working capital and liquidity ratios, debt
service coverage ratios, debt service reserves and other
financial ratios to protect the credit of the borrower.
Cross-Border Infrastructure: A Toolkit
Credit Enhancement
• Some third parties offer various credit enhancement products
designed to mitigate project level risks, sovereign risks, and
currency risks, among others.

Multilateral agencies, such as the Multilateral Investment
Guarantee Agency, the International Finance Corp., and
ADB offer various insurance programs to cover both
political and commercial risks.

Project sponsors can themselves provide some type of
support in mitigation of some risks - a commitment that
tends to convert a non-recourse financing into a limited
recourse financing.

These enhancement packages cover only specified risks.
Cross-Border Infrastructure: A Toolkit
Financial Modeling
• The most important decision making instrument in the
financing of a project is its financial model.
• The model ties up the revenue model, capex, opex,
capital structure and other inputs
• It provides projected multi-year financials, e.g. income
statement, balance sheet and cash flow statement
• The model can also be programmed to do scenario
testing, sensitivity analysis and stochastic analyses of
performance measures.
Cross-Border Infrastructure: A Toolkit
Performance Measures
• Valuation measures
 Internal Rate of Return (IRR) and Net Present Value (NPV)
• Debt-service coverage ratios (DSCRs) as the primary
quantitative measure of a project’s financial credit strength.

The DSCR is the ratio of cash from operations (CFO) to
principal and interest obligations.

CFO is calculated strictly by taking cash revenues and
subtracting expenses and taxes, but excluding interest and
principal, needed to maintain ongoing operations.

The ratio calculation also excludes any cash balances that
a project could draw on to service debt, such as the debt
service reserve fund or maintenance reserve fund.